Nasdaq OMX Europe had a hard, short life. When its closure was announced on 28 April, the multilateral trading facility (MTF) was trading just 0.79% of the pan-European equities market. That lack of liquidity proved fatal. Liquidity in lit MTFs such as Nasdaq OMX Europe, or NEURO as it was commonly called, is mostly provided by proprietary trading desks. Lit pools that aren’t backed to the hilt by firms with prop desks are going to have a hard time of it. And as a consequence, it is the sell-side and electronic market makers that will decide the fate of Europe’s trading venues with little influence from the buy-side.
The market Nasdaq OMX entered was created by MiFID in 2007, which encouraged competition between stock exchanges and the new MTFs. The business case for each trading venue was that it would cost less to trade on than a stock exchange because it used quicker, cheaper technology. Nasdaq OMX fulfilled these terms but still failed as a business.
“There are many reasons why people use a trading platform business,” says Peter Randall, CEO of retail-focused MTF Equiduct. Being first to market, cheap, faster or more professional have all been important factors, he notes. “Later offerings were cheap, but brought with them the deep sigh of European reluctance to embrace the ambitions of combative management.”
US-headquartered Nasdaq OMX, he observes, has previous form in Europe. A pan-European initiative launched in 2001, Easdaq, was shut down two years later (although its technology formed the basis of Equiduct when it was launched by Berlin Borse in 2007) and Nasdaq OMX attempted a takeover the London Stock Exchange in 2006 having acquired all of its largest shareholder’s stake. Nasdaq OMX Europe, which closes 1 July 2010, is migrating its client business to Equiduct.
Like Nasdaq OMX Europe, other MTFs are also failing to attract liquidity and even those that have aren’t finding it easy to make money, says Andrew Bowley, head of electronic trading product management, Nomura.
Based on Chi-X’s pricing model of 0.1 basis points taken on every trade, assuming a 50:50 split between orders that take and add liquidity, Bowley notes that €1 billion of trading a day will create €10,000 of revenue, which translates to €2.5 million of revenue per year. This means all of the pan-European platforms need to be trading multiple billions of euros a day to survive.
Other venues, says Bowley, will need to take virtually all of a market segment to be sustainable. “Take Burgundy for example. The Nordic market is only 6% of European turnover. We calculated on that basis that Burgundy needs approximately 93% market share to break even.”
Natan Tiefenbrun, commercial director at Turquoise, observes that in addition to speed and cost, an MTF also competes based on ownership, governance, quality of service and brand. He says, “When one examines why Nasdaq OMX Europe is being closed down while Turquoise or BATS succeeded, it wasn’t that their technology that was at fault nor was it that their pricing wasn’t aggressive enough. I wouldn’t criticise them for quality of service so I think that leaves you with their brand, their governance and their ownership. We see Turquoise as a partnership with our major clients.” In December 2009, the London Stock Exchange bought a 60% stake in Turquoise from the consortium of banks that launched it in 2008. The platform’s original owners were also its main liquidity providers via a series of market-making agreements but these were not renewed when they expired in March 2009. The LSE now has a 51% stake with the the remainder shared between founder banks and new investors from the sell-side.
Bowley says that the ownership and support of liquidity providers has proven crucial to the success of leading MTFs, “Having a liquidity provider behind you is absolutely critical,” he said. “It’s very telling that firms that have an equity participation programme linked to liquidity participation have done very well, with Chi-X in the lead.” According to Thomson Reuters, Chi-X had 16.7% of the European market by turnover in May, ahead of Deutsche Borse’s Xetra platform at 14.1%, NYSE Euronext Paris at 12.4% and the London Stock Exchange at 12.3%.
Alasdair Haynes, CEO of Chi-X, is insistent that his platform’s liquidity does not stem purely from shareholders “Chi-X is not made up of firms trading because of our 19 shareholders, it’s made up of the liquidity that we have in the marketplace because of the services that we’ve got as an exchange.
“I can tell you that within our top 20 and even our top ten liquidity providers there are non-shareholders. So I don’t think there’s a direct correlation. I do think it helps to be a mutual where your clients are also your owners,” he asserts.
Market share has fluctuated significantly between Europe’s trading venues since MiFID and it is the market makers’ liquidity that is most mobile.
Market makers and proprietary desks are primarily drawn to lit pools as they require price discovery, while buy side firms tend to favour dark pools, says Lee Hodgkinson, CEO of dark venue NYSE Euronext-owned SmartPool. “The buy-side are increasingly interested in trading in the dark for the obvious benefits – reducing market impact and improving execution prices. I think we would broadly agree that lit MTFs have a majority of their flow from proprietary desks. In SmartPool it is predominantly client flow,” he confirms.
Thus it is liquidity from market makers, high frequency traders and proprietary desks that moves between markets, making or breaking them.
Haynes acknowledges the value of such firms, commenting, “Across the LSE, Chi-X and NYSE Euronext, I think we all have roughly the same percentage of market makers and high-frequency traders. Having this mix of clients is what makes us successful exchanges.” High frequency trading is currently estimated to account for 30-40% of volume in lit books on major European exchanges.
As clients of institutions that hold such sway over trading platforms, buy-side firms should be lobbying to ensure that they get a good cut of the deal, or it could become a seller’s market, “I think the buy-side are the authors of their own misfortune in some ways,” notes Randall. “Without a strong commitment to understanding how the market microstructures are changing, I think they are inevitably opening themselves up to potential problems, not least: how do you show best execution?”
Nomura sees this commitment among its buy-side customers, says Bowley, and without it banks could seriously harm clients’ business. “Our clients are very interested as to whether our split of flow – across primary markets and MTFs – is comparable to the rest of the market. And of course the buy-side should be asking questions of brokers who seem to bias certain venues, something we are very careful not to do.”