The decline in equity trading activity since September last year is challenging the low-cost, high-volume business models of Europe’s new multilateral trading facilities (MTFs), prompting observers to suggest the platforms should focus on differentiators other than price to survive.
Values traded across Europe fell to €857.7 billion in February 2008 from €1.9 trillion in the same month last year, according to figures from data vendor Thomson Reuters’ monthly European market share reports, while volumes fell to 146 billion shares from 162.5 billion over the same period.
“Having a bunch of MTFs that do pretty much the same thing and are trying to outdo each other with lower and lower prices isn’t the best way to challenge the dominance of the primary exchanges,” says Steve Grob, director at trading technology firm Fidessa.
MTFs’ maker-taker pricing structures only afford a narrow profit margin, meaning that they have to attract high volumes to turn a profit even in favourable market conditions. But as volumes have declined, MTFs are now engaged in an increasingly fierce price war, which is cutting further into their already wafer-thin margins.
For example, following the introduction of its new fee schedule in April, Turquoise now only makes 0.08 of a basis point per trade with its least-generous rebate and only 0.04 of a basis point for its most-generous rebate, compared with 0.20 of a basis point when it launched last August.
The difficulties MTFs face in the current environment have called into question how long shareholders are willing to support them. “It is very challenging for MTFs,” says Bob McDowall, research director for Europe at research and consulting form TowerGroup. “They have a fixed cost base under which they can’t go and they require sustainable order flow to make their incremental income. That isn’t there at the moment. It is a test of shareholder resolve.”
As most MTFs do not charge for their market data, and have few other revenue streams apart from trading, they are ill-suited to protracted price wars. “This plays to the strengths of the scale incumbents,” says Anthony Kirby, director, regulatory and risk management, financial services at accounting firm Ernst & Young.
Instead of simply cutting prices, Grob at Fidessa suggests MTFs should differentiate. Some MTFs have already started branching out into new areas. Chi-X, for example, has expanded into trading technology provision following its purchase of Cicada last year, and revealed plans last week to start trading exchange-traded commodities.
One area ripe for improvement, Grob contends, is ease of connectivity. “The successful MTFs will be the ones that find ways to make connecting to them as convenient as possible,” he says.
Grob also argues that MTFs focusing on a particular segment of the European equities market, whether a particular region, market cap band or type of user, will be successful, and holds up Nordic MTF Burgundy, due to launch on 4 June, as an example.
“Once you have dominated one piece of the overall market, you can then start to move sideways into other neighbouring territories,” Grob comments. “That to me seems like a better plan than trying to take on the whole European market and be cheaper than everyone else.”
A further area for diversification is offering true interaction between dark and lit trading. While some MTFs, such as Turquoise, offer both dark and lit trading, regulatory restrictions prevent certain dark orders interacting with other types of flow. “No single MTF has really cracked that yet, and anyone that can will definitely emerge as one of the winners,” says Grob.
Shareholder and governance structures could also prove an important differentiator for trading platforms. In these low-volume times, the ability to attract statistical arbitrage and high-frequency traders is important. Those who have such firms as investors may benefit more than others. “If you a stat arb or hedge fund and you have got skin in the game with a venue, you will be more inclined to put your order flow into that particular venue,” says Kirby.
Will the MTFs’ challenging position speed up consolidation? “If you had asked me six months ago, I would have said we would be seeing consolidation by around late 2010. Now I would say we will have consolidation by the end of this year,” says Phillip Silitschanu, senior analyst at research and advisory firm Aite Group.
However, while MTFs are facing a tough time, a number of factors could help them stay the course. One is their low cost base. Most MTFs have small workforces and low overheads compared with incumbent exchanges. “MTFs are set up to run very lean and that is a saving grace,” says Silitschanu. “If they have to cut 10% of their workforce to survive, that’s only around three people for an MTF, but around 100 people for an operation such as the London Stock Exchange. As bad as markets have got and as thin as volumes have got, I think most of the MTFs have a fighting chance.”
And shareholders, though themselves cash-strapped in some cases, are unlikely to turn their backs on MTFs so soon after their launch. “The people behind these platforms have committed significant amounts of intellectual and physical capital. I don’t think any of them thought it was going to be a short-term process,” says Grob.