Show us you are ready for MTFs, analysts tell LSE

A direct strategy for dealing with new rivals is required by the London Stock Exchange (LSE) if it is to remain successful in the face of competition, according to new research from analysts at Citi.
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A direct strategy for dealing with new rivals is required by the London Stock Exchange (LSE) if it is to remain successful in the face of competition, according to new research from analysts at Citi.

“Details of the LSE management’s strategic review need to come sooner rather than later,” suggest Haley Tam and Daniel Garrod, authors of the report. “To defend itself, LSE might have to offer sizeable pricing concessions that could hurt profits.”

New competitive threats, such as Chi-X, Turquoise, Nasdaq OMX Europe and BATS Europe, are raising fears of liquidity migration and pricing pressures. Recent research from Tabb Group estimates that competitors to incumbent exchanges could attract 21% market share over the next three years.

Figures from the start of 2008 to the end of September show LSE volumes are up 3% by value traded, bucking the trend of 10-20% declines of its major European competitors. In September, LSE recorded the strongest transaction growth of its peers at 24% year on year, and recorded just under £200 billion in value traded.

In comparison, Turquoise, the investment bank-backed multilateral trading facility (MTF), has seen its average daily volume fluctuate between £1 billion and £2 billion during October, while Chi-X’s average daily volume varied between £4.5 billion and £8 billion during the same period.

It is still too early to determine whether the exchange has lost business to its new rivals, according to Garrod and Tam. “To date, evidence is inconclusive as to whether these new competitors have actually exported liquidity out of the exchanges or brought new liquidity to the market and concentrated previous OTC volumes onto their platforms,” they said.

The report predicts that a downward trend in equity trading volumes – combined with increased competition – could result in the migration of liquidity away from the exchange for UK and Italian cash equities and an “exaggerated” impact on the LSE’s operating profits.

Although the LSE has not announced a strategy designed to deal with competition head-on, many of the exchange’s recent initiatives appear calculated to counter MTF innovations.

A new rebate-based pricing structure was introduced on 1 September, comparable to the maker-taker pricing model, which has found favour with MTFs.

However, high trading volumes are required before LSE clients can benefit from rebates. “Without customers being able to do more aggregation of client order flow, we believe few customers will achieve much in the way of discounts or rebates,” read Citi’s analysis. “LSE’s competitors offer a lower aggressive fee and rebates which kick in at any level of volume. As such, the net charges of Chi-X and Nasdaq OMX (0.1bps) appear much lower than an average net charge at LSE estimated at 0.36bps.”

In its quarterly results meeting in May, the London Stock Exchange announced updates to its TradElect trading platform, including a doubling of capacity to handle 10,000 messages per second and reducing end-to-end latency to three milliseconds. The LSE said the upgrades were designed to attract high frequency traders, many of which put large volumes through MTFs.

As a further sign of its ability to respond to industry challenges, the LSE has also announced its intentions for competitive clearing by enlisting SIS X-clear to compete with its incumbent clearing house LCH. But the Citi analysis suggests more could have been done with CC&G, the clearing house it acquired as part of its merger with Italian exchange Borsa Italiana.

“Opening up access to SIS X-Clear was first discussed and agreed about two years ago, i.e. pre the Borsa Italiana acquisition,” read the report. “In our opinion, it is highly likely Borsa Italiana’s CC&G will be offered as further competition against LCH.”