Exchange mergers appear to be paving the way for a resurgence in integrated exchange groups that own and control both trading venues and post-trade operations. Could this lower trading costs?
There is a case to argue they would, but it has its doubters. Those in favour of operating trading, clearing and settlement services in a single silo point to the advantages of cost efficiency that straight-through processing can provide. MEP Sharon Bowles, chair of the Economic and Monetary Affairs Committee (ECON) of the European Parliament, counters that this integrated model can lead to anti-competitive behaviour, driving up costs.
For example the Spanish central securities depositary (CSD) and clearing house, Iberclear, owned by national exchange Bolsas Y Mercados Españoles (BME), charges multilateral trading facilities (MTFs), but not BME, for processing trades of Spanish stocks. It also requires MTFs to report the allocation of shares to trading participants over a shorter time period than it does for the BME.
Such additional cost offsets out the benefit of lower trading fees that MTFs charge, demonstrating to many that post-trade competition is invaluable to the overall reduction of costs. For this reason Bowles proposed amendments to the European Commission's European markets infrastructure regulation (EMIR) that would force equity clearing houses to interoperate, where this would not create additional risk, even if they are part of an integrated exchange business. In theory, this would allow any broker to select a single clearing counterparty (CCP) for all its European equities trades regardless of trading venue, creating competition and driving down costs.
However fellow MEP and member of ECON Werner Langen, who was the rapporteur for the committee's EMIR paper, argues that “interoperability arrangements may expose CCPs to additional systemically relevant risks” and therefore pan-European regulator the European Securities and Markets Authority should submit a report on the suitability of interoperability to the EC by 30 September 2014.
If clearing interoperability is allowed then competition would likely drive down prices and the revenues earned by siloed clearing houses. If not, integrated exchanges will be under less pressure to offer volume-based discounts to compete with independent CCPs.
Who is in favour of exchanges running their own post-trade operations?
Mainly the incumbent national exchanges themselves, who can create a strong value proposition by offering a single venue for the execution, clearing and settlement of trades. The incumbent German exchange, Deutsche Börse, part owns Eurex Clearing and CSD Clearstream, while BME owns Iberclear. By virtue of its part ownership of the Eurex derivatives market with SIX Swiss Exchange, Deutsche Börse has kept siloed operations for both equities and derivatives.
In May 2010 NYSE Euronext, now a takeover target for both Deutsche Börse and rival market operator Nasdaq OMX, announced it would create its own clearing operations by 2012 to increase revenue and allow faster delivery of new products to market.
The London Stock Exchange (LSE) was also said to be considering building its own clearing operations using CC&G, the clearing house that it acquired with Borsa Italiana on 1 October 2007.
LCH.Clearnet, the CCP for both NYSE Euronext and the LSE, risks losing its two largest customers. It saw total clearing revenues fall to €203.4 million in 2010 from €221.3 million the previous year, and equity revenues €44.3 million from €66.6 million.
How much will buy-side trading costs be affected by the fees for post-trade services?
There is some dispute over what proportion of trading costs are attributable to post-trade.
Management consultancy Oxera released a study in May 2010 in conjunction with CSD Euroclear which found that clearing fees made up 15% of the total cost of trading, settlement 2% and trading fees 83%. However the LSE disputed the report's conclusion that trading fees were the larger part of the total cost.
Whatever the proportions, costs have fallen on both sides. An earlier study that Oxera carried out with the EC, released in 2009, found that clearing fees had reduced significantly since 2006 and they are widely believed to have fallen by around 80% since MiFID. LCH.Clearnet reduced its fees in 2009 and 2010, which CEO Roger Liddell noted has contributed to a fall in the firm's revenues from clearing equities.
Four pan-European CCPs – LCH.Clearnet, EuroCCP, EMCF and SIX x-clear – had their proposed interoperability agreements inspected by the UK, Dutch and Swiss regulators, whose final approval was expected in Q1 this year.
Their ability to compete effectively against siloed clearers hinges on regulators approving the agreements.
Whether the reduction in costs from venues and clearing would be passed on to the buy-side by their brokers is another issue. Traders at asset management firms say that they do not expect sell-side firms to pass fee reductions on to them – the value they receive is in execution quality.
But if all brokers were to see costs fall, the buy-side should see some benefits long-term.
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