Stock exchanges need to adapt and evolve their services to maintain competitive advantage and avoid complacency in thinking they have a ‘divine right’ to liquidity in their home market. Or so says Jim Gollan, CEO at virt-x.
In an article reproduced below, Gollan explores the effect of MiFID, changing patterns of buyside and cross-border trading activity and how they will affect the type of services trading venues may offer. He also looks at exchange consolidation.
The shifting sands of the trading landscapeJim Gollan, CEO of virt-x
We are working in an era where European financial markets are undergoing significant change. This is particularly true in the arena of stock exchanges – one of the pillars of a nation’s financial community – where cross-border consolidation and pan-European regulation such as MiFID are combining to break down traditional, national structures.
There are several factors currently affecting how trading venues view their business models and their future. First, the financial markets are increasingly globalised, with asset managers diversifying portfolios to include not only developed but also emerging markets around the world. There has been an explosion of international indices and a focus on broad geographical investment which all adds to the increasing demand for cross-border trading. Exchanges are learning that they can no longer operate purely within their national boundaries – something that is fuelling current speculation of acquisitions and cross-border alliances.
We are also seeing a shift in the client base of exchanges due to the changing trading patterns of the buyside – direct market access tools, black box and programme trading systems are allowing a greater disintermediation of the sell side and driving the growth of OTC trading on alternative venues catering specifically to this market. Exchanges will need to adapt and evolve their services to keep ahead of these vendors for both the buy and sell side, and avoid any complacency in thinking they have a ‘divine right’ to liquidity in their home market.
Nevertheless, the most important regulatory factor currently affecting European exchanges is MiFID, the EU policy designed to create a single, efficient European trading market. The key to how this will affect exchanges is that MiFID is principles led and therefore reliant on market forces. The ultimate aim is to increase competition and level national boundaries to drive market efficiencies. Therefore it is impossible to view the impact of MiFID without taking into account the other agent of change, exchange consolidation, which is also having a huge impact on how clients of exchanges feel about market competition. I believe the interaction of these two factors could create profound change in the European capital markets and prompt market participants to reject the costly and outmoded operating models of some status quo providers.
In itself MiFID will affect the type of services trading venues may provide – exchanges will need to continue to offer as much best execution as possible through order book trading services as this is the high end of the value proposition. However if this is seen by listed exchanges as a way to extract monopoly rents from users to deliver back to shareholders, they will see an even bigger shift of trading away from the order book.
In countries with current reporting regimes, such as the UK, MiFID’s provisions are likely to result in competition which will drive down ticket fees on trade reporting and may also lead to migration of business to new venues. There will also be an impact on the provision of market data: wider transparency requirements will add to production costs, sources of market data may become more fragmented, whilst investment banks will resist cost inflation in the provision of what they regard as their market data being resold to them.
Putting these factors into the context of consolidating exchanges, the picture becomes even more interesting. We are seeing share prices of Europe’s largest exchanges currently trading at a premium due to prospective acquisition bids. To justify deals to the broad range of stakeholders, the results must deliver significant synergies and an actual growth in revenue after absorbing the consolidation costs. It is possible that, in the rush to ensure a place in the current bid maelstrom some deals may not deliver the value as hoped, and will also subject users of those exchanges to significant upheaval. The direct effect of this, as we at virt-x are hearing through our ongoing member consultation, is some anxiety amongst the user community (i.e. the investment banks and brokers).
The key issue is whether exchanges are there solely to make money for their shareholders or to make markets more efficient. Whilst the two are not necessarily mutually exclusive, the paradox of exchange consolidation is that it could reduce competition – in direct opposition to the principles of MiFID. If this happens, anxiety on the part of major exchange users could well trigger a move to alternative trading venues to the point where the liquidity shifts away from the ‘home’ exchange. Pluralism of trading venues has frequently been cited by organisations such as LIBA as a key concern, and MiFID’s levelling of the playing field on types of trading venue will help make it easier for the migration of business to occur.
What will the stock exchange of the future look like?
There’s no doubt the traditional ‘national’ exchange will have to change. Core to this will be the development of cross-border trading i.e. under a single rule book and with efficient STP. The future will be using a single click of the mouse to buy UK and sell German stocks and then also have the trades reported, cleared and settled automatically in the various jurisdictions – something that is already possible on virt-x.
Exchanges will also have to embrace their role as a service provider and not rely on historic liquidity and market position to maintain volumes. This should force a shake down of the current providers and benefit the broader market – as long as investment in technology is continued and the efficiencies are delivered back to the users in the form of tariff reductions rather than being siphoned off to increasingly vocal shareholders. It is vital to be customer-centric and keep users’ interests at the heart of all decisions and developments.
Ultimately, being agile and innovative, particularly in developing new services and adapting to changing regulation, is key. There is no doubt that we are in a particularly volatile time for the trading community; those exchanges that use it as an opportunity will be those that are still standing when the ground beneath our feet firms up.