MTFs versus Incumbent Exchanges, Round Two

As mentioned yesterday Andrew Silverman, Managing Director Electronic Trading for Morgan Stanley, chaired the second day session’s at TradeTech with a great dialogue about attracting liquidity between the new exchanges, the Multilateral Trading Facilities (MTFs) created by the Markets in Financial Instruments Directive (MiFID), and the incumbents.

This led to a second discussion of the future of trading venues with panel members:

• Cees Vermaas, Executive Director, Sales and Relationship Management, NYSE Euronext and NYSE ARCA EUROPE MTF;
• Hugh Brown, Head of Secondary Markets Product Development, London Stock Exchange (LSE) Group;
• Eli Lederman, CEO, Turquoise;
• Charlotte Crosswell, President, Nasdaq OMX Europe; and
• Artur Fischer, Joint CEO, Equiduct Trading.

Here’s my summary notes. 

The Chair kicked off the dialogue by asking Eli if the new MTFs could really attack Europe’s major markets when they are only cash equities players.

Eli responded by saying that the focus of MiFID’s intentions is to create transparency and visibility in the cash equities markets, and there will be a view that this needs to move into other asset classes, especially derivatives.

However, the focus today is still on cash equities as the job there is still only just starting.

This means creating an order flow that allows a greatly increased flow of smaller orders at higher volumes alongside dark book business for larger orders at lower frequencies.

The Chair then stepped in and stated that no-one only trades just equities though, casting doubt on the MTFs ability to attract liquidity as a solo asset class player. He then moved to Charlotte Crosswell of NASDAQ OMX Europe and asked why they weren’t amalgamating OMX Nordic into NASDAQ OMX.

Charlotte responded by saying that they didn’t “want to cannibalise our own markets, but we do need to be pan-European. So yes, we do compete with ourselves between OMX and NASDAQ to provide choices. We just don’t advertise if one is doing better than the other in the Nordic region.”

The discussion then moved into the increasing competitiveness of broker-dealers who, with their own dark pools and low latency platforms, are increasingly competing direct with the incumbents anyway. Hedge Funds become market markets and brokers become exchanges, all mean that the clarity and division of the markets is blurring and clouding over.

At this point, it was interesting that Charlotte raised a concern of the new players.

“We are the cheapest venue out there on Best Bid-Offer (BBO) but we are not getting the volume … smart order routing is not right yet and se we keep adjusting our pricing. It all comes down to the post-trade issues however, as execution costs have come down to a minimum. We can all compete at 0.1 basis points or thereabouts, but order routers ignore that because of the elephant in the room, namely clearing and settlement”.

I liked that comment as many of our CCPs and CSDs are a bit elephant-like, e.g. slow to change. And how do you eat an elephant? One piece at a time. We will get there, and EMCF and EuroCCP are just the start.

We also discussed the maker-taker model, where some players provide liquidity whilst others take it. Right now, the MTFs charge a higher basis point for taking liquidity, but they are experimenting with their models between the maker-taker model versus a flat rate of, let’s say, 0.01 bps for each trade. This hybrid structure is likely to grow.

The chair then asked whether such short-term price promotions only encourage short-term liquidity and long-term is still with the incumbents.

Hugh Brown of LSE liked that point, and stated the pricing only ever has a one-way direction, and that is downwards. He then noted that the new MTFs are not profitable yet and, with pricing unsustainable today and even more likely to be squeezed tomorrow, felt that their long-term viability and sustainability was questionable.

Artus Fisher of Equiduct agreed by saying that “we made a mistake to get into a price war”. The fact that the new MTFs have a low cost base, hi-tech platform with low latency, minimal fixed costs and more should be the advantages they trade with rather than an unsustainably low-cost promotion which means we cannot survive.

All in all an interesting chat about the future of the markets which was inconclusive. The fact is that you have one big new disruptive MTF, Chi-x, which gained first-mover advantage.

The others are challenged.

For example, when asked what is the one thing you would change, Charlotte Crosswell piped up: “not launching in September 2008” and quite rightly pointed out that when the MTFs were laying the launch plans, none of them could foresee the long-haul of liquidity drought we were going to suffer after Lehman Brothers collapse.

Therefore, Chi-x are a survivor and the others?

Without strong backing with deep pockets for a three-year cycle of deep discounted promotions and liquidity challenges based upon price improvement not being the only battlefront, several may not survive.

I wrote an in-depth review of this area for Colt Telecom during the fall of 2008, which may provide some useful background. Although the landscape has change since then, my conclusions are the same which is that there’s only room for three MTFs of any note.

Meanwhile, an interesting interview with Eli Lederman on FT.com which builds on these themes.

Btw, when I quote folks it’s just a view of their words rather than a
necessarily accurate quotation, just in case anyone pulls me up
afterwards.