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Order routers not providing Best Execution

I said my favorite presentation was Mark Howarth’s yesterday because my favorite subject is the new alternative exchanges – the Multilateral Trading Facilities (MTFs) – that have emerged in Europe as a result of the Markets in Financial Instruments (MiFID) implementation.

Chi-x began trading two years ago, soon to be followed by Turquoise, BATS, NASDAQ OMX and Equiduct. And there will be more. According to the dialogue so far, there are 125 or so MTFs registered with CESR across Europe.

Admittedly, many of these are broker-dealer based systems and services, but there are at least 10 pan-European MTFs registered, with Burgundy the next to launch.

So it’s obvious that not all of them can succeed, but having three or four in each area of service from dark pools to liquid stocks to all markets and eventually to derivatives, bonds, fixed income and other markets certainly seems to be on the cards according to the discussions here so far.

I’ll talk more about the other MTFs tomorrow but right now Chi-x is the one that shouts loudest, probably because it’s been around for longest and has first mover advantage. In fact, unlike BATS, NASDAQ OMX and Equiduct, it also had the advantage of launching well before September r2008 when the credit crisis hit, which is a definite advantage.

So Mark Howarth, the new CEO of Chi-x Europe – my friend Peter Randall left on the day I last blogged about this stuff in depth – stands up and presents some interesting slides.

For example, gross consideration for Chi-x rose steadily through to September 2008 and then dipped away as follows:

Gross Consideration (€ billions)

Q2 07         €1.5
Q3 07       €20.2
Q4 07       €34.6
Q1 08       €74.2
Q2 08     €132.5
Q3 08     €246.3
Q4 08     €205.5
Q1 09     €148.9

Now you may look at those numbers diving since Q3 2008 and think Chi-x should be worried, but that’s not the whole story in that, by the end of Q1 2009, Chi-x proudly claim fifth spot in the European pecking order of exchanges, closely followed by NASDAQ OMX Nordic and Turquoise:

Value of Equity trading, March 2009
Exchange / MTF               Order Book Trades    Order Book T/Over (EUR m)
1 London Stock Exchange        17,279,867                   123,650.0
2 Euronext                             15,365,479                    116,839.0
3 Deutsche Borse                     8,118,311                     95,835.8
4 Spanish Exchange (BME)        2,832,093                     60,682.8
5 Chi-X Europe                       10,554,888                     57,168.5
6 Borsa Italiana                       6,227,802                      45,937.2
7 SWX Europe                          2,875,388                     45,495.4
8 NASDAQ OMX Nordic              4,802,676                     43,150.6
9 Turquoise                             3,309,508                     22,567.8
10 Oslo Bors                            1,240,279                     11,397.7
11 BATS Europe                       1,760,985                       8,277.7
12 SIX Swiss Exchange                462,090                       2,802.3

Equally, market share of all the new Exchanges has been steadily rising. For example, the three new MTFs – Chi-x, BATS and Turquoise – are averaging around 20% of the DAX30 daily volume. That’s a wee dent in the Deutsche Bourse’s pie I suspect.

In fact, Mark claims that Chi-x’s research shows that there would be a significant shift in liquidity and market share to Chi-X and the other MTFs from the incumbent exchanges if best price routing were in play. This would be in the order of 17% of all orders for November 2008, 15% in December, 13% in January 2009 and 12% in February. The reason for the decreasing numbers is the decreased volume of trading during these months, rather than any uncompetitive aspects of the new MTF models.

In other words, and I’ve heard this from the other MTFs too, the fact that order routers aren’t smart enough to seek out best price in Europe right now is the reason why the liquidity sticks with the incumbents.

Not sure if true, but Chi-x claim their market share would have been 10.6% higher between November and February if the full price improvement transparency and best execution rules were enforced.

Watch that space and more on this tomorrow.

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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  • Chris,
    I could not agree more with you that fragmentation in Europe will continue to expand with new entrants and become more complex with the emergence of ‘grey’ pools of liquidity. The problem with many smart order routers in Europe is that they are driven by static, rules-based logic rather than adaptive parameters that can react to dynamic liquidity in real time. This is also a consequence of US technology being revised for a much more flexible ‘best execution’ environment than RegNMS mandated.
    However, I would like to point out that there are intelligent smart order routers designed for the post-MiFID fragmentation era – such as Quod Financial’s Adaptive Smart Order Router. Where others lack the ability to adequately seek and execute against all sources of liquidity, we have provided our clients with the ability to utilise our real-time decision making processes for liquidity discovery and executing their strategies.
    Adaptive smart order routing is an area we’re always happy to chat about, if you’d ever like to talk through it in further detail.
    Ali Pichvai

  • Chris Pickles

    Chris – it’s still interesting that many/most investment firms in the EU don’t do any form of smart order routing – they just send orders to the home exchange. Most investment firms are not members of more than their home exchange, so they route orders for foreign equities to other brokers in other countries who are members of theor own home exchange. It appears that the advice being given by legal firms to their investment-firm clients is that they don’t have to consider more than one execution venue as part of their execution policy, on the basis that this will generally result in best execution for the client. As MiFID doesn’t force order-by-order best execution, investment firms can claim that they are MiFID-compliant and are giving the best overall result to their clients.
    Until the investors wake up and take action to demand better performance from the investment firms that should be acting in their clients’ best interests, the investment firms will be able to continue to avoid having to deliver the best results for their clients