MTFs vs Securities Exchanges

Post-Trade Forum Logo Having not been down to Paternoster Square for a while, I arrived with the expectation of seeing ranks of protestors laying seige to the London Stock Exchange (LSE). However, it was as emmaculate as ever and the attendees of the fourth Post-Trade Forum had a smooth street-side to debate-side transition.

The LSE was the perfect venue given the debate topic of “MTFs versus Stock Exchanges – The future of European Securities Markets” and my congratulations to them for being perfect hosts. A larger than usual turnout greeted Chairman Gary Wright (CEO, B.I.S.S. Research) and the panellists (Nicola Horlick, CEO, Bramdean Asset Management; Brian Winterflood, Life President, Winterflood Securities; Hirander Misra, Managing Director, Misra Ventures (former co-founder and COO of Chi-X Europe) & Kevin Milne, Director Post-Trade Services, LSE).

For those that haven’t attended a Post-Trade Forum before, the format can be found here. The debate was conducted under the ‘Chatham House Rule’ for forum members – so, frustratingly for the reader, I cannot reveal who said what. However, the panel and forum discussion unearthed the following:

How did MTFs come about?
The general thrust of the discussion was that Stock Exchanges have been around for many hundreds of years, and in our current whirlwind society, they are practically ancient. Pre 1986’s Big-Bang they supported the provision of single capacity firms (Jobbers) and Fund Managers (Brokers) acting for their clients. This arrangement, by its very nature, did not require complicated legislation and its associated army of regulators – the moral maze of the Chinese Wall had not been born. Post Big-Bang these single capacity firms where swallowed by new members of the LSE, foreign and domestic banks, replacing Jobbers with “Market Makers” and Brokers with “Broker Dealers” thus heralding the birth of dual capacity firms. Investors were then faced with a single bank performing both sides of the dance, with new legislation in place in order to protect their interests.

The birth of these dual capacity firms, the rapid introduction of evermore sophisticated technology and an increased appetite for greater trade volumes resulted in the increasingly common sight of the banks operating “crossing” on buy/sell instructions – meaning the trades did not actually reach the market. This resulted in a lack of transparency, a distortion of the market and the formation of dark pools of liquidity. All this added to the increasing frustration of investors that they were not achieving “Best Execution”.

In an attempt to address these issues, MiFID came into effect in October 2007 with the aim of increasing transparency and offering “Best Execution” to investors through the creation of competition to the traditional Securities Exchange. This competion would be offered by the introduction of Multilateral Trading Facilities (MTFs). MTFs would allow new entrants to create their own “exchange”, providing choice to the members and, in time, the reduced costs associated with competition.

What have been the consequences of the formation of MTFs?
MTFs have, indeed, increased competition in the market place – challenging the existing Securities Exchanges for trading volume. However, they have not had an easy ride and very few have been successful, with only a select few actually becoming profitable.

With the increased competition (though one man’s competition is another man’s fragmentation) the costs to Market Members has increased, with the need to invest in new technology to facilitate engagement with the new MTFs. This increased expense certainly flying in the face of the idiom that increased competition drives down cost. However, for those Sell-Side firms that have invested intelligently with robust and reusable platforms, this engagement has allowed them to reduce the cost of entry to MTFs. Whether the Buy-Side are seeing the benefits of this and the achieving “Best Execution” is yet to be seen.

The question now is have MTFs provided too much competition? Is there actually fragmentation in the Securities domain? There is now a trend for Exchange Members to buy-out MTFs, indeed for Exchanges themselves to do the same, such as LSE’s take over of Turquoise. This consolidation is set to continue in the coming months. So fragmentation, if it does currently exist, should reduce over time back to a healthy level.

But has the introduction of MTFs improved transparency in the market? There was a mixed response in the room to this stated fundamental aim of the MiFID legislation. Yes, a more level playing field is emerging with the introduction of MTFs – with a reduced cost of entry to new members, however there is no appetite for the introduction of a Consolidate Tape for European Exchanges – “it is less important to see where you got shot than it is to prevent yourself from getting shot in the first place”. The real issues around transparency still lie within the Banks and Broker firms, where the lack of internal controls and manual, spreadsheet driven trading give rise to problems such as those experienced by UBS. The markets, be those traditional Exchanges or MTFs, are the enablers – it is internal controls that keep should trading check.

So, did the Post-Trade Forum reach a conclusion on the question of the future of Securities Exchanges and the roles that traditional Exchanges and MTFs would play? The overwhelming opinion was the the jury is still out on the matter. With MiFID II soon to be upon us, more changes and costs are expected to impact on the exchanges with the scope being extended to other asset classes. There was a significant minority of the room that felt that the legislators are not delivering the holy grail of “Best Execution” for the end investor.

All together a very informative and beneficial meeting. I look forward to attending further Forums in the near future. In the meantime, if you have any questions – don’t hesitate to get in touch.

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