A New Model For Changing Markets
By Stephen H. McGoldrick, Project Director, Plato Partnership.
The institutional equity markets are a complex ecosystem. In recent years the fragile balance of that system has been challenged by compromised stewardship and new regulations. It could be argued that since demutualisation, exchanges have been focused on driving value for their shareholders and the pricing power they exercise in relation to market data costs, trading fees and ancillary services has led them to tip the balance toward their own revenues. Similarly, while regulators have an imperative to ensure the security of the market, they also seek to balance that with maintaining the appeal of equities as an investment class. In recent debates the regulators have been poorly served by venues and participants who have supplied scant data. These failings are threatening the attractiveness of the equities, both for investors in the secondary market and for potential primary issuers seeking financing.
What is Plato?
In light of this environment, a consortium of market participants from the asset management and broker dealer community are collaborating to create a not-for-profit trading utility in Europe. Its governance structure recognises the traditional symbiosis and demarcations in the relationship of the buy-side with sell-side while updating that old model to reflect the significant increases we have seen in the sophistication of the buy-side approach to execution. By remutualising participant involvement in market design, the proposed governance model would allow Plato’s members to focus on driving improvements in the market without some of the challenges created by the conflicts inherent in current venues.
Integral to the vision for the platform is an academic research fund. This should produce independent research and analytics, open to peer review, and aimed at seeking out ways in which participants can collectively build a better financial ecosystem, as well as helping to inform and support the regulators’ market structure debate. This research will be funded by revenue generated from Plato’s trading utility.
In terms of its governance structure, the platform will have the participation of both buy- and sell-side firms. This is important since the success of the venue can only be guaranteed if it works for both sides. A Trust-like structure will be employed to ensure that our core principles will not be compromised over time.
Plato’s founding members include Deutsche Asset and Wealth Management, Norges Bank Investment Management, UBS, Barclays, Citi, Deutsche Bank, Goldman Sachs, JP Morgan and Morgan Stanley, along with others yet to be named. Significantly, this is the first time that this range of organisations have worked together in this manner, which we believe makes this a very exciting and unique proposition.
MiFID: A Catalyst for Positive Change
For large investors, well-functioning markets are essential, and over recent years, a number of changes to markets, regulations and participant profiles have altered the buy-side’s experience of trading in size. The forces shaping the market have led to dramatically declining average trade sizes, and with the ever-increasing prevalence of high frequency strategies, block trading has become increasingly more difficult to transact.
Plato is embracing the changes that are explicit and implicit in the regulator’s direction to the market, specifically around increasing the size of trades done in the dark. We believe that MiFID II, due to be implemented in January 2017, can become the catalyst for positive change to this ecosystem. Today, dark trading under MiFID typically utilises the Reference Price Waiver (RPW) for public non-displayed midpoint trading of child/algo orders.
However, MiFIR Article 5 imposes a cap on such trading at 8% of trades transacted under the RPW and certain Negotiated Trades in aggregate. This, together with new Trading Obligations (MiFIR Art. 23) will limit how and where trades are executed, moving more activity onto lit exchanges that are ill-equipped to serve the entirety needs of large asset managers. In the absence of a market response, this will have a material impact on the market, altering the European trading landscape significantly, especially for larger wholesale funds as well as for less smaller listed stocks.
Rehabilitating Equity Markets
There are a large number of processes and data flows ancillary to executions where we pay too much or where I don’t believe it helps any one firm if another one does them badly. What actually suffers is the equity market efficiency or external stakeholders’ views of the fairness of the market – something which the financial services industry has certainly had to deal with in recent years. It is relatively easy to identify the areas where a collective approach should produce a better outcome for less expenditure but the economics of tackling those issues are challenging if you have to create a new vehicle to do it each time.
Plato could play a vital role in helping to build fair and robust future markets through the neutral governance it is answerable to and its combined research arm.