Alternative Venues:Going from Strength to Strength


Bryan Harkins from Direct Edge talks about the benefits of innovation and the need for good customer service.
FIXGlobal: What has enabled the new breed of exchanges to succeed in an illiquid environment?
Bryan Harkins, Direct Edge: This is certainly a challenging time in the marketplace with respect to trading volumes. We are addressing this through a range of products, services and revenues that are non-transactional based and by moving towards more subscription-based products such as market data and connectivity services – basically a suite of technology and connection-based products. The role of an exchange is not just to put buyers and sellers together but also to help move their members’ businesses forward with new data and connectivity products. Innovation is especially important when trading volumes are low.
FG: What advantages do alternative venues, such as dark pools and ATS, in the US enjoy that the incumbent exchanges do not?
BH: Dark pools and alternative trading systems (ATS) are two different business models and there are advantages for each that an exchange may not have, and vice versa. Dark pools and ATS are allowed to restrict access to their platforms, offering different types of incentives for different types of flow.
Exchanges are at times hamstrung, however, because of the current application of the principles of ‘fair access’ under federal securities regulation. Exchange efforts to provide a better experience for retail and institutional orders are often reviewed under the principle: “if it isn’t made available to everyone, it can’t be made available to anyone”. As a result, exchanges can be constrained in their efforts to provide a better environment for retail and institutional investors. This can lead the firms who manage this order flow to seek off-exchange executions. There is nothing nefarious about this; in fact it is consistent with the duty of best execution. If exchanges don’t offer the best trading experience, trading volume should and will go elsewhere.
In the US, we are working with regulators to empower exchanges to offer a better product and experience to long-term investors. Not only would this help restore investor confidence, it would prospectively improve trading outcomes.
On the other hand, exchanges have advantages that dark pools and ATS do not. For example, we have a protected quote. Under regulation NMS, any quote inside the market is protected. It is a very powerful advantage to have a quote in the public market place. Exchanges also have significant brand advantages. It is very prestigious to be an exchange, and with that prestige comes a great deal of regulatory responsibility, which itself produces stronger confidence in our platform for our members.
FG: What will it take for alternative venues to experience further growth in the US?
BH: Alternative venues need to not only provide a place to trade with quality liquidity, but they also need to provide much needed competition against some of the larger exchanges, with lower fees and a variety of trading strategies that help members fill their orders efficiently.
Alternative venues should be a source of innovation, continually thinking of new ways to help members meet their trading goals. In these days of high-speed technology and very sophisticated trading platforms, it really does all come down to aligning yourself in a customer-friendly way and providing good customer service.

SBI Japannext’s Chuck Chon discusses the growth of Proprietary Trading Systems (PTS) in Japan.
FIXGlobal: What has enabled PTS to succeed in an illiquid environment?
Chuck Chon, SBI Japannext: The Japanese market isn’t necessarily an illiquid environment – it used to be the second largest market in the world. Success has not been easy for PTS in Japan; nevertheless, both Chi-X Japan and SBI Japannext have been able to chip away at the incumbent exchanges’ market shares.
While I wouldn’t necessarily call our growth rate comparable with our counterparts in Europe or the US, the PTS business model is a proven business model in the US and Europe. Hence, the model’s success in Japan should be no exception.
All PTS venue members, including mega Japanese investment houses, do understand PTS – they are the first mainstream users of PTS in Japan. Fierce competition among PTS in Japan has brought out the best of both, resulting in an increased market share.
FG: What advantages do PTS in Japan enjoy that the incumbent exchanges do not?
CC: PTS enjoy great support from the global investment market and Japanese mega investment houses who understand the value of market fragmentation in the US and Europe. They are also supported by the leading buy-side firms that understand the value PTS brings in terms of cost savings.
In addition, they receive support from retail on-line brokers as well as global liquidity providers, proprietary trading houses, hedge funds, etc. that benefited from market fragmentation and competition in the US and Europe.
The single most important difference that all PTS market participants appreciate is the tick size differences between incumbent exchanges and PTS. PTS have smaller tick sizes (one tenth) compared to incumbent exchanges. The spread for Nikkei 225 Index stocks at the incumbent exchange is around 24 bps compared to around 12 bps at a PTS. About 50% compression in the spread makes it extremely attractive for market participants.
Another advantage enjoyed by PTS is simplicity of order types (limit, IOC and FOK), which enables systems to be much faster than incumbent exchanges.
FG: What will it take for PTS to experience further growth in Japan?
CC: The Japanese market is the most advanced in Asia in terms of regulatory framework and fees associated with trading. Having said that, it would be unfair to compare the Japanese market to other Asian markets, which still lag far behind Japan. However, compared to US and European counterparts, it needs to improve.
There are three major factors that hamper the growth of PTS volume. Firstly, the 5% Tender Offer to Buy (TOB ) regulation. This presents a risk for large institutional buy-side firms to accidentally over purchase more than 5% of outstanding shares through PTS. Many buy-side participants are reluctant to deal with PTS in Japan because of this regulation. According to some experts, if PTS are exempt from this 5% TOB restriction, then their market share could grow by as much as 10% in a short time period.
The second factor is margin trading restrictions for PTS. This rule prevents retail investors from fully participating in best executions. Many retail on-line brokers have indicated to us that unless margin trading restrictions are removed for PTS, they are reluctant to participate in PTS venues. A large majority of retail end investors are currently unable to access best executions via PTS due to margin trading restrictions.
The third restricting factor is the 10% limit for PTS market share. In a nutshell, if a PTS’ six month daily average volume exceeds 10% market share of total equities traded in Japan, a PTS must apply to become an exchange. This restriction has two flaws that need addressing:
• The transition from PTS to an exchange is easier said than done. Flexible timing is needed for transition to an exchange since additional capital resources will be required to relist hundreds of companies onto a newly created exchange.
• The 10% limit is a psychological barrier for PTS market participants and many PTS venue participants have voiced this concern.

Mark Hemsley from BATS Chi-X Europe talks about the progress being made by alternative venues compared to incumbent exchanges.
FIXGlobal: What factors have allowed alternative venues to succeed in an illiquid environment?
Mark Hemsley, Bats Chi-X Europe:
Fees, technology and customer service are all important factors in attracting business, but above all, liquidity begets liquidity. We have built a healthy market comprised of diverse participants and diverse types of liquidity, which together offer customers the best chance for order executions. In addition, alternative venues provide services not offered by the incumbent exchanges – such as interoperable clearing and pan-European smart order routing. By consistently performing well in all these areas, alternative venues can increase their market share and increase liquidity.
FG: What advantages do alternative venues in Europe enjoy that the incumbent exchanges do not?
MH: While we operate under an equivalent regulatory regime to the incumbent exchanges, our pan- European business model gives us a critical advantage of broad opportunities in Europe and it is also a model that none of the exchanges have been able to adopt fully yet. Alternative venues also operate with very low-cost bases compared to the incumbent exchanges. This puts them in a good position even during periods of low trading volumes, as well as allowing them to be aggressive over pricing and responsive to customers in a way that the exchanges are not able to do – given their higher cost bases.
FG: What will it take for alternative venues to experience further growth in Europe?
MH: We see there being further opportunities for growth in markets that are in the process of adopting MiFID – for example, Spain, where we have recently begun to make inroads.
Alternative venues also have the opportunity of expanding into areas where exchanges still hold a monopoly. Market data is one area where exchange fees have increased despite their share of the market decreasing, in some cases by as much as 40-50%. We do not believe that current exchange market data fees are set at an appropriate level and we disagree with the exchanges’ policies, which often do not allow for customer choice. Therefore, we recently announced a competitive pan-European market data pricing model, with which we aim to set a competitive reference price to that charged by the incumbents.