By Lee Porter
Prior to 2000, the two incumbent US stock exchanges, the NYSE and NASDAQ, dominated the equity trading landscape, leaving little choice among traders for execution venues. More than 90 percent of all executions were transacted on these exchanges. The opportunities to execute a trade of significant size were fairly limited: your broker would either commit capital or try to execute the order “upstairs” and find a natural contra to cross the trade. This was the original dark pool.
How times have changed. Through advancements in technology, altered regulation and increased sophistication of buy and sell-side participants, traders now have a plethora of alternatives to execute their orders. This applies to both the venue and method. The exchange duopoly in the US has been broken, efficiencies gained and trading costs have tumbled, all to the benefit of end investors.
The US has led the way with the evolution of MTFs, ECNs, dark pools and broker internal crossing networks, among others. Data from Tabb Group (next page) clearly shows the trend over the past few years of the incumbent exchanges’ decreasing market share to the advantage of new entrants.
Today, over 60 ATS’ are registered with the SEC in the US. Liquidnet, the largest block crossing platform in the US, according to the TABB Group, was one of the first to emerge and remains the only venue focused exclusively on the buy-side. Market share estimates for off-exchange trading in the US and Canada vary dramatically, but all show the market share on incumbent exchanges declining with flow migrating to venues that offer differentiated execution quality.
With US-based alternative venues providing clear benefits to the industry and end investors, it was only a matter of time before operators eyed opportunities abroad. Their arrival in the UK and continental Europe immediately challenged the local exchanges, which had long enjoyed the safety of favorable regulations to protect their monopolies. Today, according to figures released by the Aite Group, an estimated 16 percent of equity volume is executed through MTFs, with Chi-X leading the way.
The next logical step for alternative trading venues was expansion into Asia-Pacific, a region of growing global importance, but with geographic, cultural and technological challenges not yet encountered in the US or Europe.
Among the first to establish a presence in the region was Liquidnet with the launch of trading in Hong Kong, Singapore, Japan and Korea in 2007. Australia followed in early 2008. In addition to these socalled “dark-pools”, such as Liquidnet and BlocSec, several internal broker pools and crossing networks have already sprung up across the region.
Yet, the number of venues, as compared to Europe and the US, remains small. Market share is also a fraction of that traded on traditional platforms. An estimated 1 percent of executions in Asia-Pacific are performed away from local exchanges, according to a report from Aite Group.
Still, forecasts for industry growth are encouraging. Aite Group estimates that by 2012, 20 percent of equity trades in Asia-Pacific will be executed through alternate venues.
Different regulation, different result
One of the key drivers for the industry’s expansion in other markets has been regulatory change. The introduction of Reg NMS in the US in 2005, together with MiFID in Europe two years later, paved the way for the entry of new trading venues across dozens of countries. These regulations were brought about to provide a framework for unbundling and “best execution”, which has helped the alternative venues flourish. The story in Asia, however, remains vastly different.
The lack of a single-market structure across multiple jurisdictions, which provides the platform to launch regulatory initiatives, is clearly lacking in Asia and has delayed the industry’s development.
Australia was the first country in the region to address the issue of potential new market entrants. ASIC, the local regulator, and the Australian government have been considering separate applications for an Australian Market License (AML) from three applicants: Liquidnet, Chi-X, and AXE-ECN, a consortium partly owned by the New Zealand Stock Exchange Ltd and various brokers. Other regulators around the region have, no doubt, been watching and waiting for the result. No AMLs have yet been awarded, but the MTFs remain confident that – despite the delays – a positive outcome is likely. Such a result may also pave the way for other countries in the region to open their markets to competition. Such an outcome would benefit all investors.
The right solution for investors in Asia
It is important to remember that most alternate trading venues seeking to expand in Asia are essentially offering a solution to structural problems, which continue to disadvantage the region’s trading community: a lack of liquidity, information leakage and wide trading spreads. Change and innovation in the trading of equities will continue to spread across Asia, albeit at aslower pace perhaps than other regions.
There are also challenges for the buyside trader, who has an increasing number of executions venues – and trading tools – to choose from. Ultimately, continued advances in technology and improvement of these tools should make their job easier. We also believe increased choice should help bring the trader up the investment value curve. That said, the buy-side trader is more empowered than ever before. With the introduction of DMA, algorithms and latterly alternative venues, the buy-side trader has taken back control of the execution process, rather than just outsource these incredibly important decisions to preferred brokers.
Today’s buy-side trader can choose where and how trades are executed, often bypassing the sales trader. As this evolves, the decisions made by the buy-side trader become more valuable, tangible and all the more transparent. The capabilities of institutions will undoubtedly grow as the technology accelerates and the knowledge base expands.
It is commonly understood that the firm that generates the most alpha is also the same firm with the best ideas which can be implemented the quickest. With this in mind, traders will need to use all available weapons in their armory to seek liquidity and secure the best possible execution for the portfolio manager.
Today, there are certainly more choices available for traders in Europe and the US, as compared to those in Asia-Pacific. Also, the challenges of regulation, fragmented geographies, trader adoption, change in trading styles and critical mass remain very apparent. Despite the many hurdles, we remain very confident that the industry will rise to the challenges across the region and deliver innovation, further empowering the buy-side.
By Lee Porter