Multiple Trading Venues in Europe: The Changing Nature of Electronic Trading in a Fragmented World

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By Peter Randall
The European equity trading landscape has undergone a period of rapid change, since the implementation of MiFID (Markets in Financial Instruments Directive) in November 2007. The new regulation shook up the financial industry in an unprecedented way mainly by the abolition of the concentration rule and the determination to make Best Execution the ultimate guarantee of protection for the investor. Although MiFID has not been successful in every aspect, it certainly succeeded in bringing a competitive edge to European equity trading, resulting in a drop in trading cost for brokers. On the flipside: the market has become more fragmented, and the complexity and cost of providing best execution are emerging as important factors.
Breaking barriers to entry
As new trading venues have started, the main challenge faced by market participants has been to facilitate the connection to new platforms. The use of FIX Protocol standards, making it easier and cheaper to connect to an exchange, was one of the key elements of the success of the Multilateral Trading Facilities (MTFs). And now the reality is that stocks can be and are actually traded on several different venues: traditional exchanges, MTFs, Systematic Internalisers and dark pools. The main European indexes are now traded, on average, on more than 5 visible venues. Furthermore, to attract liquidity, new players offer an innovative and simpler fee structure: no membership fees, no market data fees and attractive trading fees: posting liquidity is now rebated while in the meantime, removing liquidity from MTFs is still less expensive than on traditional exchanges.
With reduced costs, new liquidity available and frequent tighter spreads, MTFs have all the assets to attract the brokers. And it works. On the main European indexes, traditional exchanges have lost up to 44 % of market share.
Of course, traditional exchanges launched their own MTFs and dark pools and lowered their fees to compete with alternative platforms, but by and large these have not enjoyed as much success as the new entrants.
Despite the drop in costs of connection and membership, trading on alternative platforms generates new costs: costs of physical connectivity of course, but also unexpected costs due to the increasing complexity of trading.

Increasing complexity of Trading
To have a full picture of the market, brokers now need to connect to more venues. Of course, the connectivity costs involved are one of the barriers to entry. Not to mention that the sustainability of those models are still to be demonstrated. Brokers are reluctant to invest money in those solutions without knowing if they would reach any return on investment. In addition, even if connected to several venues, brokers have to set up efficient Smart Order Routing (SOR) systems to make the best of the opportunities brought by the fragmentation.
Following NASDAQ OMX Europe, Chi-X Europe and BATS Europe recently announced the launch of their own SOR systems, routing orders not executable at the best price on their platforms to other exchanges, MTFs, dark pools, or liquidity providers’ matching engines for a based-on-traded-value fee. It might help solving part of the fragmentation issue: accessing the liquidity where it is. But on the other hand, it also increases the number of multiple executions and the clearing and settlement issues thus raised.
For now, there is a discrepancy between where orders should be executed to obtain the best price ( for the investor ) and where they are actually executed . (Chart 2)

When we look at the reality of best execution, it is interesting to note that in January 2010 alone, 10.4% of trades on FTSE 100 stocks, 12.9% of trades on CAC 40 stocks and 13% of trades on DAX 30 stocks missed the best price across all venues. According to the figures in the chart, none of the venues, neither the home market, nor the MTFs can ensure the best price on a consistent basis. Inefficient SOR systems and brokers not being connected to all the venues explain such results.
What does that mean for the investors? Although MiFID is a visible success for brokers as their trading costs have dropped significantly, it is very disappointing in regard to individual investors, who saw nothing of these reductions or the opportunities of better prices available on alternative venues. The opportunity cost for investors is considerable: in January alone, missed best price trades on FTSE 100 stocks cost the investor up to 4M€ , trades on CAC 40: 2.5 M€ and 1.7 M€ on DAX 30 stocks. This amounts to 12M€ if we look at all the most traded European stocks.
Providing retail investors with the same opportunities
For retail brokers, liquidity fragmentation is an even greater challenge: establishing multiple connections to the ever changing number of venues with their differing post trade environments is costly. As a result retail orders are not split in search of better execution prices. The solution for this type of flow lies in a one-stop-shop approach whereby all the orders are sent and executed on a single venue that somehow guarantees the price advantage that only the most sophisticated can achieve. From our perspective, the Equiduct platform was built on the idea of providing brokers the simplest venue to achieve true best execution on a consistent basis for their customers: one entry point, the best price and one clearing and settlement organisation. By leveraging the FPL harmonisation initiatives brought by the FPL Global Exchanges and Markets Committee, connecting to these platforms is almost as easy as plug-and-play. Similarly on market data, the MDOWG (Market Data Optimisation Working Group) recommendations make implementing easy-to-integrate market data for brokers’ systems possible. Looking at the changes in the European Trading Landscape, market fragmentation has made trading in Europe more complex and at first glance confusing. However as a whole the opportunities created by those changes can outweigh the disadvantages by far. Allowing the retail investor to access those opportunities will be the next challenge for brokers and will probably be one of the key elements for sustainability and determine the future trading landscape.