Touching the Points


By Ben Springett
In this article, Nomura’s Ben Springett provides a brief overview of some of the key issues currently impacting European market structure, and shares his own thoughts on some of the changes likely to occur in Europe this year.
European market structure, has been, is, and will continue to be, in a state of change for the foreseeable future. Whilst European Commission regulation has been a significant catalyst in this, the industry itself is now looking to progress issues at a faster rate than the expected regulatory change. As such we are seeing increased interest in “self” regulation within the community, particularly in the areas of post trade reporting and efforts to provide a consolidated tape. All market participants are active in this, but it is not unreasonable to assume that it will be down to the broker-dealers to drive any change, as they typically are the ones that have the resources to invest in the process.
Liquidity Fragmentation
Market share amongst trading venues can be measured in many different ways and people can be forgiven from choosing one that paints their own venue in the best light. The accompanying two charts (Charts 1 and 2) show the steady decline of market share amongst the key primary exchanges, to the benefit of the MTF venues, although the total volume levels remain significantly lower than the pre-credit crunch days. When considering primary exchange volumes versus MTFs it is necessary to bear in mind that the primaries are only just starting to compete in each other’s markets, and as such the pan- European MTFs have had more blue chip names with which to capture their market share. This is set to change in 2010; Euronext launched ARCA last year, Xetra have launched their International Market (XIM) and the London Stock Exchange (LSE) have just completed the acquisition of a majority (51%) stake in Turquoise.

Consolidated Tape
MiFID did not mandate a market- wide consolidated tape, as opposed to the NBBO ( National Best Bid and Offer) provided under Reg NMS, and the lack thereof is one of the key concerns raised by the buy-side in a range of forums. There is however, no significant issue with data aggregation offered by a number of key providers such as Bloomberg and Reuters; in addition to some strong fragmentation analysis products available to the market (Fidessa Fragulator, BATS Europe).
In a period of time where cost base is under increasing pressure, attention has now been drawn to the inherent impenetrable conditions that exist in market data (the LSE has sole distribution rights on LSE data, Deutsche Boerse on Deutsche Boerse data etc.), and as the number of venues from which the data is required for increases, so will the interest placed on the associated charges. In an environment with considerable focus on competition, competitive forces cannot work to reduce the fees, leaving regulation as the only option, which was again addressed under Reg NMS in the US.
Benchmark consistency is another issue in Europe. In the absence of a market-wide mandate for what constitutes the “tape,” questions will be raised around benchmarks and venue coverage. What is the VWAP price for a given stock over a given period? Does it include all “Lit venues,”or just some? Do clients need to be aware that they are 10% of different volumes, when trading with different brokers for example? The short answer to the last question is currently “YES”.
The critical problems that exist are more in terms of data clarity, and not so much in delivery-quality, as is often levied. Trade reporting flags are very non-specific at present, based on the terms specified by MiFID. Increasing the number of flags that the trades are reported under will significantly increase the usefulness of this data.
The buy-side is typically most outspoken on the subject, but their concerns around price discovery, liquidity visibility and TCA / benchmarking are equally applicable for broker-dealers. In addition, the information is extremely valuable for use in both algorithmic signal engines and market share assessment for the broker-dealers as well.
We think that it is the point around reporting flags that needs to be addressed by broker-dealers, trading venues and trade data monitors (e.g.BOAT), to provide a platform for self-regulation to move forward in 2010.

Regulatory Evolution
The interpretation of MiFID is a much vaunted phrase, but it’s worth bearing in mind a number of points when considering, what is “Best Execution” and indeed whether all brokers can be the “Best” when clearly there are differences in approach!
Figure 3 shows the key “Best Execution”principles that are important to understand the intentions of MiFID and to understand any comparisons with Reg NMS as well. They clearly show the impact of principle-based regulation (MiFID) versus rules-based regulation (Reg NMS):
The following phrases have been taken from the explicit MiFID guidelines on broker requirements to achieve Best Execution. Brokers must:

  • Take all reasonable steps……but it is not an absolute obligation
  • ….on a consistent basis……but not on a trade by trade basis
  • ….client instructions must be followed……this impacts broker obligation for best ex
  • ….in accordance with a firm’s best execution policy……not all possible execution venues need to be considered

So how does a client gain an understanding of whether their broker is providing “Best Execution?” It might not be easy given some of the data limitations already mentioned, but quality, independent TCA (Transaction Cost Analysis) is key. Whilst brokers are well positioned to provide a wealth of data on trades executed with them directly, the client challenge is to reconcile this across not just providers, but across different execution channels as well.

Dark pools in Europe
A subject area that receives a more significant share of media attention than market turnover – as shown earlier – but nonetheless is a fast moving segment of European structure that can’t be ignored.
Dark pools in Europe can currently be split into the following categories:

The estimated market share of all dark pools in Europe is currently around 3-4%, a figure corroborated by a recent FSA (Financial Services Authority)/CESR (The Committee of European Securities Regulators) study for the EC. Regulatory interest was heightened in this space in 2009 when FESE (Federation of European Securities Exchanges) claimed the number could have been as much as 40%, which would raise questions around the ability of the market to perform price formation in the view of the regulatory and supervisory bodies. If nothing else, this ambiguity raises the question of post-trade transparency in this market segment.
Increased sensitivity resulted in EuroMillennium having to change their matching process (prior to being absorbed by Smartpool) and Liquidnet also had to amend a part of their offering. This stifling of innovation has been criticised by broker-dealers and trading venue providers more broadly.
It is interesting to note that the broker-dealer crossing networks and the more traditional MTF/exchange provider model started in very different places. Broker-dealers crossing networks evolved as an efficient means of matching business that has gone on for many years and just became increasingly automated. Only since 2007, have brokers given clients access via a thin algorithmic layer to their resident liquidity in Europe, and started to classify all of the crossing taking place therein as occurring in their “dark pool”.
This highlights an important potential distinction in what a pool is trying to achieve, and therefore what value it can offer to participants. Pools attached to lit trading venues can offer hybrid order types and on-routing services to try and capture SOR order flow as it is routed to market. Broker-dealer pools (both internal and MTF) will seek “blockier” flow that is typically latent on an order blotter, not being executed by a working strategy.
Nomura became the first broker dealer to launch their dark pool, NX, as an open access MTF in January this year. The key reasons for this were to increase post-trade transparency for the dark pool, and open the access to all market participants to attract an increased activity. But this is not a new precedent that must be followed by all other broker dealers. Firms may be disinclined to do this to protect the value of their internal liquidity, as has been the case for the broker dealer community historically.
2010 in the dark pool space may well see additional brokers announcing MTF launches, but most focus and most value, should be gained from the advent of third party dark liquidity aggregation services that can achieve a greater breadth of access than any single broker can offer. Turquoise/LSE/Baikal and Chi-X have already announced / launched products in this space.
So for 2010, we’ll see MiFID II being on the agenda for most industry events and written about in print. Addressing some of the limitations and ambiguities mentioned here will certainly be part of the objective, but a significant amount of attention will also be focused on expanding the asset classes under coverage. Exchange Traded Funds (ETFs) and Option markets will be reviewed, as well as Fixed Income securities. Dark pool evolution will continue and with the regulators increasing their understanding of the space over the last year, there is significant potential for innovation to accelerate, but it will remain in the focus of the EC. Improvements in post- trade data clarity would probably provide the biggest tangible change for the buy-side, which by itself is a huge topic that needs continued focus from all participants.