Trading US Stocks European Style – 20 April 2010

Few can have missed the announcements from the LSE’s Turquoise and NYSE Arca Europe that they will each soon begin trading US stocks. Both venues will aim to attract the HFT/algo community which will be able to exploit differences in prices between these platforms and their US counterparts. On this point, the Turquoise plan is particularly aggressive as it will allow users to trade for free initially. This shows just how determined senior management at the LSE Group really are, not just to win back market share but to really get on the front foot in the battle for liquidity. Certainly David Lester, the new Turquoise CEO, sees Turquoise as just the right kind of vehicle they need to help achieve this and introduce new business models quickly.

The interesting thing in all this is whether any such trades fall within the remit of MiFID or not. Obviously US stocks are not included within the CESR list and so it would seem that they should not fall under any kind of MiFID best execution requirement. On the other hand they are being traded and cleared in Europe and so it seems unlikely that any such transaction would come under the aegis of the SEC. Maybe they are exempt from either which raises some interesting issues in the current environment where the overriding view is that we need more, rather than less, regulation. Alternatively, we might see a real touch point on this issue with the very different US trade-through rules having to be interpreted through MiFID style best execution obligations. Not sure that matters for the HFT boys but I guess retail punters like me will be able to ask that pesky MiFID question again next time we want to buy some more stock in Apple or Google.

Anyway, NYSE Arca Europe and Turquoise should be commended for coming up with new ideas that the incumbent MTFs might find hard to challenge. I wouldn’t be surprised if they started to flex their multi-asset muscles further in this respect too.

Less haste more speed – 8 April 2010

Quite a lot has been written over recent weeks about the London Stock Exchange’s market share and last week helped to clarify some of the issues. Prior to this period the LSE had enjoyed a temporary boost in volumes driven by the triple witching hour on March 19th when many traders go to the LSE in order to cover their equity options positions. But this was just a small kink in the underlying trend which shows the fragmentation of FTSE 100 stocks seemingly on a never ending incline. The winners last week were, of course, Chi-X (26.5%) but BATS Europe is also steadily moving up the rankings and accounted for just over 10% of the FTSE 100.

To be fair, it probably makes sense to add the Turquoise volume back to the LSE as they are now its majority owners but, nevertheless, the trend appears to be almost irreversible. Further analysis, however, shows that this might not be the case. Instead of looking at actual market share take a look at average trade size and value. Last week both the LSE and Chi-X executed nearly the same number of trades in FTSE 100 stocks (just over 1.1 million each) yet the average trade size and value of the LSE trades was over twice those on Chi-X. The difference in trade size was even greater between the LSE and BATS Europe.

The newer venues appear to have been successful in attracting smaller order sizes which, typically, are associated with larger orders that have been sliced and diced algorithmically or generated by the high frequency players. Given that the average order size in FTSE 100 stocks has fallen steadily, it looks like Chi-X and BATS have been especially successful in appealing to these market participants. To play in this game, of course, you need to be able to offer a very fast matching platform. It makes perfect sense, then, that the LSE is going full steam ahead to implement its new low-latency platform, Millennium Exchange, in September.

On a separate note, I took part in a lively debate at Q15’s London Service Providers’ Quorum last week. One of the big themes for discussion was the continuing dissatisfaction amongst buy-side firms trying to achieve best execution within Europe’s fragmented markets. Seems there’s still a way to go yet in meeting this challenge.

Smart Routing: The Sat Nav of the Trading World – 18 March 2010

A couple of people have pointed out to me that the dial seems to be really moving now in terms of fragmentation across the Nordic region. A quick look shows that Stockholm’s share of the benchmark S30 index has now fallen to around 72% and that the FFI for the same index has shot up by 15% just since the beginning of the year. We’re also seeing a similar situation in Copenhagen where fragmentation has grown 20% since January as well. Seems like there are two forces at work here. First, as more trading firms implement smart routing technology then more liquidity leaves the primaries and is traded on the cheaper alternative platforms. This then creates a kind of ‘perfect storm’ whereby the liquidity grows on these platforms making them even more relevant in terms of becoming destinations for best execution. The second is education. More and more buy-side firms – both retail and institutional – are asking their brokers “the MiFID question” in terms of revealing the different venues their brokers considered when executing an order. And, brokers themselves are reaping the commercial benefits through offering more sophisticated smarter venue access.

Much like Sat Nav, smart routing seems to have evolved from a high cost, high tech gadget (that you show off to your friends) to a standard feature found on most quality order management systems. It also comes in a number of different flavours to suit different trading needs and budgets. Both pieces of technology have transformed the way people operate. For someone like me, who regularly ferries his kids to different sporting events at the weekends, Sat Nav has been a godsend. No more getting lost or having to remember badly written instructions – just type in the objective and let the technology do the work! The same is true for smart routing, especially as it allows traders to simply enter a trading objective and then let the computer work out the best route.

Judging by our last readers’ survey, it appears the fragmentation community likes the concept of auctions with around 60% coming out in favour. This was despite Olof’s comment on my last posting that highlighted just how important they are for the primary venues. Either way, the concept of auctions is a guaranteed way to funnel liquidity towards a particular venue as SOR technology will always direct flow to an auction if it’s available. It’s a bit like programming your Sat Nav system to follow only motorways and ignore alternative routes. On this point, maybe the alternative venues should get together and see if they now have enough collective liquidity to create their own alternative auction.

Anyways, I think I’ll ask the boys at Fidessa Labs about building me an SOR app for my iPhone.

Freaky Fridays – 4 March 2010

A few of us here at Fidessa Towers have been wondering about the spiky path fragmentation has taken over the past year or so. Whilst the overriding trend is upwards there have been a number of times when the rate of fragmentation has suddenly dipped only to recover its upward trajectory the next day. This was particularly evident with the FTSE 100 last month where the LSE’s average market share for February was around 40% and its average trade size was around 2,600 shares. Yet on Friday the 19th its market share suddenly jumped to 53% and its average trade size rose to 3,858. The Fragulator shows similar patterns in previous months when the LSE’s market share suddenly jumps on the third Friday of every month.

The clue as to why this happens could well be in the timing of the jumps, with the third Friday of every month coinciding with the expiry for equity options contracts. It’s likely that anyone in possession of an “in the money” option will seek to take – or force delivery of – the underlying asset (in this case, shares) on that day. This is then associated with a desire to crystallise the gain by liquidating the cash position and so the net result is a huge jump in equity volume traded on these days. The LSE actually facilitates this by having a special intra-day auction on these days and so, as a result, its market share gets a significant boost. Holders of such options seem uninterested in looking at alternative venues for better executions as they have already factored in their gains based upon the LSE’s price. I guess it’s a bit like finding out you’ve got a winning lottery ticket – you don’t really care what the cost of the cab ride is to go and collect your winnings.

If this analysis is correct then it’s another example of how the primary exchanges can use the concept of auctions to their advantage and effectively close out the alternative community. Obviously auctions are a useful and necessary part of an orderly market but the problem is how to make them work in a way that is fair to all venues concerned. BATS Europe, for example, has tried to introduce its own concept of an opening auction although this has met with limited success to date.

Anyway, this seems like another good “ask the audience” opportunity:

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Finally, thanks to Electronic Broker for your comment on the last blog, Tick Tax. It raises some interesting points about the risk of overburdening the provision of market data and the source of competitive differentiation between the primary and alternative venues which I’ll be exploring in more detail shortly – stay tuned.

Tick Tax – 25 February 2010

Just returned from a very stimulating week in Japan where I was asked to present on High Frequency Trading and global fragmentation at the Japan International Banking & Securities Systems Forum. There was a great point made by Chuck Chon, CTO of SBI Japannext, when he was asked how his alternative venue differentiated itself from the mighty TSE. Amongst other points, Chuck confirmed that SBI was committed to lower tick sizes as this has the effect of narrowing the bid-offer spread for any particular stock. He went on to say that crossing the bid-offer spread is like a tax that is levied every time anybody (retail or institutional) participates in the market. The challenge, however, is that traditional market makers actually like a wide spread as they are the ones who are effectively charging the “tax” in the first place. High velocity HFT firms, on the other hand, prefer very low spreads as they are constantly in and out of the market.

So primary markets have to decide whether to maintain a higher tick size, which keeps their traditional market makers happy, or bow to the pressure from the HFT community. This reminded me of a similar debate in Europe and especially in the Nordic market where NASDAQ OMX Nordic only reluctantly agreed to reduce tick sizes when they came under stiff competition from the MTF community.

This whole issue seems to highlight the differences between the traditional business models for equity trading and the new world order that is emerging. The bizarre thing is that, at least in the case of tick sizes, the interests of the HFT community and the retail punter seem very well aligned.

Anyway, my thanks to everyone at Fidessa kk in Japan and especially to Hiroshi Matsubara for being such a great host and guide.

Jumping the Queue for Order Flow – 19 February 2010

A couple of announcements have caught my eye over the past few days. This week saw the launch of a smart routing service called CYCLE from BATS Europe and, last week, I was at a seminar in Stockholm where Turquoise’s Adrian Farnham presented its own liquidity aggregation service – TQ Lens. Both of these announcements highlight how venues are starting to overlap with other players in their continual quest for order flow. The rationale is simple – by offering to onward route any order that doesn’t match on their own platform, these operators hope to encourage more people to use their service in the first place. It’s a tricky game though and potentially takes them into the space occupied by the broker community, i.e. finding the optimum destination for their customers’ orders. Of course, the brokers are offering matching platforms too – in the form of their own dark pools – that aim to provide more effective executions for some types of order flow. The net result is confusion over whether you are using any such service as a destination, as a smart route to other destinations, or both.

This raises some interesting technical challenges as any particular order may run through a number of potentially different pieces of smart routing kit before it reaches its final destination. It’s not obvious how the “smart” decisions made at the beginning of the order’s lifecycle will persist through these other systems (especially if they’re from different suppliers). This is different from the situation in the USA where Reg NMS forces venues to onward route any order that it cannot match at the NBBO (National Best Bid and Offer) and so there is an agreed standard for how venues operate in this space.

Whether you are a broker or a venue the objective is the same – to move ahead of your competitors in the queue for order flow. In the absence of any defined rules as to how to play the game it’s not surprising that both brokers and venues are looking to jump the queue any way they can.

Latency Wars – The Empire Strikes Back – 5 February 2010

Few can have missed the announcement this week that the LSE’s new low latency platform, Millennium Exchange, will be up and running in September. This comes just months after its acquisition of the Sri Lankan firm, Millennium IT, which supplies the technology and is testimony to the new thinking now taking place at the LSE. The same news item also mentions that the LSE has adopted a “self certification procedure” for the transition which will place the onus on the trading community to ready itself for the new platform. This is a canny move by the LSE as it enables them to regain the initiative and, at the same time, set the agenda for its members and technology partners. This is because both will need to focus on ensuring an orderly transition to the new platform between now and the go-live date.

Jeremy Grant’s article on FT Trading Room earlier this week highlights what all the fuss is about: latency and the growing number of High Frequency Traders who supply more and more of the liquidity in today’s markets. Whilst we can all debate whether the HFT phenomenon is a good or a bad thing, they are most definitely here to stay and have been a fundamental force in fragmenting liquidity both in the US and in Europe. Now that Tokyo has joined the low latency debate with the TSE’s new arrowhead platform it will be interesting to see if this ignites the fragmentation fuse in Asia too.

This headlong rush to low latency must of course be accompanied by due consideration for resilience and failover. Most technologists agree that there is a basic trade-off between speed and resilience – the faster you go the harder it is to put the car back on the track if something goes wrong. In the US, this is much less of an issue as the rest of the market provides resilience in the event of a glitch at any one venue. As we have seen in Europe, however, the lack of a consolidated tape and other factors mean that trading seems to simply stop in the event of an outage at a primary exchange.

On this point, it was interesting to see the results of our own poll on how best to solve the current issues surrounding the lack of a European consolidated tape. 60% favoured a collaborative approach as opposed to more regulation. With the stakes so high, and so many vested interests, it will be a great achievement if we can solve these issues ourselves without more “help” from the regulators.

The Luck of the Irish – 27 January 2010

Looks like it’s Ireland’s turn to run the gauntlet with the MTF community. Pretty much all the MTFs – Chi-X, BATS, NASDAQ OMX Europe and Turquoise – have announced that they will be trading Irish stocks from now on. For this reason we have now included the Irish Stock Exchange (ISE) and its accompanying index (ISEQ) on the FFI website. A quick look revealed that many Irish stocks are in fact traded on the LSE and so Dublin’s market share of its main index is less than 30 percent already.

This is a good pointer to the decoupling that is occurring between indices and their parent exchanges. In Dublin’s case it’s got nothing to do with MiFID but the simple fact that the LSE is the bigger marketplace for some of the large cap Irish stocks (which make up the ISEQ index). For other indices, such as the FTSE 100, the CAC 40 and the DAX, we are slowly but surely seeing them decouple from their parent exchanges and start to exist in their own right. The more this continues to happen, the happier the MTFs will be as this helps to break apart the concept that any given stock or index should “belong” to a specific exchange in terms of trading.

As this process continues, country-specific indices may become less relevant as we are all increasingly forced to adopt a more pan-European perspective. In time the S&P Europe 350, the FTSE Developed Europe Ex UK Index or sector-specific indices like the Dow Jones EURO STOXX® Telecommunications index may well become more relevant than the current crop of country-specific indicators.

I guess when this has happened you could say that MiFID will have done its job in terms of breaking down the national monopolies in equities trading across Europe.

Is it all over for Dublin as far as keeping hold of its current market share of ISEQ stocks? So far it’s too early to tell and, of course, there is nothing to stop the ISE reinventing itself as a pan-European venue and taking on the MTFs at their own game.

The T Word – 20 January 2010

It was interesting to watch Andrew Bowley’s video interview on Finextra regarding the launch of Nomura’s dark pool – NX. It helped crystallise the love/hate relationship between dark pools and the T word – Transparency.

Andrew Bowley made a good point about how the pursuit of MTF status for NX had been going on for a long time and wasn’t just a knee jerk reaction to the increasing regulatory pressure on the dark pool phenomenon. He also talked about how greater transparency was a good form of advertising for his brand and would help attract customers. This would seem to be the case, too, for Instinet’s dark pool – BlockMatch – which went down a similar MTF route. Other dark pool operators don’t quite share Andrew’s view on transparency although this is a function of their diversity rather than any attempt to be necessarily opaque. On both sides of the Atlantic there is a wide array of activities being labelled dark pools, all of them offering different services aimed at different market sectors. In the US, for example, dark pools operated by GETCO and Knight are market maker dark pools where the pool operator is always taking the other side of the trade. Others, like Liquidnet, are buy-side only crossing networks. In yet another category are the venue operated pools such as Chi-Vision or the LSE’s Turquoise (nee Baikal) that offer aggregation services by providing dark SOR connectivity to other dark pools. And, finally, there are the broker-owned dark pools such as SigmaX (Goldman Sachs) and Crossfinder (Credit Suisse). This is what is causing the regulators such a headache as it’s impossible to regulate effectively in such a diverse environment.

This is all part of a wider transparency issue in Europe that revolves around the lack of agreed standards for pre- and post-trade market data. I have commented a few times that an industry derived solution would be better than anything imposed from above. This, however, requires that industry players adopt a grown-up approach and collaborate when perhaps their instinct is to try and compete. With this in mind, it was interesting to read the European Data Consolidation paper sent to me by Andrew Allwright at Thomson Reuters. While it naturally has a Reuters sales bias it does succinctly highlight the issues and make a number of sensible recommendations that could form the basis of a long term solution. I’m not sure that all the proposals outlined will work in practice but this is a community problem and I believe we should be working together to resolve it. Naturally it will require some discussions about the detail.

Anyway, this seems like a good time for another “ask the audience” moment.

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Fragmentation Fever Goes East – 6 January 2010

Looks like 2010 is going to be a pretty interesting year in the battle for liquidity between the established exchanges and the more recently established MTFs and dark pools. It also looks like fragmentation fever is likely to spread eastward, too. This is being driven by a number of factors that include technology, regulation and commercial opportunism. The introduction this week of arrowhead by the Tokyo Stock Exchange will bring the performance of the TSE more in line with global standards and so open the door for the High Frequency community and brokers that can exploit microsecond price movements. This, in turn, will encourage the growth and use of PTSs (the Japanese equivalent of America’s ATSs or Europe’s MTFs). Currently PTSs only account for a fraction of Japanese equity order flow but the ability to arbitrage between them and the TSE may well provide the stimulus the market needs.

Meanwhile, the regulatory picture in Australia is set to change now that the Australian Securities and Investments Commission will have the ability to grant new exchange licences. This will open up its domestic market to other competitors and so allow Chi-X Australia, AXE and other alternative venues a realistic shot at gaining market share. Given that trading volumes are smaller than in Europe or the US, however, it will be interesting to see how much fragmentation the domestic Australian market can take and it would seem that any alternative venues will need to attract flow from other Asia Pacific countries in order to be truly viable.

The Singapore Exchange and Chi-X Global have joined forces to create the first exchange-backed dark pool in the Asia-Pacific region which will compete with the global dark pools already operated by the big banks. Put all these things together and they might be enough to set off a wave of fragmentation in that region. As we’ve seen in the US and Europe, once the change happens there’s no going back. Countered against this, of course, is the argument that without a single regulatory mandate for change across the whole region, the domestic incumbents should be able to fight off the newcomers one by one. This was certainly the case in Europe pre-MiFID where a number of well constructed initiatives (anyone remember Jiway, for example?) failed to wrest liquidity away from the primaries without the help of a regulatory imperative behind them. On the other hand, maybe the events of the past few years in the US and Europe have changed the trading landscape forever and so it is simply a question of time before we see a similar, fragmented, situation across the Asia Pacific region. Perhaps the biggest driver for change, however, will come from the big banks and brokers themselves. Having invested such huge sums in SOR and dark pool technology they will be keen to leverage this investment every way they can.