Exchange Wars
Seven global brokers (Credit Suisse, CitiGroup, Deutsche Bank, Goldman, Merrill Lynch, Morgan Stanley and UBS) are to start a de novo pan-European Exchange to rival the more geographically-oriented existing entities. According to the Financial Times, these players currently control over 50% of existing European order flow and would absolutely create a credible threat to the current exchange infrastructure as well as the proposed linkages of the NYSE/Euronext and NASDAQ/LSE.
This announcement is one more step in the push by the brokerage community to regain control of its order flow, increase execution efficiency and reduce the cost of global trading.
Initially, exchanges were utilities, where brokers could meet, discover supply and demand, and trade. With exchange demutualization, exchanges now serve their stockholders rather than their constituents. Becoming publicly owned creates the need to grow revenues, cut costs, consolidate, raise prices and reduce research and development, which we are beginning to see either in the US or Europe, or both.
This is not good for the brokers. They are on the other end of exchange price increases, service reduction and the need to grow revenue. Not only are they unhappy about recent price increases or service cuts, they resent it, especially since they control/direct a significant amount of exchange order flow, hence the desire to create a new marketplace.
While the US is worried about NASDAQ and NYSE controlling execution, in Europe the problem is not only execution, but also clearing and settlement as exchange ownership of depositories limits inter-exchange competition. However, two events may change this.
The first is an announcement made by the EU Commissioner for the Internal Market and Services, Charlie McCreevy, on an agreement by European Exchanges and Depositories to provide more open access; and the second is an announcement by the DTCC on the launch of its Trade Information Warehouse, which creates a centralized and secure global infrastructure for the post-trade processing of over-the-counter (OTC) derivatives. While this initiative is currently only for OTC derivatives, the press release goes on to add, “Initially, the warehouse will support credit derivatives, and then extend to other OTC derivatives products including rates, equities, FX and commodities.”
Maybe I am reading this a little too literally, but couple the DTCC announcement with the announced consortia, and you have the bulge bracket brokers complaining about cost and developing a new pan-European exchange to reduce execution friction, and a low-cost quasi-public depository/utility opening up for business in London. If I were an exchange/depository in Europe, I would be concerned.
The bottom line is: Europe is up for grabs. Just as the US OTC equity markets were thrown into turmoil by the 1997 Order Handling Rules, and the US-listed business is up for grabs under Reg NMS, now Europe is the battleground as MiFID changes the ground rules, global exchange consolidation looks inevitable, and new pan-European exchanges, depositories, and clearing business are being announced daily. While we do not know who will win, one thing is certain: competition creates activity, and in this market, activity will be a good thing for all investors.