Following the European Union's adoption of the Markets in Financial Instruments Directive (MiFID), multilateral trading facilities, or MTFs, have proliferated in Europe to compete with traditional exchanges. But can so many platforms survive?
Pundits predict a shakeout in the space over the next nine months. And that timetable seemingly was accelerated when Turquoise experienced a serious drop in its volume in March after its liquidity agreements with market makers expired. Meanwhile Nasdaq OMX Europe has failed to gain the volume it anticipated, despite offering a low-cost, high-speed platform. The MTF began trading pan-European securities in September 2008.
While speculation about consolidation among the MTFs may be premature as many of the alternative trading systems only went live in the past six months, it's inevitable that winners and losers will emerge, and the trading venues already are striving to differentiate their business models, compete on rebates and, most of all, generate better prices than the exchanges in order to attract liquidity. But what will it take to attract order flow from brokers and buy-side institutions?
Several MTFs already have begun to capture market share in blue-chip stocks away from the incumbent exchanges, and fragmentation has begun to occur. Chi-X Europe has emerged as the front-runner with nearly 20 percent market share in the U.K.'s FTSE 100 blue-chip index; BATS Trading and Turquoise, however, also have made key inroads.
Peter Redshaw, a research VP in Gartner's Banking and Investment Services research group focused on Europe, the Middle East and Africa, stresses that the MTFs that launched after Chi-X need some differentiator or incentive to attract order flow. "The newer ones have to be as reliable or better -- they've got to be as fast or faster," he says.
For instance, Turquoise recently enhanced its rebates to rebuild its market share. And Neuro Dark, the pan-European dark pool from Nasdaq OMX, announced that participants in its MTF would qualify to purchase up to 1.3 million shares of Nasdaq OMX Group if they met certain volume thresholds.
Where the MTFs have the edge over exchanges is in their low-cost structure. They resemble IT companies, suggests Gartner's Redshaw. "They don't have a big, fancy building," he says, conjuring images of the NYSE's neoclassical columns. "It's basically an IT operation with the requisite licenses, and it may have a staff of 50 that do marketing and strategy."
But low costs and state-of-the-art IT alone will not determine the fate of the MTFs. It's more likely that a combination of factors will influence which MTFs survive and which are sold and merged into one of the other contenders.
Unlike in the U.S., where Reg NMS dictates best execution requirements, European traders don't have to go to an MTF because it has the best price, notes Miranda Mizen, principal at TABB Group. Price, speed, reliability, quality of execution, rebates, and cost of clearing and settlement all factor into order routing decisions, she says.
"Connectivity will be an important factor as well in seeing whether the new entrants will be able to eat into the Chi-X lead or not," adds Gartner's Redshaw.
In the current financial climate, sell-side firms likely will begin to question whether they should link to the ever-proliferating stream of MTF startups, according to John Barker, managing director for Liquidnet Europe, Middle East and Africa. "Whether you are a buy-side or major sell-side firm, you're looking at your budgets and starting to be more choosy about who you connect with," he comments.
Liquidnet's block trading system has been operating in Europe for seven years as an alternative venue and reclassified as an MTF after the emergence of MiFID. It has the advantage of sweeping order management system blotters, enabling buy-side firms to directly access its negotiated block trading pool. But as buy-side firms takes more control over their executions, they are expected to connect to the other MTFs directly as well.
For now, however, the trading occurring on MTFs is mainly an arbitrage and rebate game. In fact all the MTFs have set up their matching engines in London to minimize the latency for participants. After all, European MTFs entered the market promising to be cheaper, faster and more reliable than the exchanges. While that still appears to be their strategy, they had better find a way to deliver on that promise soon, or they may face extinction.