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MiFID Brings New Trading, Data Management Opportunities

January 1, 2007
By Chris Kentouris

Judith Hardt, secretary general of the Federation of European Stock Exchanges, says that the jockeying for position among European exchanges and their increasingly feisty member firms is "like playing chess with all the pieces moving at the same time."

The game is being redefined by the Markets in Financial Instruments Directive (MiFID), which requires that firms offer their clients best execution-a concept that incorporates not only price, but also speed, certainty and costs of clearing and settlement. The directive eliminates the concentration rule that forces trades in a number of European countries to be conducted on national exchanges and gives rise to a new category of players called systematic internalizers, which can match trades on their own books.

The European Commission sees MiFID as central to its efforts to break down barriers to cross-border securities trading and usher in a single European capital market. Until recently, "much fanfare has been made about the mega costs of complying with the directive," says Graham Bishop, a London consultant specializing in European Union legislation. But Bishop, who recently wrote a report commissioned by consulting firm LogicaCMG on business opportunities related to MiFID, believes that its provisions create an attractive opening for "new high-speed trading platforms."

As the November 2007 deadline for MiFID implementation looms for the 25 European Union member states and three nonmembers, investment firms are showing a willingness to challenge the dominance of established exchanges. Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs Group, Merrill Lynch & Co., Morgan Stanley and UBS-under the banner of Project Turquoise-in November announced plans to form a joint, pan-European trading platform. Together, the seven banks account for more than 50 percent of share-trading volumes on the London Stock Exchange (LSE). All are also backers of an alternative trade reporting facility that came together this past summer, code-named Project Boat.

There's more: Chi-X, a multilateral trading facility built by global agency brokerage Instinet, has introduced trading in U.K., German and Dutch equities. Equiduct, led by former Dresdner Kleinwort Wasserstein director of IT strategy Robert Fuller, is using the technology of the defunct Easdaq and Nasdaq Europe to create a new electronic, pan-European trading platform, planned to launch in the second quarter of 2007.

These initiatives come as the major European exchanges, not least the LSE, are fielding or making takeover bids and facing competitive pressures that are exacerbated by the new entrants. The track record of upstart trading systems from the dot-com era is spotty-Jiway, a joint venture of Morgan Stanley and Stockholm's OMX, failed, and London's Tradepoint was absorbed into the SWX Group's virt-x-but times have changed, the memberships are resolute and the exchanges have little choice but to take notice.

Competitive Response

"Our investment in technology and trading services continues to reduce the cost of trading markedly for all investors," LSE spokesperson John Wallace said in reaction to Project Turquoise. "Since the 1997 introduction of [LSE trading platform] Sets, the average weighted spread of shares in the FTSE 100 has been reduced from 96 basis points to 14. The London market is already open to competition with the existence of various trading venues."

Paris-based Euronext, which has a merger agreement in place with NYSE Group, parent of the New York Stock Exchange, has said that it expects to cut its fees by upward of 15 percent after the merger, while Frankfurt's Deutsche Borse said it would not be "greatly affected by the competitor."

"It was inevitable that banks would try to create connectivity with their peers in these types of projects, but what is remarkable is how quickly they were organized before MiFID takes effect," says Ralph Silva, senior analyst in the Paris office of research firm TowerGroup.

The question now: Can Europe afford to support all the national exchanges plus new trading facilities that are likely to emerge post-MiFID? Presumably, trade flows will gravitate toward venues that are not only cheaper, but also faster and more cost-effective, facilitating best execution and providing an array of services around pre- and post-trade transparency.

"There could be some consolidation among exchanges, or they could be forced to offer some new services," says David Brown, an associate partner in the London office of consulting firm

Adds P.J. Di Giammarino, chief executive of JWG-IT, a London-based capital markets think tank specializing in MiFID preparations, "The [exchanges] have a distinct advantage over the new ventures, and a lot will depend on how much they will reduce their fees. It won't be easy for anyone to shake their dominance, but brokers are certainly having a lot more leverage than they did in the past."

Bishop projects three possible scenarios for how the European landscape will shake out under MiFID: retention of the status quo, in which exchanges are the dominant providers of trading liquidity; the rise of a few systematic internalizers; or the coexistence of a few exchanges and systematic internalizers.

Observers agree, however, that aside from the merits of systematic internalization, some of the largest investment banks could easily offer their smaller peers a soup-to-nuts or à la carte menu of trading and data-dissemination and -storage offerings to assist in MiFID compliance. Such services might be particularly useful to private banks, retail broker-dealers and even fund managers looking to off-load their compliance with MiFID to their executing broker-dealers.

MiFID is also shaking up the status quo in market data. The directive obligates all firms to report post-trade data to any public arena-not only to their local exchange-within three minutes of a transaction's completion and to store data on competing prices to prove best execution. Systematic internalizers must also publish pre-trade quotes for "normal size" orders in a public venue in close to real time. In doing so, firms can charge for data dissemination at a reasonable commercial rate.

Data Costs

The seven investment banks in Project Turquoise plus ABN Amro and HSBC signed the letter of intent to create the Project Boat trade capture and market data dissemination platform by August 2007. "The opportunity for investment banks to capture, pool and disseminate their own market data has been there for a very long time," says Andrew Miller, managing director of Arcontech, a London-based market-data software specialist. "MiFID has just become a catalyst for brokerages to [develop] their own market data communities."

Project Boat aims to reduce the cost of managing data, as participants can save on trade reporting fees and share IT costs in addition to selling their own data dissemination and reporting capabilities. Second- and third-tier players may not be able to handle their own data management responsibilities under MiFID, which some analysts have estimated could cost upward of EUR200,000 ($262,000) annually. Whatever route investment firms take in response to MiFID, the data challenge is at the heart of it all, they say.

Project Boat targets LSE in particular, because in the U.K., market participants must report over-the-counter trades to the exchange, which collects fees for trading reporting and generates further revenues by collating and selling the same data back to its members and information vendors they use. LSE does not break out its fee income from data services, but analysts have cited figures of GBP10 million ($19.3 million) annually from trade reporting alone.

Members of the Project Boat consortium have declined to be interviewed and disclosed little about how the platform will work or who is providing the underlying technology for handling 4,000 to 5,000 trades a second, according to knowledgeable sources. Contenders likely include Telekurs, Reuters, Bloomberg and Thomson Financial. Members of a separate initiative under the real-time market data subcommittee of the MiFID joint working group, which has just released a final model for pre- and post-trade data dissemination, define Project Boat as a data aggregator.

"The real-time data group has recommended that firms send their pre- and post-trade reports to intermediaries known as data aggregators, which will in turn pass along that information to data distributors such as information vendors," said Richard Gissing, president of Gissing Software in Kent, U.K. "It is unlikely that systematic internalizers will take on the role of data aggregators, but exchanges and consortia such as Project Boat could do so."

Gissing Software and Arcontech are in discussions with members of Project Boat to provide links to each other and to data distributors. "There will be a lot of opportunity to create a more level playing field and bring an end to market data being available from only one source," says Arcontech's Miller.