THE HONEYMOON IS OVER.

The screw is turning and MTFs now have to prove their staying power. Mary Bogan reports 

The tables have turned in the marketplace for execution venues in Europe. Caught on the back foot by the arrival of a pack of leaner, hungrier, techier and cheaper MTFs it’s not long since traditional exchanges looked like sleeping dinosaurs in the revolutionary new trading landscape created post-MiFID. More recently, however, it’s the alternative trading venues, not the exchanges, who have found themselves fighting a rear-guard action.

With business plans that were written for more buoyant times, many MTFs have found the going tough in subdued equity markets. In 2010, NASDAQ OMX Europe closed its doors for good while Turquoise, the trading platform set up by banks in competition to the London Stock Exchange (LSE), was bailed out by its arch rival. More recently, Chi-X Europe fell to BATS Global Markets then, in October, the Nordic-focused platform, Burgundy, was sold to Oslo Bors.

Even after this major consolidation the environment is still challenging. Over the last year, BATS’ market share in FTSE 100 stocks, for example, has fallen from 40% to around the 30% mark and, with indications that business is flowing back to the LSE, the young pretender has been forced to come up with new strategies to drive up revenues.

“What the new guys did was create a commoditised marketplace in trading equities,” says Hugh Cumberland, solutions manager with technology provider, Colt. “That worked when volumes were high but this is a new market scenario. The challenge facing all MTFs now is to figure out how they can innovate to make money out of a commoditised service, or how they can create or acquire new added-value businesses. But without deep pockets, that’s going to be tough. Diversification is a capital-intensive strategy.”

Innovate or die

Continued pressure on pricing, and innovation in the trade and post-trade space, will be key strategic goals for BATS Chi-X going forward, according to chief executive Mark Hemsley. But that hasn’t stopped the venue announcing effective price hikes in trading fees as it grapples with difficult conditions. From January, under changes to the “market taker” scheme operating on its two ‘lit’ books, BATS will no longer offer a rebate to customers adding liquidity to BXE, the old BATS Europe platform.

Traders taking liquidity will be charged a fee of 0.15 basis points, a removal rate which, BATS claims, is the lowest in Europe. Meanwhile, for adding liquidity to CXE, the old Chi-X order book, participants will receive a lower rebate of 0.15 bps while the 0.30 bp fee for removing liquidity remains the same.

Squaring the circle, says Hemsley, is about offsetting price increases with new ways to trade. “Whilst we do want a higher margin out of both books, we haven’t just raised prices. We’ve also been innovative in how the books are structured so we can put pricing pressure on different parts of the market. We’re proposing a different theory about how our books work and how customers interact with them,” he adds.

In tandem with pricing changes, BATS has also created new order types that allow traders to ‘sweep’ the two books. It means orders not filled on, say, BXE can be directed straight to CXE.

“What we’re saying is: try to get filled at 0.15 but, if you can’t, we will automatically send you straight to the other book and you will execute at 0.30. We were the first to offer this dual book structure but, before, they were just the original BATS and Chi-X books moved onto new systems. Now we’ve used pricing in an innovative way that not only differentiates between the books but also creates new order types to help customers access the books in a way they would logically if removing liquidity. The changes also leave posters of liquidity with an interesting decision too. They can either go for a rebate on CXE, or they can get a first look at liquidity on what maybe a less-busy BXE book, and stand a better chance of getting to the front of the queue to interact with the flow.”

Innovation in execution isn’t the only area of focus for BATS Chi-X. It is also in the post-trade space, following the introduction of four-way interoperability on its platform, is designed to drive down post-trade costs and make consolidation in the CCP market, easier, less risky and less costly to achieve. The firm has also turned its attention to the high cost of market data charged by the incumbent exchanges.

In October, BATS started charging for market data in a move some observers interpreted as another sign of a struggling firm. However, the change, says the firm, is more about provoking the argument on high data costs, a major barrier to a consolidated tape, than earning revenue. By showing it can charge a price for data that covers a significant part of the European market, BATS is hoping to exert pressure on exchanges to unbundle data packages and lower prices.

The decision though by BATS Chi-X to apply for a licence, and become a fully-fledged exchange, is probably the clearest sign yet that the writing is on the wall for the old MTF model. If given the go-ahead, BATS would be able to trade in derivatives contracts, compete for retail investors and challenge the LSE for listings business. It would also stimulate more flow from conservative fund managers whose mandates require they trade solely on licensed exchanges.

The jury is out

According to Peter Lenardos, an analyst with RBC Capital Markets, this latest move, which is part of a series of growth initiatives undertaken by BATS since its failed IPO in the US in March, makes sense. “This seems like a natural progression for the company to legitimise its business,” he says, although he expects it to have little impact on LSE’s market share.

However, as BATS’s transitions from Young Turk to establishment player, the need for a new trading organisation that can kick up some dust again is pressing, says one of the men who led the MTF revolution, the former chief executive of Chi-X, Alasdair Haynes. Heading a new MTF, Aquis, which plans to launch next year, Haynes says recent price hikes are just one indication that competition is weakening.

“The duopoly has become the pervasive model in Europe’s markets. Over 95% of all business in the UK, Germany and Switzerland, for example, is shared between two venues – BATS and the national market. Duopolies may be marginally better than monopolies but it’s not what regulators or the MiFID regulations had in mind. What we’re offering is a brand new business model with a brand new pricing structure designed specifically for the austerity age.”

The big idea behind the Aquis model is to turn trading into a utility business. In just the same way as mobile phone companies charge different prices for different packages, so the Aquis plan is to charge a monthly flat fee for connection and then a set fee relating to usage only and not the value of the share traded. “There is no reason why what you pay is linked to the underlying value of the equity. Why should it cost more to trade a Glaxo than a Vodafone when the underlying cost of the message is the same?” says Haynes.

According to Haynes, the “revolutionary” pricing model will result in “a significant lift in volumes, attracting business from mainstream investment banks, high frequency traders and mid-tier brokers and, in time, innovation could spread to other underlying asset classes.

Whether there is room for a third player, and whether a new MTF can succeed where others have failed, remains to be seen, says Steve Grob, group strategy director at Fidessa.“What is evident to date is market participants don’t want five venues; so far, they’ve preferred one primary and one alternative. The interesting question now is, with BATS raising prices and starting to charge for market data, will the marketplace decide it wants three venues – a primary, a pan European and a small domestic MTF that makes sure the big guys don’t run away with themselves. Can a new venue do to BATS Chi-X what BATS Chi-X did to the LSE? My feeling is it won’t be easy and it will probably need more than just cheaper pricing. But it’s not impossible.”