We can observe that regional capitalizations are approximately similar; certainly more so than comparing regional values traded. Why are the values traded so much higher in USA than Asia Pacific? The answer must be, at least in part, due to the mature presence of high frequency automated trading algorithms.
In 2009, for the first time since records began, Asian WFE members, driven particularly in China, recorded more value traded than those in Europe, a signal encouraging international investors further to Asia Pacific.
Aside from Australia, and to some extent Japan, Asia Pacific has yet to enjoy the dramatic surge of on-order book liquidity present in the more “electronically developed” US and European markets. The lesson to learn from Europe is that introduction of more sophisticated automated trading coincides with shrinking trade sizes. In this scenario, contra revenues, i.e. Exchange, and in particular, clearing and settlement fees as a proportion of value traded, substantially can increase.
Introduction of CCP ‘User choice’model is one approach to address this trend, (See Box on next page).
Conclusion
Automated trading drives liquidity growth. A market can increase its attractiveness by reducing frictional costs, enabling flexible automated behaviour, welcoming complementary liquidity pools, and maintaining a level playing field.
With the advent of global CSAs, markets more likely will attract incremental liquidity if they commit to high quality of markets criteria and if they join broker execution networks with clients that have global CSAs.
Figure 3
Progress and proliferation of Cash Equities CCP ‘User choice’
As brokers compete to provide faster execution, reduced market impact, and better results for end investors, the consequence to order books is a trend of increasing number of “bargains” and lower average bargain size. Depending on tariff structures, particularly those correlated with number of tickets, the growth in numbers and thus fees are outstripping growth by value. This is particularly true of the post-trade tariff models. The result can be that brokers processing the same value of client flow can suffer increasing costs of processing that flow year-on-year. This profitability impact is under scrutiny on the sell side.
Clearing and settlement are now priority themes for trading floors. The 2008 Lehman default dramatically highlighted the differences between markets that have, and do not have, Central Counterparties (CCPs).
The result is an imperative to introduce CCPs for markets that do not have them: for example, NASDAQ OMX Nordics launched mandatory CCP in October 2009.
Firms have different business models and profiles of order execution, margin, and collateral.
On 12 Dec 2008, UBS was the first broker to go live with the CCP‘User choice’ model via the LSE. The beauty of the User choice model is that benefits are available to those who elect to switch CCPs, yet those who wish to remain are not forced to change. This competition encourages providers to remain nimble on fees and functionality.
In 2010, the ‘User choice’ model enabled by CCP interoperability is becoming the rule rather than the exception. The landscape map summarises the current position of CCP competition in an increasingly fragmented post-MiFID Europe.
Reading the landscape map
Down the left side are the CCPs that serve more than one EU market, listed alphabetically.
Blue boxes include live dates, where available, from a functional readiness potential. Post the February 2010 announcement by Dutch Swiss UK regulators, some models may require additional time before launching due to additional regulatory review of new interoperability proposals. Across the top,
separated by vertical lines, are:
- Exchanges and MTFs ranked from left to right by largest number of trades using Federation of European Securities Exchanges (FESE) July 2009 year-to-date statistics. The more blue per row, the more markets that can be consolidated by that CCP, with higher weightings of fee saving potential where blue boxes cluster to the left: today CCP fees correlate more with number of tickets than value processed. In fact it is this fixed cost per ticket aspect of CCP tariffs in an environment of shrinking trade size that increases basis point costs to brokers as brokers process the same value of client business. Added to the CCP chart are average trade sizes measured in EUR thousands (EURk) per trading platform. So with average trade sizes for Chi-X at 6k/trade and Detusche Boerse at 12k/trade, broadly it requires 2 trades on Chi-X to process same value as 1 trade on Deutsche Boerse; this impacts the comparative clearing costs associated with Chi-X.
- EU third party dark-pools.
- SecFinex Securities Lending platform majority owned by NYSE Euronext.
- New entrants not yet ranked by FESE.
Note that Burgundy and Quote MTF are planning to start with EMCF and add interoperable CCPs later; Ireland uses a separate instance of Eurex Clearing.
Benefits of User Choice for CCPs
In general, we prefer organic market solutions to those imposed by prescriptive regulation. The commercial benefits of the‘User choice’ model are multiple and manifest:
- Introducing CCP with netting for bilateral markets saves significant CSD settlement fees: x1 per CCP net stock position vs many times each gross stock trade.
- Plugging in once to a CCP that serves multi-markets effectively gets access to the rest of oncoming markets ‘for free’.
- Competitive clearing via ‘User choice’ model encourages incumbents preemptively to cut fees e.g. as we have seen ahead of live dates for new entrant CCPs.
- Different firms may have affinity for different CCPs based on e.g. respective order execution profiles. Firms are not forced to bear switching costs, they have the freedom to choose to do so.
- Competitive clearing gives firms the opportunity to consolidate their multimarket flows onto a single (or fewer) CCP(s) of their choice and offers two more advantages:
- Where a CCP has a volume discount, incremental flow across names and markets saves significant CCP fees; and
- Where a single name trades on multiple platforms with different CCPs, consolidating to 1 CCP saves settlement fees: e.g. if VOD trades on LSE&x-clear + Chi-X&EMCF +Turquoise&EuroCCP, there are at least 3x net settlement fees / VOD reflecting 3 CCP net messages to the CSD; e.g. once a single CCP x-clear cross-nets all of VOD trades via LSE Chi-X Turquoise, 1x net settlement saves 2/3 costs x number of instruments traded.
With average orderbook trade sizes ranging from EUR 4k to 28k on the CCP slide, it is clear that focusing on a cost/trade metric can lead to spurious conclusions; the better basis point calculation enables more meaningful apples-to-apples comparisons. The EU Commission is helping with the critically important Code of Conduct tariff Transparency by encouraging trading and post-trading providers to include value-traded stats on respective fee invoices.
Exchanges that can grow liquidity are successful. Markets world-wide can encourage liquidity for the benefit of end investors by implementing the following priority action requests:
(i) Lowering fees and improving invoice transparency;
(ii) Enabling off-orderbook to complement on-orderbook activity; and
(iii) Offering users a choice of CCP to lower frictional costs and mitigate systemic risk.
