01 July 2004 Features

 

Market movements

US exchanges are adopting the European electronic order book structure, and Europe is moving towards the US settlement model, setting the scene for more competition says David Bannister

Globalisation and automation go hand in hand, so it was no surprise to see that the advent of electronic trading on international stock exchanges led to a rapid increase in cross-border trading in Europe and beyond.

Lagging behind that development has been the creation of a pan-European settlement system, though the EC has pushed for this.

In the US, the move to fully electronic exchanges has only just begun, but because of its size and structure, it has had a unified clearing and settlement system in the form of the DTCC.

On both sides of the Atlantic, the industry is heading in the same direction — unified electronic trading and settlement systems — but from different directions, and this will mean an interesting period of change as the various entities manoeuvre for position.

“The US and Europe are mirror images in terms of their structure. There you have the DTCC and a set of exchanges that are really fiefdoms, and in Europe it’s the reverse, because basically everyone agreed on centralised electronic order books,” says Chris Gregory, director of execution services at Penson Worldwide, which provides execution, clearing, settlement and custody services to broker dealers and private client asset managers in the US, Canada and UK.

“As an industry, we’ve moved on. In Europe we went through this sort of quite boring debate about things like open outcry markets, and we are now electronic pretty much everywhere,” Robin Cave, managing director of equity markets at Merrill Lynch, told a recent industry round-table hosted by Orc Software. “In reality, from an investment banking point of view we created one pan- European exchange a long time ago — as soon as you have one terminal where you press buttons and always route off to different exchanges it feels as if it’s one pan-European exchange. And it’s only the settlement side which tends to separate it.”

In that arena, the prime players — Clearstream, LCH.Clearnet, Euroclear and OM Group have all already made clear their intentions to carve out their stakes in the business, with Euroclear particularly active in the last month (see news, page 7), including the unveiling of its plans for a harmonised platform and its recently-added ability to settle London Stock Exchange trades.

The exchanges themselves are being pretty punchy, with much of the limelight focussed on Chicago, where the Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBoT) have both recently introduced incentive programmes designed to boost electronic trading in the face of the continuing assault from Eurex US since its launch as a fully-electronic US futures and options exchange at the beginning of the year.

“What I find so fascinating about the bit we are at now is I feel we’ve all had a chance to catch our breath. Whether it be looking at Euronext with all the different mergers and combinations they’ve got up to. Now they’re having a chance to stand back and say ‘right, well, what about the marketplace, is the market set up as we want it to be?’” says Cave. “In the case of Eurex they’ve had a look at Europe and decided to take on a battle with the US.”

In that battle, Eurex US has itself announced a package of incentive programs “to further enhance trading activity in US Treasury futures”. Among its offerings to entice participants are a new revenue sharing initiative focusing on high frequency smaller size trading for proprietary accounts that started earlier this month and allows firms to share in 40% of Eurex US’ 2005 revenues and 25% of 2006 revenues, up to $20 million each year.

On top of that, having obtained regulatory authorisations in 11 European countries, most recently in the United Kingdom, it is introducing a European trading hours market making program to persuade participants to provide liquidity during European trading hours.

“Customers have been very supportive of Eurex US and with the receipt of regulatory approval in the UK, the exchange can now connect the European and US customer bases in U.S. Treasury futures,” says Satish Nandapurkar, CEO of Eurex US. “This incentive plan reinforces our liquidity and will help to enhance the diversity of our order book.”

Whatever the outcome of that particular battle, or that between the European clearing and settlement institutions, there is a fundamental change in the market structure occurring, though one that is part of an ongoing process.

“The consolidation of exchange business [in Europe] over the past few years will continue, but not at the same rate,” says Simon Nathanson, chief executive of electronic agency brokerage NeoNet, which offers direct market access to international exchanges.. “There has been successful technical integration and when you have efficient distributors like ourselves, you don’t need to consolidate exchanges. The US exchanges have not moved in the same direction or at the same speed, because they are not fully electronic, although they are becoming more and more electronic.”

Nathanson says that he anticipates the clearing scene in Europe to roughly follow the same trajectory as the exchanges. “First you collaborate on rules and then on technology platforms, then you get some mergers, but there won’t be one European clearing platform — it will get much more flexible, and people will have choices, which is important. In the end it’s the investors that will put the pressure on the brokers and the banks, because they are the ones that are paying for all this.”

Dominic Brutin, chief executive of AtosEuronext, a joint venture company that provides the technology underlying the Euronext exchanges and others, is in agreement with this. “It will be down to competition, and there will be two, or three, maximum.” Pushed, Brutin says that he’d put his money on these being centred on the Nordic regions, Frankfurt, leaving London and Euronext scrabbling over the putative third centre.

Brutin is already looking beyond the US/Europe market, however. “In Asia there is the emerging market in China and the need to open there, where everyone is looking at full electronic systems, and all working on the same systems in terms of rules.”

Back in Europe, Penson’s Gregory says that the settlement market will go through two phases: “First they all adopt Swift messaging, then they head in the direction of some form of consolidation,” he says. “You can see how it’s starting to evolve in the same direction as the US.”

Surely there here are still political and sentimental issues before the European nation states cede ground here? “It makes it more complicated, but investors have no sentiment,” says Brutin.

Gregory thinks likewise: “Politics is what you talk about over dinner. This is business.”