Crossing borders

Sherree DeCovny

Cross-border trading in securities and derivatives has been increasing for years, as investors seek to diversify their risk and enhance returns while issuers look to attract a broader investor base.

According to the World Federation of Exchanges, as of 31 December 2007 the 51 major world stock exchanges had over 45,000 companies listed, of which about 3,200 are overseas (cross-border) listings. But regulatory and cost barriers make it impractical for most companies to list their shares on foreign exchanges. That means investors need another way to tap into opportunities in foreign markets.

To some extent, exchange consolidation is making it easier to access foreign markets. The merger between the NYSE, Arca and Euronext created the world’s largest owner of stock exchanges, and the organisation is getting bigger all the time. In June 2008, NYSE Euronext agreed to buy 25% of Qatar’s Doha Securities Market for $250 million. Then in July 2008 it acquired a 5% equity position in the Multi Commodity Exchange, India’s largest commodity derivatives exchange.

Post-merger, NYSE Euronext has been burning the midnight oil to simplify and merge its many technology platforms. Its goal is to reduce operating costs by $250 million a year and at the same time deliver a single low latency, high-throughput platform for customers to access all asset classes across all geographies.

Speaking at Sifma’s Technology & Management Conference in New York in June 2008, Larry Leibowitz, executive vice president, head of US Markets and Global Technology at NYSE Euronext, said the development and roll out of the Common Customer Gateway Universal Trading Platform is well underway. It already has been rolled out in the NYSE, replacing the old Common Message Switch gateway, and 35% of customers are connected to it.

“We’re starting to get to the tipping point in terms of sunsetting the old CMS system,” he said. “Those of you who haven’t gotten your technology converted from CMS to CCG, well, you’re at a competitive disadvantage,” he warned.

Other exchanges are going down a similar route as NYSE Euronext: Eurex, the International Securities Exchange and The Options Clearing Corporation are also developing a transatlantic trading and clearing link. Eurex members will have access to ISE options products and be able to execute orders in the ISE order book using their existing connectivity to Eurex. In addition, Eurex customers will be able to clear contracts traded via the link to ISE through their existing clearing accounts at Eurex Clearing. Subject to regulatory approval, Eurex, ISE and OCC expect the transatlantic link to be implemented by the second half of 2009.

However, sceptics say the exchanges’ single platforms may not deliver true economic benefits to customers because there is bound to be an extra surcharge for the convenience. For instance, either the exchange or the broker will likely take a big cut on the foreign exchange transaction when, say, a US customer wants to buy stock in Germany denominated in euros.

“The exchanges could certainly introduce this, but I don’t think it would be nearly as cheap and nearly as flexible as what we’ve put together over the years,” says Steve Sanders, senior vice president, marketing and product development at Interactive Brokers.

Interactive Brokers’ customers have a universal account, which they use to buy currency to do foreign transactions. The process is fully transparent because the customer sees a tight bid/offer spread prior to doing the deal. If they do not want to buy foreign currency, customers can fund the foreign transaction by taking out a loan collateralised by the money in their universal account.

Interactive Brokers is both a market maker and a broker, and its strategy is to become a direct exchange member and set up self-clearing operations worldwide. The company has three criteria for entering a country: the exchange must be electronic, there has to be sufficient liquidity and there must be a level playing field for all participants. Typically it penetrates a new exchange as a market maker. Once the trading and clearing technology is in place, it offers a brokerage service to customers. Currently it is linked into more than 70 market centres around the globe.

In each country, exchanges have their own unique regulatory and clearing environment, and differences in the way products are executed. Interactive Brokers is finding this, for instance, as it prepares to become a broker on the National Stock Exchange in India. But its IT staff is well versed in establishing connectivity via a dedicated T3 line to exchanges and the clearing houses as well as dealing with cultural nuances. With this know-how the company can connect to exchanges within months.

Some brokers penetrate a new market by becoming a remote member of the exchange, which is cheaper than becoming a direct member. With the advancements in communications technology and network management, remote access to trading infrastructures has become more feasible and less costly. Brokers can either establish and maintain a direct connection or connect to a third-party extranet that is also connected to the exchange.

Some exchanges are keen to attract remote members because it is a way to capture liquidity from big arbitrageurs, hedge funds and algorithmic traders. Others do not want allow remote members because they are concerned that large foreign firms will disintermediate local brokers. To this end, the local brokers can become sponsored access providers who allow other firms to use their pipes to route orders to the exchange through their license.

Foreign brokers can gain access to exchanges abroad through several technology platforms. GL Trade, for example, offers a multi-asset platform that enables trades to be executed in equities, options, futures, foreign exchange and fixed income securities. Worldwide, the company has more than 700 brokers with about 35,000 screens hooked into its network. Buy-side firms also use the platform.

“We provide access to 150 markets around the world on all these asset classes,” says Gerard Varjacques, chief executive of GL Trade. “We also receive market data from these markets and are able to distribute this market data on our screens around the world.”

GL Trade recently became the first trading platform vendor to be certified on the new Brazilian Stock, Mercantile and Futures Exchange derivatives gateway. BM&F/Bovespa prohibits remote membership, so the new FIX 4.4 derivatives gateway will enable the exchange to receive worldwide broker-sponsored direct market access orders. “Anyone anywhere in the world can get DMA flow to the BM&F,” Varjacques adds. “Previously it was a closed market where you had to be in Brazil.”

Admittedly, trading through local brokers is not for everyone. Interactive Brokers will only partner with local brokers when it wants to test the water in a new market. Many overseas firms are not discount brokers; they are in the business to provide advice and charge for it. “For us to sign up with another broker and have to pass those costs on, it’s just not worth it. The customer is better off going overseas and opening up an account,” says Sanders. “We always want to deliver every trade at the cheapest possible cost. The only way to do that over the long run is to be self-clearing, whether it’s in the US or any other country.”

Clearly there is no one-size-fits-all approach in cross-border trading. The good news is technology is providing alternatives for exchanges, brokers and investors alike to take advantage of opportunities as they arise.

SGSS offers foreign remote services in Athens

The Athens Stock Exchange is notorious for manual processing, an absence of omnibus accounts, and concentrated trading in just a few blue chip stocks.

Since global investors are a major force in this market, Société Générale Securities Services saw an opportunity to become a direct member of the exchange and become the first custodian to offer services to foreign remote members.

SGSS in Athens offers a tailor-made product for remote brokers on the Athens and Cypriot Stock Exchanges. It performs post-trade tasks such as splitting and allocating trades, counterparty matching, and clearing and settlement of on- and off-exchange transactions. It handles funding and cash management functions such as the daily calculation and funding of obligatory contributions to the supplementary fund. It also provides value-added services such as buy-in alerts, corporate actions, threshold reporting and legal representation.

Remote brokers are mainly using proprietary systems, developed in-house that are connected to OASIS, which is the Integrated System for Automatic Trading of the Athens Stock Exchange through APIs. The connection between the remote broker and SGSS Athens is achieved through Swift technology and the use of encrypted file transfers as a backup.

Taking advantage of the common trading platform between Greece and Cypriot, SGSS in Athens has expanded its services in the Cypriot Stock Market. Using the same settlement platform, SGSS is capable of offering clearing and settlement service to remote members that wish to connect directly to this stock exchange.

“We intend to grasp any opportunities that might arise in the future in order to have a presence in other neighbouring countries,” says Panagiotis Papapetrou, SGSS head of custody trustee services for Greece. “There are already discussions between market authorities to expand the common platform among other countries, such as Romania and Bulgaria and SGSS is following them closely.”