Kyle Wingfield highlights a critical issue surrounding the investment banks' new EU trading platform (Wall Street Journal 22 November 2006) - that it represents not only a potential threat to exchanges, but also to second-tier brokers and investment banks in the EU.
If the initiative succeeds, there could be serious consequences for those who may have expected to be able to continue to use their current exchange membership to guarantee the "best execution" that the new MiFID regulations demand. If a significant proportion of trades are executed off the main exchanges, and only visible through post-trade reports, then only those in the charmed circle will have genuine access to best execution. The rest may be obliged to join the new trading system as well as their current exchange in order to guarantee best execution, and the terms may not necessarily be very palatable.
The investment banks' announcement comes on top of a series of recent trading and reporting system announcements, including a number that formalize multilateral block trading networks to access so-called ‘dark liquidity’. Dark liquidity consists mainly of institutional interest in trading large blocks of stock in negotiated deals with other institutions, keeping these institutional trades out of the open markets.
The temptations of this 'dark liquidity' to institutional investors and their brokers are clear. Increasing trading volumes have not been balanced by corresponding reductions in exchange fees and there is some evidence that buy side trading strategies are losing out to the faster and sharper proprietary traders. A recent Plexus report on trading costs identified a more than 100% increase in the cost of trading over the last two years, most of it due to trading delays and market impact. No wonder that investors with large blocks to shift would rather trade out of sight.
With the major players threatening to seize control of the open market, and keep their clients’ block trades in the dark, it is clear that the new post-MiFID trading environment holds some serious challenges for the second-tier.
