Time to embrace European derivatives competition

For decades, the European derivatives landscape has been dominated by national exchanges, often monopolies and duopolies in local markets.

These dominant institutions have so often entrenched themselves by either being, or moving to, the vertical silo model controlling both trading and clearing, thus locking in, or locking out market participants.

However, lack of competition in European derivatives has robbed both participants and consumers of choice; this in turn has led to high costs for both trading and clearing, as well as a failure to innovate and improve the servicing of clients.

Trading fees for derivatives have remained exorbitant, in contrast to the equity markets where the cost of execution has fallen by as much as 80 per cent due to competition from new venues since the introduction of the Markets in Financial Instruments Directive (Mifid) in 2007.

Derivatives clearing has resulted a move towards the “vertical” silo, which has locked those that wish to trade into using one service provider, or indeed locked others out. Again, clearing in derivatives has remained very dear. By comparison, the cost of clearing in equities has come down by more than 50 per cent in the last seven years.

These derivative models may have served participants’ needs reasonably well. However a new landscape is developing, driven by the financial crisis and ensuing regulation, a critical element of which is to encourage open access and competition across market infrastructure, to the benefit of participants and consumers alike, as exemplified by the review of Mifid.

Certainly in the level one text released recently there were some very positive pro-competition language around opening access to clearing houses that would help to breakdown vertical silos.

And here in the UK, the Financial Conduct Authority has in it its statutory objectives to promote effective competition in the interests of consumers and its market division recently completed a three-month consultation into the competitive practices of UK exchanges.

Unfortunately, certain EU states have already lobbied hard to protect national interests in the Mifid ll level one text, a development that could delay the benefits of competition in clearing for another five years after initial implementation.

Additionally, market incumbents have begun publicly to lobby against the introduction of what appears to be pro-competition regulation. A recent article in this newspaper highlighted quotes from two established exchanges voicing criticism of Mifid ll and suggesting that it had the potential to create systemic risk and stifle innovation by introducing open access.

In contrast it is essential on the back of positive regulatory moves that market stakeholders act in the spirit of competition and embrace it. This should include fair treatment of new entrants and acceptance of the devices they must inevitably use to gain traction and market share against incumbent monopolies.

The direction for the industry is clear: competition is coming, for both regulators and the market are demanding it

These strategies are little different from those such monopolies themselves pursued to launch new or gain market share in existing products – every successful launch provides an example. Resorting to what may be perceived as anti-competitive behaviour will certainly be seen as a crude and thinly veiled attempt to stamp out new competition, against the interests of all market participants.

Higher trading and clearing charges drive up expenses for end users such as pension funds or mortgage companies for the instruments they use to hedge their risk, which in turn adds cost to the essential products they offer.

Furthermore the services, infrastructure and technology of equity markets have advanced rapidly post-Mifid and have been a key part of the initial success of multilateral trading facilities over many incumbent exchanges. That contrasts with the lack of innovation in derivative markets.

The direction for the industry is clear: competition is coming; for both regulators and the market are demanding it.

The real question is, will those in the market who hold the reins choose to fight it, or embrace it and let the customers decide who offers the products and services most appropriate for them?

Daniel Hodson is the former chief executive of Liffe and an independent non-executive Director of Nasdaq OMX NLX