Even in good times the cash equities market is a notoriously difficult place for banks to make money. While equity derivatives revenues are booming, commission rates paid for the more traditional business of making markets in stocks have dwindled. According to McKinsey, the largest US fund managers enjoyed a 30 per cent decline in equity trading commission rates from 2004 to 2005.
The growth of electronic trading and the unbundling of research and trading commissions pushed down margins. Now more regulation is on the way: Regulation NMS in the US will be followed later this year by Mifid in Europe. Both will require traders to seek the cheapest price available for clients – though the Mifid rules are more broadly defined and less prescriptive.
This will mean an acceleration of the rapid pace of change in stock trading. Those banks that have not already pulled out have had to invest in technology to meet the new rules. But their ability to take advantage of lower charges on electronic exchanges and trading systems should help them as well as their clients.
In Europe, where newer, more fragmented markets are developing rapidly, lower costs may boost volume sufficiently to make up for the squeeze on commissions. The bigger banks may also be able to grab more market share: in 2005, 60 per cent of buy-side traders did more than 60 per cent of their business with their top 10 brokers, up from 47 per cent the previous year, according to McKinsey. But those unable to generate sufficient volume will find the going harder than ever.
Monopolistic incumbent exchanges also look vulnerable: electronic communications networks and alternative trading systems already account for 10 per cent of volume. That is bound to rise. The banks behind Project Turquoise, a Mifid-inspired plan for a European low-cost exchange, have a strong incentive to channel business its way.
On balance, more efficient stock markets, reduced costs, and greater pricing transparency seem to be the refreshingly positive effects of this latest wave of regulation.