Incumbent exchanges in trouble

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When surfing for pet insurance or a plasma TV, most shoppers don’t care which website they use as long as it is cheap, fast and reliable. The same principle now underpins equity trading. Deregulation and technology are finally transforming the industry.

In the US 11 years ago, after a price-fixing scandal, the Securities and Exchange Commission required brokerages to display customer orders publicly so they could be matched elsewhere if better prices existed. That led to a proliferation of cheaper, faster trading platforms that have gradually eaten away at the incumbent exchanges’ market shares. Today, fewer than half the trades in NYSE-listed stocks actually happen on NYSE. A similar process has begun in Europe; European Union rules now require best execution and are agnostic about where it takes place.

Can the incumbents stop the rot? The London Stock Exchange, Deutsche Börse and Euronext (owned by NYSE) have upgraded technology and services but the slippage has started. Chi-X, which launched in Europe just over a year ago, claimed a 3 per cent share in the EuroStoxx 600 index in April, Reuters estimates.

Incumbents can try to buy their way out of trouble. NYSE and Nasdaq OMX both bought the two strongest upstarts, which themselves had bought some smaller rivals. But that has not stifled competition: witness the rise of Kansas-based BATS. It pioneered inverted pricing, where for some stocks the rebate for posting orders exceeds the fee for taking them. BATS, which should launch in Europe this year, now has about an
8 per cent share in Nasdaq stocks.

Unlike the US, Europe lacks a unified clearing and settlement infrastructure linking all trading venues. But that will just slow the pace of migration, not stop it. Neither does Europe force exchanges and platforms to re-route orders to rivals that display better prices, as in the US. Fortunately, brokers and new exchanges are building the systems to do that anyway. Over the years Europe’s incumbent exchanges have seen off plenty of new entrants. This time round the threat looks much more serious.

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