The European Union wants to open vertically-integrated exchanges to competition and introduce tougher regulation of high-frequency trading firms as part of a wide range of reforms aimed at shaking up trading in Europe.
The draft law proposed by EU’s executive European Commission, and seen by the Financial Times, is part of a review by Brussels of its four-year old markets in Financial Instruments Directive (Mifid). However, authorities are keen to tighten regulation of financial markets in the wake of the financial crisis and the advent of high speed trading, which has carved out a significant slice of daily volume on equity markets.
The proposed legislation covers all assets, including shares, derivatives and commodities, and comes at a critical time for European market infrastructure operators. The proposal to open so-called “vertical silos” comes as EU antitrust regulators are examining the planned merger between NYSE Euronext and Deutsche Börse, while the London Stock Exchange confirmed on Friday it had made a bid to buy a controlling stake of LCH.Clearnet, the London-based clearing house.
The German and US exchange groups, operators respectively of the Frankfurt and New York Stock Exchanges, agreed to an all-share merger that would create a behemoth with four times the revenues of the London Stock Exchange and dominate European derivatives trading.
Both Deutsche Börse, through its Eurex clearing house, and NYSE Euronext, with its Liffe London futures exchange, operate so-called “vertical silo” models – an industry term that refers to an exchange that controls both the trading of derivatives and the clearing of them. It potentially allows exchange operators the power to lock out competitors and keep lucrative contracts and revenue in-house.
Market participants, such as banks and interdealer brokers, have opposed silos because they wield pricing power over them and want choice over where their trades are cleared. The Commission’s proposals would allow banks to choose other clearing houses to clear derivatives traded in NYSE Liffe, the derivatives trading platform of NYSE Euronext. A decision on the deal is expected in early December.
“Member states shall require that investment firms from other member states have the right of access to central counterparty, clearing and settlement systems in their territory,” the draft report said, adding that access should be “non-discriminatory”.
The proposals are at an early stage and the outcome of the policymaking process is uncertain. The draft legislation is still being discussed within the European Commission before being unveiled next month. It will be subject to further amendments and to come into force it will require the approval of the European parliament and member states.
The UK, which has been fighting an uphill battle to expand access to clearing facilities, will take heart at the thrust of the proposals. However, British officials and the Commission still remain in a relative minority among member states and parliamentarians, who largely take a more positive view of vertically integrated exchanges.
The draft legislation also proposed that the suspension of share trading on one platform should trigger a suspension on all platforms to avoid confusion when one venue is hit by a technical glitch. Last month, NYSE Euronext and Borsa Italiana, two of Europe’s largest stock exchanges, had to suspend parts of their operations over technical issues, as markets convulsed amid fears over sovereign debt levels.
The draft legislation also wants to extend its reach to include the European emissions trading scheme in the wake of alleged thefts of €30m worth of carbon permits in January. The scandal shut spot trading of contracts in the EU’s emissions trading scheme, the largest carbon trading scheme in the world.
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