NYSE Arca Europe plans to launch two programs starting next month to entice liquidity to its new equities trading market in Europe. Arca Europe, which launched in March, is owned by NYSE Euronext, whose Euronext exchange platform trades French, Belgian, Dutch and Portuguese stocks.
Arca’s foray marks the first time one of the three biggest European exchange operators is competing with its rival markets for trading. In this case, Arca Europe, which is organized as a multilateral trading facility, will trade stocks listed on the London Stock Exchange and Deutsche Boerse, along with other European markets.
Arca Europe has entered a tough environment. Nasdaq OMX Europe, a pan-European MTF that competes with exchanges and other MTFs, including the successful broker-owned Chi-X, has not gained traction. While the Markets in Financial Instruments Directive, or MiFID, changed the regulatory landscape in November 2007 to facilitate competition in European trading, the resulting competition, thus far, has mainly entailed Chi-X gaining significant market share from the incumbents. Only recently did the dominant exchanges and Chi-X begin facing competition from Turquoise and BATS Europe, two new MTFs whose owners include large brokers.
Cees Vermaas, executive director in sales for European cash markets at NYSE Euronext, believes the trading landscape in Europe will change, with MTFs gaining 40 to 45 percent of the trading volume in European blue chips within three years. For that to happen, the corresponding market share of the incumbents would have to drop significantly. Currently, the four biggest exchange groups, which includes Nasdaq OMX, represent at least 75 percent of the market in their own major indices.
Arca Europe’s intention is to be in the lead pack of MTFs. “To build a market we need good pricing in combination with passive flow, which includes client limit orders on Arca Europe,” Vermaas said. He spoke to Traders Magazine after a press briefing for reporters last week.
On May 1, Arca Europe will launch a liquidity provider program and a liquidity sponsor program. The former obligates participant market-making firms to make markets in 38 stocks, while the latter requires the broker-dealers to send flow to Arca Europe, also in the same stocks. The 38 targeted stocks are constituents of the Dow Jones Euro STOXX 50 index, and exclude equities already traded on the NYSE Euronext regulated markets.
Arca Europe declined to name the firms in the two liquidity programs, but said it has a total of five participants. They include three banks and two proprietary trading firms. “The liquidity providers will have spread requirements and will be required to match the best prices [quoted] elsewhere on a continuous basis,” Vermaas said. “The liquidity sponsors will have daily volume requirements on a continuous basis.” The liquidity sponsors, he added, have agreed “to represent client or passive algorithmic flow on Arca Europe,” subject to their best execution obligations.
In return for these commitments, participants in both liquidity programs will trade for free on the Arca Europe platform, instead of paying the 0.15 basis points fee for providing or taking liquidity that other participants pay. The programs will last for three months, Vermaas said.
Arca Europe’s programs are a bid to attract liquidity. However, it may not be able to offer big broker-dealers some of the advantages its rivals can extend to those brokers.
“Based on the experience of MTFs so far, it’s clear that a commitment from order flow providers, particularly those who may own a chunk of the platform, is pretty critical,” said Justin Schack, vice president for market structure analysis at Rosenblatt Securities, a New York-based broker-dealer that provides research on trading venues.
“Arca Europe doesn’t have a group of committed order flow providers that owns a piece of that market,” Schack said. “They have a built-in group of users on the Euronext platform and will reward people who use Arca Europe with cheaper pricing on their main platform.” The pricing benefits on the Euronext platform that Schack referred to are designed to benefit all participant firms that add or take liquidity on Arca Europe.
Arca Europe currently has 12 participants and expects to increase that to 50 by the end of this year, Vermaas told reporters last week. Euronext has about 200 participants, all of whom can readily connect to the Arca Europe platform, he said.
Mark Howarth, interim CEO of Chi-X Europe, points out that his MTF learned early that order flow providers were key to the platform’s success. Chi-X Europe was launched by Instinet two years ago. Instinet remains its controlling stakeholder, but the firm also gave equity stakes to 14 broker-dealers and active trading firms based on their participation levels in the MTF over a specific period of time. “Our ability to provide equity to our largest participants has proven to be extremely helpful, as it creates a true partnership between the market center and the participant that might not be there otherwise,” Howarth told Traders Magazine this week.
That business model has clearly worked. Chi-X currently has between 13 and 20 percent of the market share in FTSE 100, CAC 40 and DAX names. The model has also produced other benefits. “As a result [of the ownership structure], the innovations we continue to introduce–like our capacity increase to 225,000 messages per second or the Chi-Delta dark book–are done with a tremendous amount of input from our participants and shareholders,” Howarth said. Chi-Delta is Chi-X Europe’s non-displayed crossing book that’s scheduled to launch by this summer.
Other MTFs have followed in Chi-X’s footsteps. “Just as Chi-X has owners that are order flow providers, so do Turquoise and BATS,” Schack said. However, he noted, Turquoise no longer benefits as much from this, since its market share declined after the mid-March expiration of its market-making agreements with its bulge-bracket owners. Nasdaq offers another example. “Nasdaq has great technology and free pricing [if a firm’s liquidity provision equals its liquidity taking], but they’re doing almost no volume,” Schack said. “Order flow providers don’t own part of that platform, so they cannot capture a capital gain from trading on it.”
He added that Nasdaq essentially acknowledged this when it announced on March 30 that it would give low-cost options in Nasdaq OMX shares to users of its pan-European platform that meet certain market share thresholds this summer. “If you’re owned by order flow providers with an incentive to use your platform, you’re going to get market share,” Schack said.
Adam Sussman, director of research at research firm TABB Group, considers the ownership structure of trading venues important, but notes that the ability for ownership to translate into liquidity is overestimated. “Those making decisions about equity stakes in execution venues are not the same people making decisions about where orders are routed, and those decisions aren’t coordinated,” he said.
What’s key, in his view, is pricing and technology, and whether market centers are able to create a business model that attracts the right amount of liquidity. “MiFID brought about a greater degree of [regulatory] homogenization across European markets, but there are differences in the relationship between banks, dealers and asset owners in various European countries that will affect how fragmentation occurs in those countries,” Sussman said. And that, he added, will affect how order flow is distributed to various market centers in those regions.
In the European equities trading landscape, perhaps the only thing now clear is that fragmentation is on its way. The big exchange groups are gearing up for this. Deutsche Boerse last week announced it would launch an MTF called Xetra International Market to trade pan-European stocks by the end of this year (its current electronic trading platform is called Xetra). The expectation is that the London Stock Exchange will follow suit. At the same time, new MTFs such as Burgundy in the Scandinavian region, where Nasdaq OMX has a lock on 90 percent or more of the volume, are planning to launch, encouraging further competition in a landscape that until recently saw almost none.
