Surviving the e-revolution
Cross-border markets are nothing new. What has changed, however, is the technological infrastructure that underpins the activities of market participants throughout the globe. Whilst there are still relatively large swathes of the international financial markets that rely on and enjoy a physical market, participants in almost every area of the international capital markets have now come to embrace a new, electronic, trading landscape.
Let’s be very clear on one thing at the outset. Market acceptance of the ‘e-revolution’ is driven by one factor and one factor alone. The fundamental purpose of banks and securities houses is to make as much money as possible from as many people as possible as long as it doesn’t upset the regulators. That is the end: technology is simply the means. The development of electronic platforms has therefore led issuers and investors to question the traditional role of the broker, and to challenge the raison d’être of the formal exchange, the traditional province of the equity markets.
Two debates are being held. First, there are the arguments relating to why we actually need brokers and market-makers at all. Surely, the reasoning goes, the way in which financial markets are structured is sheer lunacy. If we started with a blank sheet of paper we would never allow so many tiers of intermediation: we would never have such preposterous discrepancies between ‘wholesale’ and ‘retail’ prices and we would never pay the middleman to take a cut when we could keep all of our profits to ourselves and screw the rest. In Europe, the visionary cross-border market we were all led to believe in has yet to materialise in earnest. Whilst local ties do continue to exist, investors are increasingly conscious of the need to reduce costs across the board.
So then: the market drawn up on the clean sheet of paper would consist simply of organisations and individuals wanting to buy and sell shares, no matter who they are, what they are, or how much and how many they have to trade. On the face of it, the ‘one size fits all’ rationale is very persuasive. However, as experience has shown – with Tradepoint particularly springing to mind – so is the argument against. Despite the huge assets held by the major players that comprise the global fund management community, they do not place orders of sufficient frequency, or of a size that serves to create liquid markets on a continuous basis. Elbowing-out the traditional sell-side to buy-side relationship in favour of a platform allowing everyone to jump on board is, therefore, unlikely to provide an answer in its own right.
The second debate – one that has been rather difficult to ignore for the past year or so – is all about whether we need so many exchanges and trading systems and what exactly is their purpose in life. The reason that these two areas of discussion are so closely entangled is because, in seeking any answers about the infrastructure required to serve the markets, there needs to be clarity as to what types of firms those markets themselves consist of. Unless we are clear about this, we cannot predict with any great certainty where consolidation will lead us. In that sense, whatever conclusion comes of the endlessly unfolding deliberations over the future of Europe’s equity markets, it will prove not to be the end-game but another – albeit highly decisive – turning point in determining their infrastructure. Market participants always prefer to deal with knowns rather than unknowns and, for the time being, until fund managers become more accustomed to placing direct orders and bypassing the broker and the associated commissions, that infrastructure must be designed to accommodate the intermediary, for whom the writing is far from on the wall.
While investors remain far from ready to ditch the intermediary-based infrastructure once and for all, they do, notwithstanding, have three fundamental expectations: cheap execution, depth and liquidity. However, if pursuit of these objectives was all that counted, the traditional model of the national stock exchange would have become extinct long ago. In its place, pan-European contenders – beginning in earnest with Easdaq – would have had scores of would-be members and issuers beating a path to the front door. Easdaq has a rightful claim to be the only stock market operating on a truly pan-European basis, with a unified infrastructure including a single rule book, a single membership, a dedicated trading platform, seamless cross-border trading and settlement and complete independence from any national market. On paper, therefore, Easdaq is the epitome of a cost-effective, liquid marketplace. However, it will not have escaped your attention that Europe’s equities markets did not undergo a wholesale migration to Easdaq when it opened for business in 1996 and that , with around 70 listings to its name, it has not matched expectations since that time.
In making predictions about the number of exchanges, it can be all too easy to return to the blank canvas idea I referred to above: that we will end up with the ‘one size fits all’ model. One day it might happen, but for the foreseeable future I believe that markets will continue to be served by a variety of types of systems, each targeted towards specific needs. In this sense, the bond markets display similarities to the equities markets. In this swiftly developing environment, a host of electronic systems are seeking to carve themselves niches from the various segments of the domestic and international securities markets. Some are directed at the wholesale players, some at the institutional and retail ends of the market. Some focus on government issues, others concentrate on corporate debt. Some offer anonymous trading, others operate on a name give-up basis. Some operate as intermediaries, others – albeit in a much rarer category – as exchanges, such as Coredeal, where ISMA has a majority shareholding. Despite these differences, all entrants into this market are already beginning to face competition.
Going forward, I firmly believe that the continued competitive pressures on market participants to cut costs will precipitate a relentlessly steady erosion of the old ways in favour of electronic trading: there is undoubtedly a further shakeout yet to come. Right now, however, is too early to attempt a conclusive opinion as to where, precisely, that shakeout will occur.
John Langton is chief executive and secretary general of the International Securities Market Association in Zurich.