With mediocre returns and money moving out of equities to fixed income, some financial firms are merging or dropping their equities operations. Overcapacity and the high cost of keeping up with market leaders have been a problem in the last two years or so.
“With commission spending lower, the buy-side trading function is getting leaner and more selective, and the sell side is experiencing the crunch. Simultaneously, the cost of technology and regulatory compliance has skyrocketed, said the Instinet review.
It was developed by Alison Crosthwait, Instinet’s managing director of global market structure research.
Technology is required and costly to keep up, she writes.
“Simultaneously, the cost of technology and regulatory compliance has skyrocketed. Capital requirements and the implementations of /preparations for the Volcker Rule, the Market Access Rule and the Large Trader Identification Program have been and will continue to be expensive. And with technological innovation and improvement sure to continue, keeping up is crucial and at the same time expensive. Margins are being squeezed from every angle.”
Consolidation has been one response.
“... in Europe, Altium Capital has closed its securities division and Evolution Group, Merchant Securities, Arbuthnot Securities and Collins Stewart Hawkpoint have accepted takeover offers—and additional consolidation of buy-side firms, brokers or high-frequency shops would not be surprising.” Opportunities may appear in private share trading and in electronic penetration of emerging markets.
Like most market professionals, those at Instinet are somewhat underwhelmed by politicians’ discussing topics like high frequency trading.
“The resulting debate can often sound ludicrous to a practiced ear.” A typical regulatory response is to require more information, but the ability of regulators to process it usefully is not proven.
“...the enforcement of many of these proposals is just not feasible.”
No surprise that Instinet does not like a financial transaction tax which it says would directly impact the investment returns of end-investors. This point is subject to debate, though. The impact on a fund with low turnover would be minimal; the impact on high frequency traders would be much greater. And more than a few investment managers contend that low turnover is good for returns.
Instinet expects continued evolution of electronic execution management systems (EMS). They will move from brokers such as Barclays, Citi and Bank of America Merrill Lynch to neutral agency-only brokers like FlexTrade and TradingScreen.
As high-frequency trading matures, margins will tighten and firms will look for other ways to make money, such as institutional trading services and market-making, often gaining the expertise and technology through acquisitions or building upon their existing intellectual property.
Complex spread trading will increase.
“..in the past 18 months, the number of Complex Order Books (COBs) for spread trading has increased from two to five (AMEX, ARCA, CBOE, ISE and PHLX). With this fragmentation comes the need for a set of tools such as smart routing to assist traders in executing spreads.” COBs. Whew, just what the industry needed -- another acronym.
Despite the newsworthy exchange merger failures -- ASX/SGX, TMX/LSE, NASDAQ /ICE/NYSE and apparently soon, NYSE Euronext/Deutsche Borse, alliances are moving ahead in other parts of the world.
“For example:
• Korea Stock Exchange and Tokyo Stock Exchange have agreed to work together on data, listings and technology cost management;
• BRIC + South African exchanges have established an alliance to list each others’ stock index futures and index options contracts in local currencies;
• ASEAN Trading Link: Singapore, Malaysia, Philippines, Vietnam and Indonesia; and
- Andean Exchange Link/Mercado Integrado Latino Americano (MILA): Chile, Columbia, Peru and Mexico.”
And competition continues to evolve, with examples like the Chi-X launch in Australia. Brazil’s BM&FBovespa fights true competition while working to attract high-frequency traders. BATS and Direct Edge have expressed interest in the market but are stymied by the fact BVMF owns clearing and settlement, says Crosthwait.
Korea is doing well with retail trading and also because it can serve, somewhat, as a proxy for China, and with much easier access. Regulators are supporting new trading systems but a 30-basis point stamp tax, payable by the seller, is likely to more than compensate for official words of encouragement.
