Order routers not providing Best Execution

I said my favorite presentation was Mark Howarth’s yesterday because my favorite subject is the new alternative exchanges - the Multilateral Trading Facilities (MTFs) – that have emerged in Europe as a result of the Markets in Financial Instruments (MiFID) implementation.

Chi-x began trading two years ago, soon to be followed by Turquoise, BATS, NASDAQ OMX and Equiduct. And there will be more. According to the dialogue so far, there are 125 or so MTFs registered with CESR across Europe.

Admittedly, many of these are broker-dealer based systems and services, but there are at least 10 pan-European MTFs registered, with Burgundy the next to launch.

So it’s obvious that not all of them can succeed, but having three or four in each area of service from dark pools to liquid stocks to all markets and eventually to derivatives, bonds, fixed income and other markets certainly seems to be on the cards according to the discussions here so far.

I’ll talk more about the other MTFs tomorrow but right now Chi-x is the one that shouts loudest, probably because it’s been around for longest and has first mover advantage. In fact, unlike BATS, NASDAQ OMX and Equiduct, it also had the advantage of launching well before September r2008 when the credit crisis hit, which is a definite advantage.

So Mark Howarth, the new CEO of Chi-x Europe – my friend Peter Randall left on the day I last blogged about this stuff in depth – stands up and presents some interesting slides.

For example, gross consideration for Chi-x rose steadily through to September 2008 and then dipped away as follows:

Gross Consideration (€ billions)

Q2 07         €1.5
Q3 07       €20.2
Q4 07       €34.6
Q1 08       €74.2
Q2 08     €132.5
Q3 08     €246.3
Q4 08     €205.5
Q1 09     €148.9

Now you may look at those numbers diving since Q3 2008 and think Chi-x should be worried, but that’s not the whole story in that, by the end of Q1 2009, Chi-x proudly claim fifth spot in the European pecking order of exchanges, closely followed by NASDAQ OMX Nordic and Turquoise:

Value of Equity trading, March 2009
Exchange / MTF               Order Book Trades    Order Book T/Over (EUR m)
1 London Stock Exchange        17,279,867                   123,650.0
2 Euronext                             15,365,479                    116,839.0
3 Deutsche Borse                     8,118,311                     95,835.8
4 Spanish Exchange (BME)        2,832,093                     60,682.8
5 Chi-X Europe                       10,554,888                     57,168.5
6 Borsa Italiana                       6,227,802                      45,937.2
7 SWX Europe                          2,875,388                     45,495.4
8 NASDAQ OMX Nordic              4,802,676                     43,150.6
9 Turquoise                             3,309,508                     22,567.8
10 Oslo Bors                            1,240,279                     11,397.7
11 BATS Europe                       1,760,985                       8,277.7
12 SIX Swiss Exchange                462,090                       2,802.3

Equally, market share of all the new Exchanges has been steadily rising. For example, the three new MTFs – Chi-x, BATS and Turquoise – are averaging around 20% of the DAX30 daily volume. That’s a wee dent in the Deutsche Bourse’s pie I suspect.

In fact, Mark claims that Chi-x’s research shows that there would be a significant shift in liquidity and market share to Chi-X and the other MTFs from the incumbent exchanges if best price routing were in play. This would be in the order of 17% of all orders for November 2008, 15% in December, 13% in January 2009 and 12% in February. The reason for the decreasing numbers is the decreased volume of trading during these months, rather than any uncompetitive aspects of the new MTF models.

In other words, and I’ve heard this from the other MTFs too, the fact that order routers aren’t smart enough to seek out best price in Europe right now is the reason why the liquidity sticks with the incumbents.

Not sure if true, but Chi-x claim their market share would have been 10.6% higher between November and February if the full price improvement transparency and best execution rules were enforced.

Watch that space and more on this tomorrow.