Fragmentation, Low Volumes Vex Europe’s Sell Side

Terry Flanagan

European broker-dealers face a continuing difficult business environment, marked by the core challenge of effectively sourcing liquidity across multiple trading venues and amid tepid volume.

The redrawn landscape is partly a function of regulatory change, specifically Markets in Financial Instruments Directive (MiFID), the sweeping 2007 ruleset that aimed to open up the business of routing and executing trades to competition. That resulted in a proliferation of new trading venues, which have seen order flow dry up over the past few years, quite possibly to levels that can’t sustain all players for the long term.

“The cost of implementing a proactive strategy to exploit fully the fragmented liquidity landscape would have been onerous enough without the added pressures of dwindling trading volumes and commission rates, and the destabilising market uncertainty, David Morgan, marketing director of trading and client connectivity for SunGard’s capital markets business, wrote in a report. “The steadily increasing fragmentation of liquidity across both lit and dark trading venues has increased both the complexity and cost of every broker’s business, and continues to force hard decisions in the drive to maintain access to significant venues on behalf of clients.”

Just a shade more than half of the value traded in the benchmark FTSE 100 index is executed on the London Stock Exchange; the rest goes to multilateral trading facilities (MTFs), according to Morgan. Other major European exchanges typically have national market shares of 60% to 65% of the value of listed stocks traded.

The fragmentation and soft revenue trends afford relative advantages to the largest brokers. All “Smaller and specialist brokers have serious strategic decisions to make as they consider how to get more fully involved in the fragmented pan-European equity market,” Morgan wrote. “To follow the path of the larger brokers with a comprehensive multi-venue trading strategy could prove financially ruinous, given the extensive investments that need to be made.”

To be competitive, brokers need offering such as access to major MTFs and dark pools, low-latency connectivity to venues, links to clearing providers, smart order routing, and transaction cost analysis. Some or all can be prohibitively expensive.

In Morgan’s view, one operating model that cuts costs and makes for a more sustainable broker business is software as a service (SaaS), where the broker connects to a global trading network stored in the cloud which caters for all aspects of the trading process. The broker retains control of its business relationships, as well as other potential differentiators such as research, strategy and  and client service.

“Outsourcing technology and the associated direct management tasks allows for greater focus on core business activities,” Morgan said.

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