Market Fragmentation Goes Global

Terry Flanagan

The European markets are no stranger to market fragmentation, with no less than 24 lit equity venues across the union. But that has not stopped global exchange operators NYSE Euronext and Nasdaq OMX from launching additional trading platforms.

Nasdaq OMX has unveiled a plan to break into the European interest-rate futures market, challenging the established duopoly shared by former merger partners NYSE Euronext and Deutsche Borse. Their proposed tie up was nixed because of their perceived dominance in the European Union’s listed derivatives market.

Nasdaq’s new venue is set to launch early next year, pending regulatory approval. It will look to garner order flow by being a one-stop-shop for customers, offering the trading, clearing and storing of trades in one place. It will also offer competitive execution and clearing fees, along with ‘optimized margin calculations.’

“The new market will be a single platform for both short-term interest rate and long-term interest rate euro- and sterling-based listed derivative products,” said Charlotte Crosswell, chief executive officer of NLX.

NLX will clear through LCH.Clearnet, the Anglo-French clearing house currently being acquired by the London Stock Exchange.

Regardless of the name recognition a new venue may bring, entering a space that is highly competitive can be very difficult, especially when there are massive established incumbents. For instance, Goldman Sachs’ highly successful Sigma X dark pool has done well in the U.S. and Europe, but had to pull out of Canada after just a few months due to disappointing volumes.

NYSE Euronext’s Liffe and Deutsche Borse’s Eurex platforms control some 90% of the European listed derivatives space that Nasdaq looks to enter. UBS analyst Alex Kramm said that Nasdaq will face an “uphill battle” and that other rivals, including the LSE and Bats Chi-X Europe are also likely to enter the space with their own fixed-income derivatives platforms in the near future.

“You’re seeing fragmentation in Europe now,” said Tim Mahoney, chief executive of Bids Trading, an U.S. dark pool operator. “But there’s not as many venues there as in the U.S. They’re still working out the rules. But when it’s done, you will see even more new competitors.”

More competition is usually seen as a good thing for the end investor, as it usually leads to lower transaction fees. But that isn’t necessarily the actual end result.

“The fragmentation of the markets is not to the benefit of longer term investors,” said Manoj Narang, chief executive and founder of Tradeworx. “Their order routing is not as sophisticated as HFT firms. Their ability to compare quotes is not as sophisticated. The more different venues there are, the more traders who are technologically sophisticated are at an advantage.”

Exchanges have been criticized for what some proclaim as pandering to the high-frequency trading crowd. Services such as co-location and maker-taker pricing are derided as favorable to low-latency trading strategies.

NYSE Euronext on June 20 launched a London-based regulated exchange, NYSE Euronext London, to rival the London Stock Exchange for listings. It established the venue in 2010, but had not had any takers for listings until Eurotunnel, the owner of the rail tunnel linking England and France, decided to shift its listing there. NYSE says it is now in talks with new potential issuers and hopes that the venue will become an extension of its pan-European operations.

In addition to having 24 lit equities venues, the European Union also has 16 additional dark order venues across its continent, according to Bats Global Markets.

“We have a really simple end game in this business,” said Mahoney. “If your venue can help lower the cost of transaction and have a lot of liquidity, you will survive.”

While dark trading has been blamed for a substantial portion of the market fragmentation seen in the U.S. markets, with nearly 15% of total equities volume being done in the dark, unlit venues in Europe only account for about 4% of total volume. The dark order books of Bats Chi-X Europe combine for about 1%, making it the largest dark pool operator, while UBS’ multilateral trading facility also trades about 1% of volume.

In the world of new exchange competition, it seems that when it rains, it pours. Nasdaq last month announced that it will launch a third U.S. options market, Nasdaq OMX BX Options, which will utilize the existing trading rules from its Nasdaq Options Market. The new venue will use the self-regulatory license that was recently surrendered by the Boston Options Exchange. BOX Options in late April received approval from the Securities and Exchange Commission to become an SRO itself.

The niche Chicago Stock Exchange, which month-to-date in June has traded just 0.45% of average daily equities volume, or about 30 million shares daily, also announced plans in April to start a second equities trading platform.

In addition to the new options exchange from Nasdaq, the International Securities Exchange is also considering starting up a new venue. In bucking the industry-wide shift away from traditional trading floors and toward all-electronic models, the new venue could potentially have a physical floor. However, any floor that the ISE would create wouldn’t look like the traditional open-outcry trading pits. Rather, it would be something completely new and innovative, and different to anything currently on the market.

Miami International Holdings is planning on launching a new options exchange later this year. The New Jersey-based company has also said that it plans to launch an equities exchange down the line as well. Both platforms are to be located in Miami and would be built from the ground up. They would focus on listing securities and stocks from companies based in Central and South America.

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