The EU's Markets in Financial Instruments Directive (MIFID) was designed to improve share price transparency, but parallel moves to allow new competitive trading platforms (such as Project Turquoise) threaten to reduce transparency
The law of unintended consequences is complicating Brussels’ latest attempt to create a single, Europe-wide investment market. An important aim of the Markets in Financial Instruments Directive (MIFID), which took effect on November 1, 2007, is to improve share price transparency. But parallel efforts to increase competition by allowing new operators to run share trading platforms threaten to reduce transparency, at least in the short term.
As new markets come on-stream, the number of data sources proliferates, and with it the risk of delays in the collection and reporting of deals. The growth in the popularity of dark liquidity pools, which allow deals to be done away from public scrutiny, also threatens to increase uncertainty. Nerves have been further jangled by confusion over the progress of what is likely to be one of the biggest new players in the liberalized investment market. Project Turquoise, a share trading platform backed by nine of the largest European and US investment banks, has suffered from delays and disagreements between its owners over issues of senior management, technology and strategy.
The good news is that these uncertainties may be no more than the usual teething troubles encountered following the introduction of any far-reaching change. ‘MIFID is not another Big Bang,’ says William Haney, director of corporate services at Thomson Reuters. ‘It will evolve over time.’
In the short to medium term, however, IROs run the risk of missing rapid developments in their company’s shareholder list. Two recent situations that made the headlines were the off-market purchase of a 10 percent holding in Biffa, a UK waste management company, and a large share sale by two directors of Europe and Australia-based Game Group. Neither deal was reported through the London Stock Exchange (LSE), and many investors did not hear about the trades until the following day.
Knowledge is power
IROs and other users of share trading and pricing information set great store by the LSE’s end-of-day prices. There are concerns that this source of information could be diluted if all trades are not captured.
‘Is there a mechanism for these off-market trading systems to report prices back to the LSE for valuations?’ asks Mark Hynes, managing director of IR at PR Newswire. ‘This is not sexy stuff, but it is a back office activity that makes markets work.’
The timing of publishing pricing information is provided for under the MIFID rules. Broker dealers and platforms must publish pre-trade information immediately. They have three minutes to publish post-trade data; block-trades, depending on their size, must be reported within one to three days. The real issue, however, is where the data appears.
Based on the US experience, trading volumes are likely to increase once new platforms enter the market and stock exchange fees come down. This is likely to cause a sharp rise in program or algorithmic trading by hedge funds and others seeking to exploit price discrepancies.
An increase in the use of high-frequency trading strategies by hedge funds and others contributed to an 86 percent increase in trading volumes on the LSE in the 11 months leading up to March 2008. The average yield per bargain fell from 134p to 89p last year, however, as the exchange came under increasing pressure to offer bulk discounts.
A sharp rise in trading volumes was also reported by Chi-X, a trading platform that celebrated its first anniversary in April. Chi-X reported a 176 percent rise in the number of trades in the first quarter of 2008 over the preceding three months. It accounted for around a third of all trading in several leading UK stocks on some days in March, notes Peter Randall, chief executive of Chi-X Europe.
The launch of Project Turquoise – now expected in September – is what most fascinates market watchers. Turquoise plans to halve total trading costs and capture 5 percent of all trading in European equities within a few weeks of its launch. These volumes will come from an expansion of the market rather than from grabbing market share from the incumbent exchanges, a spokesman says.
Turquoise will trade 300 of the most liquid equities on its transparent or ‘lit’ book, with a further 1,200 slightly less liquid stocks on its dark order book.
‘The lit book will be able to access the dark book,’ says a Turquoise spokesperson. ‘You won’t know you are getting access, but this will open up liquidity.’
The spokesperson also points out that dark order books are already provided by many large players on both the sell side and the buy side. ‘I can’t see how we are going to make life difficult for IROs,’ he adds. ‘Dark books already exist without us.’
