Equities trading focus | Market structure | James Hilton Yesterday’s gone
James Hilton, Co-Head of AES Sales, EMEA at Credit Suisse takes a look at the changes in market structure over the past six years and argues that, despite pressure from some, for the end investor it would be a retrograde step to turn back the clock.
O
bserving the development of equity market structure
over the last 6 years has been fascinating. Introducing competition into a monopolistic industry has been at times disorientating, and has presented both challenges to the established order and opportunities for new entrants. The resulting market structure, which includes fragmentation of liquidity and an increase in non-displayed liquidity, has proven to be an irresistible target for established players keen to demonise the shift away from the old exchange-concentrated trading environment. This is to be expected from threatened monopolies, but when the rhetoric and scaremongering are stripped away, it is clear that competition has measurably and significantly reduced transaction costs, at great benefit to the end investor.
Costs down The Credit Suisse Composite Cost Index (Exhibit 1, red line) compiles the trading costs of a broad range of institutional investors, adjusted for trade
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size and execution style. Our Transaction Cost Index (Exhibit 1, black line) goes one step further by normalising for spikes in volatility, creating a better apples-to-apples comparison of structural costs over time. Transaction costs began to fall in late 2009 and have been almost a third lower since the beginning of 2010. Even though costs have risen slightly recently, they remain 16% below their pre- 2010 levels. Though numerous market structure changes have taken place – making it difficult to attribute the reduction to a single factor – our analysis suggests that alternative venues and crossing networks are major drivers.
Competition Multilateral Trading Facilities (MTFs) introduced competition into what was previously a monopolistic environment. They have disrupted the existing order, offering attractive pricing in a bid to win market share. To keep pace, traditional exchanges have been forced to reduce fees (though many have increased the charge for auction trades, where they retain a monopoly).
Given the reduction in revenues, it is unsurprising that exchanges complain about MTFs – and their pricing in particular – time and again. However, what’s bad for the bourse seems to be good for trading counterparties. In our analysis of Credit Suisse
orders sent using time- and volume-based tactics in 2012, we found that trades exposed to alternative venues outperformed on a relative basis by 4.4.bps versus Implementation Shortfall (IS) and 0.1bps versus VWAP. It is worth remembering that total transaction costs are down, so the relative outperformance from MTF exposure seems to be an overall improvement rather than a zero-sum gain. This suggests that the introduction of competition in the exchange space has increased the efficiency of the market, lowering transaction costs for its users by reducing the rents accrued by its operators.
Crossing networks Crossing “networks” have existed – in some form – for as long as stock has changed hands. As this practice has become more
Best Execution | Summer 2013
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