Traders Magazine Online News, July 27, 2009
Nina Mehta
The London Stock Exchange’s decision to ditch its maker-taker pricing, seen as a bold move by some and as backwards by others, runs counter to the trend in European market centers. But it’s the latest volley in a series of pricing moves intended to alter the European trading landscape.
The LSE plans, on Sept. 1, to switch to a traditional fee schedule that has the same pricing regime for both sides of the trade. In doing so, it will scrap the maker-taker pricing it adopted in September 2008.
“We’re trying to ensure we have a differentiated approach that’s customer-focused and that extends greater awards to our largest customers, the more they trade,” said Patrick Humphris, a spokesman for the LSE. With competition among market centers heating up, the exchange is aiming for more volume from its biggest customers by enabling them to decrease their trading costs.
Citi is one firm that will see its costs shrink. “Overall, we’ll pay less to the LSE,” said Jack Vensel, head of electronic trading at Citi in London. “But it seems like a step backward,” he added. “The industry is progressing to a maker-taker model. [The LSE] may be giving up some opportunity to use pricing to motivate their members to behave in specific ways.”
Vensel noted that brokers nowadays have less discretion about where to send customer flow, given the fragmentation in European trading, the rise of smart-order routing and the need to pursue best execution. With access to an increasing number of venues, he said, more flow will continue to go to the newer venues.
Another electronic trading executive at a global broker-dealer in London agreed. “Hedge funds or proprietary trading shops doing automated market makers or running an arbitrage or high-frequency strategy may be more price-sensitive,” he said. “Their behavior will be more influenced by price than the behavior of a large bank with a diverse client base.”
“It’s a risky strategy the LSE has deployed,” this executive said. “We applaud it, it’s gutsy, they’ve said their core customers are traditional customers, but it remains to be seen whether it will be successful from a liquidity and market share perspective.”
“Europe is moving to a maker-taker structure,” said Phillip Silitschanu, a senior analyst at research firm Aite Group in Boson. “I’m hard-pressed to see the LSE’s logic.”
Multilateral trading facilities such as Chi-X Europe and BATS Europe have adopted maker-taker pricing to attract liquidity providers to their markets. This pricing has been used in the U.S. to win volume away from the dominant markets by appealing to price-sensitive firms. Some of these market centers are now experimenting with additional pricing and routing gambits in a bid for flow.
According to data published on the BATS web site, the LSE last week had two-thirds of the market share in FTSE 100 names, based on value traded. MTFs had the remainder. Earlier this year, the LSE’s share of trading in the FTSE 100 was more than 75 percent.
The LSE’s move comes at a time when MTF volume, based on value traded, is increasing across Europe. Aite expects MTFs to account for 20 percent of European trading by the end of this year, up from 15 percent in the first four months of this year. The research firm thinks that by 2013, half the industry’s volume could go through MTFs.
Maker-taker pricing is one of the main carrots dangled before participants by markets competing with the LSE, along with extremely low-latency infrastructure and trading platforms. “With that carrot, passive order flow is rewarded, while charges for aggressive order flow are commensurately higher,” Humphris said. “The risk with that carrot system is that you’re essentially penalizing one type of order flow.” The flow that’s penalized, in his view, is flow from the biggest customers.
Instead of using liquidity takers’ fees to subsidize the rebates for liquidity providers, the LSE will institute the same pricing schedule for both sides of the trade. The exchange will charge customers 0.45 basis points per trade for the first £2.5 billion of value traded each month. The fee drops to 0.40 bps for the next £2.5 billion, 0.30 bps for the next £5 billion, and 0.20 bps for trades once the firm has traded £10 billion in value.
The exchange’s current pricing ranges from a fee of 0.75 bps to 0.45 bps per trade for liquidity takers, with the marginal rate decreasing based on the value-traded pricing band. The first £7.5 billion of value traded each month, for instance, gets the base take rate, while anything above £30 billion is charged 0.45 bps per trade. The rebate for liquidity providers ranges from zero to 0.40 basis points, based on the value-traded pricing band.
In addition to drastically shrinking its pricing bands, the LSE, as a sign of the times, will cut its minimum fee per trade to 10 pence, from the current 25 pence. The LSE’s Humphris noted that this change reflects the market’s decline in asset values as well as the shift to smaller average execution sizes because of algorithmic trading.
Citi’s Vensel said the 10-pence minimum fee would likely be a boon for brokers and customers. “The decrease in the minimum charge should be very beneficial,” he said. As the FTSE 100 has lost value, the cost of trading, in absolute terms, has decreased. “But the current 25-pence minimum has remained a hurdle for low-priced stocks,” Vensel said. “The decrease to 10 pence will shrink the execution costs for those trades.”
Vensel also noted that the LSE is cutting tariffs by approximately 10 percent. “As fees come down, the friction to trades comes down,” he said. “For any firm trading algorithmically, this should help to lower execution costs.” However, he noted that algorithmic trading has become more sophisticated, with algos providing more liquidity, based on the market conditions for a particular stock, than they might have a year or two ago. As a result, the ratio of aggressive to passive orders has decreased for some strategies.
Aite’s Silitschanu pointed out that the LSE is appealing to investment firms struggling with lower asset values. “If you’re a portfolio manager or trader, when the markets are as tight as they are and it’s hard to find returns, you want to eliminate variables from your monthly costs,” he said. If you can reduce how much you pay in trading costs, you’d want to do that.”
Silitschanu also noted that the LSE might also be hoping to differentiate itself from the MTFs eyeing its volume, whether or not the new pricing boosts the exchange’s market share. “It’s an unusual step,” he said. “I don’t think this will affect the LSE’s liquidity significantly, but it could go a couple percentage points either way.”
The LSE clearly hopes its new pricing will draw more volume its way. “Customers will be rewarded based on how much they trade, so the more they trade, the cheaper it becomes,” Humphris said. He noted that some of the firm’s smallest customers currently pay more than its largest customers, because they collect a lot of rebates. “That’s a perverse system,” he said. “We think a different pricing structure will stimulate trading and stimulate our largest customers to trade more.”
But big banks aren’t so sure. “Pricing alone right now in this marketplace isn’t enough to move people to or from the LSE or another venue,” Citi’s Vensel said. “As more people have the option to use smart-order routing, it will be increasingly difficult for the LSE to hold on to its market share.” He added that 100 percent of people without smart-order routing go to the incumbent exchange.
The executive at the big broker that declined to be quoted by name added that the lack of a trade-through rule in Europe also boosts the importance of smart-order routing. To avoid missing liquidity, brokers must access more venues themselves, which encourages fragmentation.
He said he expects more pricing changes from the LSE. “If you look at the LSE pricing changes, they represent a decrease from where they were for large firms, but they’re not a substantial decrease,” the exec said. “We’d expect to see more fee reductions in the future.”
Automated market makers, statistical arbitrage firms and other high-frequency shops are also trading more in Europe. These firms’ black-box models rely on low-latency trading and, in some cases, rebates to help fuel their strategies.
The LSE said it isn’t forsaking this group. “We expect high-frequency traders will continue to use the LSE, partly as a result of the lower liquidity-taking pricing schemes and the execution certainty on our market, and partly because we remain the price-formation venue in the U.K.,” the LSE’s Humphris said.
To cater to those and other latency-sensitive firms, the exchange is upgrading its technology. The LSE plans to either upgrade its current TradElect trading platform or choose an alternative platform, according to Humphris. “We will keep on investing to ensure that our technology is fast and scalable to meet the needs of to high-frequency traders and expected growth,” he said.
The LSE is also building out its pilot co-location program for firms that want to be closer to the exchange’s matching engine. Over the next several months, Humphris said, the LSE intends to quintuple the co-lo capacity in its data center. He added that the pilot, which is already oversubscribed, has proven to be successful.