Who will win the fight for control of Capital Markets

7 of the world biggest investment banks today laid down a challenge to Europe's stock exchanges by saying they will set up their own share trading system next year, seriously undercutting the charges levied by existing exchanges.

The banks involved are Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley & UBS, who are effectively the major brokers in the secondary equity markets in Europe, accounting for about 50% of volumes reported on Exchange - this includes business undertaken on behalf of clients.

Money & staff have been committed by the banks to the project, codenamed Turquoise.

This is a fascinating power struggle. For years, the banks have complained that the Exchanges are unfairly extractly value in several ways:-

a) data relating to the prices made by firms, the depth of the order books and the trades executed are sold by the Exchanges, most of whom are not "for-profit" companies. The brokers argue they are providing the content which is then being resold back to them at high cost.

b) Aside from reselling data, the Exchanges make money from the transaction fees they levy. This is a direct "tax" on the market. Running the utility on an not-for-profit basis, it is argued, would reduce costs.

As commercial enterprises, rather than the mutual associations they used to be, the Exchanges have placed their primary duty to shareholders rather than customers. Ironic then that the most commercial of ventures, namely capital markets brokers, are complaining that their importance is overlooked and that rewards are unfairly distributed.

This has been a fairly open secret around the City for some months and I've had many conversations to many friends inside these brokers about the motivations behind it as well as the challenges it presents. Ultimately, no one really wants liquidity to fragment across many execution venues, but technology now enables any the smarter firms to easily re-aggregate liquidity from multiple sources and pick off disparities between them, which may only exist for miliseconds.

For the avoidance of doubt, miliseconds matter and firms spend considerable fortunes trying to get closest to the "machine" which hosts the Exchange data - they will literally pay $100k's to site their trading machines within an arms length of the Exchange box (or the very least the outlet pipe). Physics matters!

Of course, the Exchanges could put much better deals on the table and thereby address the immediate declared issues of the firms. But this option will now be a permanent guillotine over the heads of the exchanges, which can't and won't be disguised by the firms.

That said, other firms may refuse to route their orders to a venue which is operated by their competitors, thus undermining its success. Yet markets move quickly to wherever there is liquidity.

Irrespective of their positioning, all of these firms are wily operators and if any do align with exchanges, they will extract their price.

Make no mistake, the stick has been revealed and the losers will be the exchanges.

posted by John Wilson @ 9:51 PM Permanent Link newsvine reddit


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