When MiFID opened up European trading so that the incumbent stock exchanges faced competition from nimble new entrants in the form of MTFs, there was excited speculation that the old would rapidly lose out to the new.
The argument was simple. The old exchanges were burdened with legacy cost-structures, last-generation technology and arthritic business processes. Look at the difference in costs. Compare the £10 million of Chi-X operating costs with the £333 million of the London Stock Exchange group; trading services alone cost £133 million at the LSE. Should the news that the LSE was in talks to buy Turquoise be seen as a desperate move by a dinosaur to mate with a mammal?
In fact the revolution has been less than overwhelming. Of course, the new entrants have taken market share. If an incumbent starts with 100% market share, it can only go down. But the new entrants have made less headway than their enthusiasts would have predicted.
|All European equity trading||
Market share by value
|Markit BOAT (OTC)||
(Note: this table measures shares of pan-European trading, so even if an exchange had 100% of its domestic volume, it would show up as much less than 100% here. But I think it is valid to measure shares of pan-European business, as the MTFs were set up to operate across multiple markets.)
In fact, the most significant development has been the growth of OTC trading. In other words, banks have taken advantage of the freedom offered under MiFID to own their business, by trading away from formal platforms and publishing their trades through a variety of channels. MTFs have, indeed, grown rapidly from a standing start. They have appealed especially to traders where their new technology has given them advantage in speed of execution and low costs.
For all that, in every market the traditional exchange has retained its position as the core market place, in spite of its apparent handicaps. It turns out that the differences in regulatory obligations between an exchange and an MTF are not so significant in practice. (Bourse Consult has extensive experience from advising prospective MTFs on their regulatory options). In some respects, the regulatory position of an exchange even gives it advantages in offering its services in foreign markets, which may not be open to MTFs. The absence of a single post-trade process (as exists in the US) also protects the incumbents: market firms that have hard-wired their back offices into the established exchange will tend to use it, rather than establish new connections with new CCPs. Interconnectivity between the CCPs serving MTFs and those serving exchanges is still at an early stage.
All this reinforces the perception that the exchange remains the central institution in its market place. Its price is still seen as the reference price. It has an established role, for example in listing, and a brand and reputation that the new entrants cannot easily match. The activities in this bundle reinforce each other.
A stock exchange faces a delicate balancing act going forward. If it is true that its strength derives from being perceived as the central institution, then it depends on providing a breadth of services – listing, supporting small companies and so on – some of which may not be economic individually. This exposes it to having parts of its business cherry-picked by competitors with no obligation to take on the full range of institutional responsibilities. But if it tries to re-invent itself as a light-footed competitor for MTFs, it runs the risk of jettisoning its core strengths while entering a competition it cannot win.
 Year to end-December 2008
 Year to end-March 2009 including London Stock Exchange and Borsa Italiana, excluding intangible and exceptional items
 Source: Thomson Reuters Equity Market Share Report