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| Mackay: ATS enhance capital market efficency | |
Tony Mackay is in a celebratory mood. The electronic trading platform, Chi-X Europe has made steady gains since he and his team at Instinet Europe established it a year ago. Since the MIFID (Markets in Financial Instruments Directive) regulatory regime took effect in Europe in November last year, the alternative trading system (ATS), where European-listed stocks can be traded, has fared extremely well.
By all indications, it looks like Chi-X Europe will become the first truly successful electronic communication network (ECN) operating outside North America.
With its early success in Europe, Mackay is now taking Chi-X to the global arena. His next stop is Asia, particularly Australia, where regulators have announced plans to open the market to competition and provide an alternative platform for trading Australian stocks, in a departure from the present situation where it is all concentrated with the Australian Stock Exchange (ASX).
Mackay, who is the global CEO of Chi-X, is confident that the platform will do well in the region. “Once we get approval in Australia, we hope to grab at least a 10% share of trading volume in the first year and 20% in the second year,” he says.
The significant amount of liquidity now flowing to Chi-X in Europe is already worrying some of the more established stock exchange operators, such as the London Stock Exchange, and some are attempting to counter this development by investing in systems that can accommodate a huge volume of algorithmic trades.
Mackay, however, says that an ATS such as Chi-X would, in fact, lead to a surge in liquidity flowing into the Australian market, given that the buy-side and the sellside are likely to become more active in the market. This, he says, is what has happened in the European markets where Chi-X Europe operates. “We do not see Chi-X undermining the exchanges, but instead, it will enhance the efficiency of capital markets.”
Given the developments in London, Mackay believes that it would now be easier to convince regulators in Asia to allow Chi-X into the region. Mackay says there are no concrete plans as yet for the launch of Chi-X in markets such as Tokyo, Hong Kong and Singapore, but they can quickly do so when the opportunity presents itself.
Alternative trading systems, such as Chi-X, are entities that operate like a stock exchange but they are not as regulated as their more traditional counterparts. They operate an automated system that brings together the buying and selling interests within the system. Their key advantage stems from faster execution, cheaper cost and anonymous handling of trades, which is not possible if the purchases or sales are made in public markets, such as stock exchanges.
By providing extended trading hours access to equity markets around the world and an innovative form of investments, such as financial instruments from the private equity segment, ATS offers investors wider trading opportunities.
The rules for trading in an ATS are considerably less strict than for exchanges, where the only way investors, who are not members of the exchange, can trade in the market is through their member-brokers.
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In an interview early this March, Mackay tells The Asset that trading activity in the Chi-X now makes up around 10% of the turnover of the main index in the London Stock Exchange. Chi-X’s success, he adds, is even more remarkable given the trading volume it has built up, especially blue-chip insurance companies. “In March, the platform accounted for 20% to 40% of the trading volume of the blue-chip counters.”
The rapid scaling-up of activity is due to MIFID requirements, where traders and brokers have to seek the most efficient and least costly means of executing trades. The main objective of this European Union law, which provides a harmonized regulatory regime for investment services across the 30 member states of the European Economic Area, are to increase competition and consumer protection in investment services.
Mackay, who used to run Instinet Europe, says that despite highly fragmented markets, Asia has huge potential. This is the reason why Mackay will be moving from London to Hong Kong in the middle of the year, a transition that should be smooth, given that he has been stationed in Asia thrice before. The Australian native says that Hong Kong’s time zone is convenient for co-coordinating with people based in London. In addition, it will be an efficient base for him, since it takes relatively less time to fly to Sydney from there.
Mackay says that their application to operate as an ATS in Australia is now pending with the regulator, but expresses confidence that a decision will be made by the second half of the year. Two other alternative trading systems have currently applied to operate in Australia, namely, Liquidnet Australia and AXE, the latter of which is partly owned by the New Zealand Stock Exchange.
Tangible benefits
Mackay considers that out of the three, Chi-X is the only one that maintains a central limit book and so, most closely simulates the operations of ASX. The other applications, he says, work more like crossing networks. According to him, the regulator is taking time to make the decision, because, “They have to refine the rules and be careful before introducing real competition to the ASX”.
The Chi-X executive, however, says that the fear that the ASX could suffer from diminished volume is not entirely justified, given that a more efficient platform will attract even more players and volume into the market.
Many exchanges in the region have failed to make the necessary investments to keep abreast with market developments. Mackay cites the numerous operating breakdowns suffered by the Tokyo Stock Exchange in recent years. These problems, he says, have deterred a significant amount of liquidity from being invested in Japanese stocks. “The breakdowns made people worry that their trades could be jeopardized, so many stayed away,” he states.
Mackay says that Chi-X’s business in Europe is expected to gather momentum in the second half of the year, as the MIFID environment spurs real activity from the sellside. “The sell sides are trying very hard to differentiate themselves from each other and they see the value of bringing in more trades to Chi-X.” The platform, he says, is undeniably attractive to use for trading, given that the average spread of a Chi-X trade is 2bp to 3bp better than a trade on the underlying exchange.
Mackay is confident that other exchanges in the region would eventually introduce competition to their national exchanges, by allowing the entry of more alternative trading systems and electronic communication networks (ECNs). Mackay himself believes that changes in the region will occur very soon.
According to him, the competition to Chi-X Europe presented by other ATS in early 2008 has not materialized. “For now, everyone is only looking at Chi-X’s success.” Its success, however, will intensify the drive and spirit of competitors such as Turquoise, Millennium and others to catch up.
In describing how the success of Chi-X in Europe will translate into the Asia zone, Mackay says that most of the global banks that dominate trading in Asia are now big users of Chi-X Europe and there is a lot of overlap between these two markets. “What many in the sell-side discover is that Chi-X is indeed a much cheaper platform to trade, and it even has a better technology to boot.”
Mackay denies that some sellside operators have had difficulty directing liquidity to them. “It is very easy to trade with Chi-X and if there has been any problem, it has been quickly resolved.”
Despite the fragmented markets of the region and intense lobbying of established exchanges to keep them out, Mackay believes that the region cannot afford to do so, if it wants its market to be more efficient in attracting liquidity inside and outside the region.
Mackay believes that Asia will catch up with Europe a lot more quickly in employing algorithmic technology for trades, once platforms like Chi-X are allowed to operate in its markets. “At the present, it is very difficult for most of the algorithm trading strategies used in Europe and the US to be deployed in Asia, because the technology of the Asian exchanges is not geared to it and a rational cost structure is not in place.” Admittedly, he says, the development of algorithm trading strategies in the region is still in a “chicken-and-egg predicament”. “Once the region’s capital market becomes more efficient, then algorithmic trades will advance considerably,” he states.
“ATS such as Chi-X could meet with success a lot quicker than people are expecting in Asia. Markets such as Singapore and Hong Kong would also want to attract the liquidity that more efficient trading platforms such as Chi-X can attract.”
Mackay warns that markets in the region that fail to reform will lose out. “Right now, there is a global battle for capital among economies, and the countries that provide the right infrastructure will attract the most liquidity.”
