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While the London Stock Exchange, as a simplification, 25 years ago took its historic (and incredibly complex) rule book and hired computer experts to program it, the new platforms started at the other end of the chain. As Chi-X CEO Peter Randall puts it, it built a communication network first and then put a matching engine in the middle of it, using leading-edge technology.
As a result, Chi-X can handle at least 50 000, probably 100 000 and maybe even more transactions a second - Randall says they haven't actually tested the limit - whereas the LSE, he says, can handle no more than 4 200 transactions a second.
Operating costs are also a fraction of the LSE's, allowing Chi-X to shave the spread between buying and selling prices and hence the cost to participants. It operates from a single open-plan office at St Katherine's Dock with a staff of 27; the LSE, says Randall, employs 1 100.
Expansion
Chi-X Europe - its full name - is authorised and regulated by the UK Financial Services Authority as an approved Multilateral Trading Facility (MTF). It is a subsidiary of London broker-dealer Instinet Europe, where both Randall and his chairperson Tony Mackay worked when they devised Chi-X.
It opened for the German and Netherlands markets in March 2007, the UK on June 29 2007, and has since extended to eight others - most recently, Austria on August 8 2008. Four others are being investigated.
As I write, late on Monday afternoon, Chi-X has a 20.9% market share of today's combined trade on itself and the primary UK market - the LSE. In the Netherlands, this figure is 16.9%; in Germany, 12.8%; and in Paris, 12.1%.
However, in London Chi-X makes markets in the FTSE-100 stocks and 171 of the FTSE-250. These constitute some 85% of the total market, but Chi-X's market share is much higher in some individual stocks.
Again taking Monday's figures, it had 36.3% of the combined market in Yellow Group, 35.9% of Kingfisher, 33.4% of Royal Bank of Scotland, 32.4% of Babcock International and also 32.4% of Cadbury. It claims 94.2% of its quotes are at or better the primary markets', and 40.7% better, with an average differential of 2.73 basis points.
Among its current trading participants are ABN Amro, Barclays Capital, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Fortis, Goldman Sachs, ING, J P Morgan, Lehman Bros, Merrill Lynch, Morgan Stanley, Société Générale and UBS.
Turquoise
Meanwhile Turquoise, another electronic multilateral trading platform which is backed by nine investment banks and originally hoped to launch last November, finally started operations on 15 August with five stocks each in the UK and Germany. It has already expanded to cover 1 267 stocks in 13 national markets. It uses technology provided by Cinnober, a Swedish independent provider of technology to financial markets.
Lke Chi-X, Turquoise cites the Markets in Financial Instruments Directive (Mifid), put out by the EU late last year, as a key factor in its development. Mifid requires all stockbrokers to give individual customers best execution - that is, the most favourable or sell prices, whichever is relevant - though it doesn't stipulate how.
Turquoise's shareholders include BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley, Société Générale, and UBS. All of these, note, also trade through Chi-X, and may well have to, to comply with Mifid.
About half a dozen other MTFs are being developed. Turquoise CE Eli Lederman believes these new entrants could capture 50%-60% of Europe's cash equity markets within a year.
Whether they can ever replace the primary markets is another question. After all, it's the primary markets like the LSE that vet the stocks before they can be traded, and provide essential ancillary services. The multilateral trading platforms simply match deals and ride on the back of these primary markets in a way analogous to how some purported cell phone operators simply repackage and resell time from MTN or Vodacom.
It may be harsh to call them parasitical, but it's not entirely unfair, in either case.
Impossible in SA?
Is the JSE vulnerable to this sort of competition? After all, its technology is basically licensed from the LSE, and thus subject to similar attack. Ironically, the relative backwardness of SA's telecommunications network could be its saviour.
Randall says that though the SA market is ostensibly promising, the poor availability of high-speed telco links makes it impossible for a modern system like Chi-X's to function effectively.
The JSE, too, has done more than most to minimise its dependence on basic market-making. According to its latest interim report, barely 25% of revenue came from equity trading fees, though they are still the biggest single revenue source. Still, the JSE won't be protected indefinitely by an outmoded telecoms infrastructure, and I'm sure a technogeek like its CEO Russell Loubser isn't ignoring the potential threat.
The spread of the MTFs creates another problem: how does it affect the integrity of indices like the FTSE or DAX? Randall concedes it's a real issue, but one for the primary markets to address, not the MTFs.
- Fin24.com
