Thirty hours in the company of European exchange executives provides evidence of a willingness to innovate, but also a defensive-minded preoccupation with the perceived unfairness of their competitive position. Buy-side trading desks looking for new initiatives to stimulate exchange trading of institutional-sized orders should not hold their breath.
The sub-title of the 2012 convention of the Federation of European Securities Exchanges (FESE) held in Istanbul on 20-21 June was: can we do a better job serving the needs of our economies?
Stung, like other capital markets professionals, by the calls of politicians and the mainstream media for the sector to perform a more 'socially useful' role, exchanges are embracing the SME Growth Market proposals in MiFID (not withstanding FESE's legitimate concern that lighter listing requirements will send the wrong messages to long-term investors).
Stimulating SME growth is an obvious area where society could benefit from exchanges doing "a better job". The institutional investor that can sift through today's start-ups to buy a stake in the Apple or the Microsoft of tomorrow will almost certainly make higher returns for pensioners and other end-clients than by juggling blue-chips, while also providing much needed equity capital to firms looking to grow their service offerings and payrolls. In the current economic environment – with low interest rates in most European countries but a retrenchment of bank lending to low-risk credits – those that can get bank funding don't need it, but those that do, can't. But SMEs won't necessarily come running. The regulatory and reporting burdens of a public listing are well known. And alternatives sources of funding - from debt capital to crowd sourcing to 'friends-and-family' rounds to venture capital - are growing in abundance. Each of these may have their drawbacks, but the evidence of their appeal is there for all to see in the IPO stats of recent years. As such, it makes sense for exchanges and their regulators to work together to make a more compelling case for a stock listing.
The Istanbul Stock Exchange is showing the way by working with Turkey's capital market regulator to create a zero-cost listing, including reporting and advisory services. This is welcome, but insufficient on its own. Any portfolio manager or buy-side trader knows that research and liquidity in SMEs is thin on the ground. Exchanges have a limited influence on the supply of content, but they can structure their SME markets to maximise liquidity and minimise spreads. Creating the right incentives for market makers is likely to require regulatory involvement, but trading hours can be restricted to bring together as many buyers and sellers as possible. One putative SME exchange operator at the convention intended to open for just eight hours a week.
Such pragmatism is a positive sign. And innovation can also be seen as exchanges look to exploit the opportunities presented by reforms to the OTC markets. The Group of 20’s demands for greater transparency and reduced systemic risk - primarily through central clearing, instrument standardisation and more stringent post-trade reporting - provide a great incentive for exchanges to develop expertise in fixed income and derivatives.
But the concern for institutional investors is that bourse operators will continue to ignore their equity trading needs. The exchanges lament decreasing average order sizes on their central limit order books and fret about the implications for price formation of lost market share. They query the motives of banks and other alternative platform operators that offer dark trading and internalisation. They call on the buy-side to take greater control of their order flow and on regulators to level the playing field between regulated exchanges and other venues in terms of market surveillance and other market integrity responsibilities. Individually, the gripes of the exchanges with today's equities market structure are well-founded and worthy of debate. But collectively, they reflect a mindset that still seems to resent the need to compete, that still regards the exchange as requiring a special, protected status.
During my time in Istanbul, I heard many references to the public good served by the centralised exchange, but did not hear of any plans by an exchange to make it easier for institutions to trade blocks on their platforms. And I can't help thinking that a less pronounced sense of legitimacy and entitlement might help to unblock the pipeline of innovation.
Full disclosure: FESE paid for my flight and accommodation in Istanbul in return for my services as moderator of the convention's panel discussion on the MiFID review. I remain grateful for the opportunity to mix with such a wide range of exchange executives and for the help of FESE's friendly, capable and professional staff.