When I first met Mark Hemsley four years ago he was CEO of Bats Chi-X Europe, an equities multilateral trading facility (MTF) that had become the single largest trading venue by volume in Europe. However, in the relatively short time since, that MTF has become a regulated exchange, branched out into exchange traded funds (ETFs), foreign exchange (FX) and launched a post-trade reporting service.
The rise of its European business mirrored the rapid success of its US parent Bats Global Markets, founded as an alternative trading system in 2005. It too has seen huge growth that has enabled it to rival much older exchange operators such as NYSE and Nasdaq.
In March this year, Bats once again began a new chapter in its development after it was acquired by Chicago-based derivatives exchange CBOE for $3.4 billion. The TRADE met up with Hemsley to get an idea of how the new, enlarged group is going to look and what its key priorities will be as MiFID II approaches.
Hemsley, now president, Europe at CBOE Holdings, says that integration of the two businesses is already underway.
“It is early days but the main thing we’ve already done is have the CBOE derivatives team in Europe join us in our London office. This means we can introduce them better to out significant customer base in both equities and FX,” he explains.
By bringing the CBOE team in to work alongside their Bats colleagues at such an early stage, the firm is hopeful it will create a two-way dialogue that benefits both sides of the business.
“The CBOE side has been educating the team about the company’s derivatives offer, not just the leading VIX and S&P products buy a range of other derivatives that CBOE offers. Meanwhile we are helping them to get to grips with the complex market structure issues in Europe, particularly MiFID II.”
“We’re organising ourselves with product managers who understand their particular areas. We have the trade desk team which is all local here in London, while FX is very much a global product and derivatives are being handled out of Chicago and Kansas.”
But merely expanding the client databases of the two firms is not in and of itself a reason for two of the biggest names in their respective fields to merge, Hemsley says there is a lot more than this behind the logic of the acquisition.
“The merger enables us to offer a wider products set but it also gives CBOE a much bigger footprint outside of North America, access to the world of FX and equities and of course the Bats technology which CBOE is adopting.”
He is also hopeful the combined group will able to pool its resources to make a big push into Asia, where both firms currently have a relatively small presence, though Hemsley stresses it is growing. The FX offering in particular will be vital as part its strategy to become a truly global operation and to realise its ambitions in the Asian markets.
MiFID manifesto
Moving on from the implications of the merger, many of which will not be fully realised for some time, Hemsley is also keen to talk about the most pressing issue facing all European firms this year, MiFID II.
“There are several important angles around MiFID II, firstly that the volume caps will compromise dark MTFs and it is evident that a large number of stock will be going straight over the 8% total volume cap in January next year,” he explains.
Bats already had plans for how it would deal with MiFID II well underway prior to news of the CBOE acquisition. Among the main pillars of its strategy in this area is its periodic auctions. While these take place on the lit market, they will prioritise orders based on size, rather than time, something the buy-side has been demanding as a way to facilitate larger trades while not falling foul of the dark trading caps.
“The early results are good and we expect more trading activity will take place via the auctions as the broker crossing networks begin to wind down.”
Auctions have been widely viewed as one of a number of potential solutions to the dark trading problem that MiFID II creates, and Bats’ rivals such as the London Stock Exchange have also modified their auction offering to try and anticipate the changing trading behaviour expected to come once MiFID II comes into force in January 2018.
As well as offering auctions Bats is also seeking to take a share of the increasingly lucrative large-in scale execution market and compete with the likes of Liquidnet and ITG with Bats LIS. For this service, Bats has teamed up with BIDS Trading, a US-based company that offers block trading using a blotter scraping mechanism to match large orders together.
However, Hemsley says its own offering is distinct in the market as it will crucially include the buy-side.
“We’re offering a combined buy-side and sell-side environment, because it is important to have dealers involved in this as well. The crucial thing for us to offer the buy-side is choice in terms of how they connect and how they execute.”
The services allows traders to decide whether to execute via their own order management system or using a sell-side broker and will have more access to contingent IOIs and, Hemsley promises, more control over their execution.
“If the buy-side can interact with each other but have manual control over that process, they will be able to upsize their transactions,” Hemsley adds.
The third and final component of Bats’ MiFID II strategy is addressing the buy-side’s potential headaches over their new trade reporting responsibilities.
With regards to trade reporting, Bats has launched an assisted reporting model that allows buy-side firms to enable their brokers to submit trade reports on their behalf using the broker’s existing connectivity to Bats Europe. Bats has also announced joint initiatives with both Bloomberg and Trax that enables those customers to utilize Bats Europe for their equity trade reporting needs.
“What we’re offering is giving the buy-side the choice either to handle their own reporting or they can get their broker to do it on their behalf for just a few thousand pounds per year,” explains Hemsley.
The squeezed middle
Speculating on how the post-MiFID II environment might play out, mid-sized deals that are too large for the lit market and dark MTFs, and too small for the large-in-scale waiver, appear to be under the most pressure.
“Lit books tend to be full of €10,000 trades, dark MTFs more like €10,000-30,000 and then the big block trading will be €1 million plus. The real issue is going to be those trades in the middle, which would have been traded on the BCNs in the past. That BCN flow will now have to find various other homes” says Hemsley.
One answer is that such trades will get aggregated into a larger order that fits the large-in-scale threshold, he explains, while others may get split up to be worked on the lit market or dark MTFs. Hemsley believes new initiatives, such as its own periodic auctions, will also help to meet some of this demand for mid-sized trading opportunities.
“We think our periodic auctions will hit the sweet spot between the smaller trades on the continuous markets and the larger, negotiated block deals,” he adds.
Bats launched its periodic auctions back in October 2015 to counteract declining order sizes. Auction events take place throughout the day and have a random end time which will allocate trades based on price and size rather than time, provided the matches are within the European Best Bid and Offer price range.
“It’s important for the buy-side that they can choose how they want to trade,” Hemsley says, “You decide the urgency and the priority, we don’t want to jam everyone into one place.”
Choice appears to be something the buy-side will have in abundance post-MiFID, as Bats and its competitors scramble to push out an ever broader range of block trading, auctions and new order types in order to adapt to the new regulatory order.
There is no doubt 2017 is going to be a huge year for CBOE and Bats, transforming them into true global and multi-asset players. Bringing the two very different companies together in a way that can produce greater growth will be a challenge, as will adapting to the rapid changes in regulation being seen not just in Europe but across the world. Hemsley is confident the firm has already got in place many of the answers investors are seeking, but it will also face issues including Brexit, a possible rollback of regulation in the US and an increasingly volatile political situation in many of the countries in which it operates.