By Joyce Moullakis and Nandini Sukumar
Nov. 18 (Bloomberg) -- Goldman Sachs Group Inc., Morgan Stanley and investment banks in Europe are using the early success of new trading platforms they have backed to push exchange fees lower.
Goldman and Morgan Stanley, whose profit in the first three quarters is down 44 percent from last year, and brokers at firms such as Merrill Lynch & Co. and Citigroup Inc. have demanded European exchanges cut trading tariffs. The companies have won new clout by backing alternate trading platforms such as Chi-X Europe Ltd. and Turquoise and by urging rival bourses to set up shop in Europe.
``Banks have been angry for some time about fees,'' said Benn Steil, director of international economics at the Council on Foreign Relations in New York and an expert on exchanges. ``They've pointed out that volumes have grown and fees haven't come down. And in an environment like this, you can expect them to ratchet up pressure. They definitely have more leverage now with the likes of Turquoise and Chi-X.''
A year after the European Union's Markets in Financial Instruments Directive made competition possible, new entrants are gaining traction, offering some cheer for banks as the industry confronts its worst year since the Great Depression. At stake are billions of dollars in trading revenue.
London-based Turquoise, owned by the biggest investment banks and run by ex-Morgan Stanley executive Eli Lederman, drew 4.8 percent of trading of FTSE 100 stocks yesterday, two months after launching, according to Sanford C. Bernstein & Co. in London. Chi-X, a unit of Instinet Europe Ltd. that began operating last year and is also backed by investment banks, is the most successful of the new platforms. It captured 15.7 percent of trading in FTSE 100 stocks yesterday.
Bats, Nasdaq OMX
Citigroup, the fourth-biggest U.S. bank by market value, said it executed 40 percent of its U.K. trades last month on Chi-X, 12 percent on Turquoise and the rest on the London Stock Exchange. The bank owns stakes in both Chi-X and Turquoise.
Two U.S. exchanges that began operating in Europe during the third quarter are also putting pressure on established bourses. Bats Trading Inc., a three-year-old company that grew into the No. 3 U.S. equity market, says it plans to be ``aggressive'' in winning at least a 10 percent market share in the region. It accounted for 0.5 percent of trading in FTSE 100 stocks yesterday, according to Sanford Bernstein.
Nasdaq OMX Group Inc., the bourse handling the most U.S. share trades, cut some fees by more half on Oct. 23, five weeks after opening its pan-European trading platform. It's now cheaper to trade an LSE-listed stock through Nasdaq OMX Europe than directly on LSE.
Breaking `Monopolies'
As a result of the competition, London Stock Exchange Group Plc, NYSE Euronext and Deutsche Boerse AG have each cut some fees. LSE has changed the way it charges brokers, and NYSE Euronext and Deutsche Boerse plan alternate trading platforms of their own. The NYSE Euronext platform, called NYSE Arca Europe, will trade 400 to 500 stocks that aren't currently listed on the company's four European bourses. It is aimed at taking business from both LSE and Deutsche Bourse.
``Exchanges were monopolies,'' said Ashok Krishnan, managing director of execution services at Merrill Lynch in London. ``That chain has now been broken. They have to react differently.''
That's what LSE did when Nasdaq OMX Europe lowered fees. On Nov. 1, the U.K.'s biggest exchange said it will charge alternative-trading platforms for doing deals on its market. LSE, which earlier cut fees for brokers who add liquidity, said it would charge 1 basis point on a trade that is ``business on behalf'' of other markets.
LSE's new rivals are offering to route traders through LSE if they can't find a match for orders on their markets.
Winners and Losers
``We've wrung some of the efficiencies out, like speed and new fees, but there's more to go,'' said Rob Maher, head of advanced execution services sales for Europe, the Middle East and Africa at Credit Suisse Group AG, which owns stakes in Chi-X and Turquoise. ``Looking at volumes, it's going to be a battle. The current environment means we will see who the winners and losers will be much more quickly. It is unlikely one will see any of the major multilateral trading facilities disappearing anytime soon, as they have deep pockets and serious backers.''
Banks worldwide are reeling from $710 billion of writedowns and credit losses since last year and more than 158,000 job cuts. Investment banks and brokerages have been hit on three fronts at once, as global equity-market valuations slump, institutional clients seek lower brokerage commissions and brokers are forced by technological changes to trade more to execute orders.
`Squeeze the Vendor'
``Overall the banks are getting squeezed, so they squeeze the vendor,'' Christopher Concannon, Nasdaq's head of transaction services, said in an interview. ``It's business. You're trying to control your costs. And through this wonderful margin goes a red line that's exchange fees.''
The seven largest U.S. brokerage firms posted equity- trading income of $9.69 billion in the second quarter, the lowest level in 18 months, according to data compiled by Standard & Poor's Equity Research Ltd. Their combined equity trading revenue peaked at $12.5 billion in the first quarter of 2007, S&P said.
Commissions earned by brokers trading European stocks are also declining, down about 5 percent this year compared with 2007. Most of the reduction stems from a drop in rates paid by institutions -- an average of 15 basis points on so-called high- touch trades and 5 basis points on electronic trades, according to a September report by Greenwich Associates in Greenwich, Connecticut. A basis point is 0.01 percent.
`Loss Leader'
As trading algorithms and computer systems grow more sophisticated, orders are sliced into smaller and smaller pieces so they can more easily find the best match. This means that while the value of trades is declining, brokers are trading more to execute them. That's part of the reason exchanges are enjoying a boom in volumes, which translates into higher costs for brokers.
``The equity trading businesses have become a loss leader,'' said Richard Bove, an analyst at Ladenburg Thalmann & Co. in Lutz, Florida, who has followed brokerages for 26 years. Bove expects the industry's equity-trading revenue to decline by as much as 15 percent this year.
That has intensified pressure on exchanges. LSE charges about 0.65 basis points a trade, according to Mamoun Tazi, an analyst at MF Global Securities Ltd. in London. That compares with 0.2 basis points and 0.4 basis points for the multilateral trading facilities, as the new entrants are called.
Fee Reductions
``Cash equity is a commoditized business, which means that price will be the main differentiator,'' Tazi said. ``The competitive advantage of liquidity was reduced by the introduction of the new regulatory regime and recent advances in technology. This means the LSE will lose significant market share.''
Tazi said LSE's earnings may fall 42 percent in the next three years because of greater competition and lower volumes.
The increased competition ``is timely,'' said Andrew Silverman, managing director of electronic trading at Morgan Stanley. ``We will see more pressure on exchanges to reduce costs.'' Fee reductions need to be ``deeper,'' he said.
Bryan Koplin, Goldman's executive director of electronic- transaction services in London, made a similar point.
``Exchanges, just like all providers, need to demonstrate value for services rendered,'' Koplin said.
LSE Reaction
LSE announced price cuts on Aug. 1 that it said would make it ``the cheapest trading venue in Europe for major users.'' The exchange said it will stop charging per trade, and instead will look to the value of the order and also offer incentives to some traders using its electronic order book.
``We believe we are competitive and intend to remain competitive,'' said Patrick Humphris, a spokesman for the exchange. ``We recently moved to a maker-taker fee structure, which offers substantial discounts and rebates for the highest volume clients. There may be some venues that seek to offer their services at less than economic rates, but this clearly isn't sustainable in the longer term.''
Deutsche Boerse, Europe's biggest exchange by market value, announced on Aug. 26 that it would cut fees for algorithmic traders and offer new clearing packages, moves that may trim as much as 35 million euros ($44 million) from revenue.
The announcement came a week after the Swiss Stock Exchange decided to lower tariffs by as much as 30 percent on its London SWX Europe market, where the biggest Swiss stocks were listed. Last week the exchange shut the market amid competition.
`Regulation, Not Competition'
NYSE Euronext, the world's largest owner of stock exchanges, also said it has cut fees for traders using several of the company's bourses.
The price cuts have pleased James Laing, who oversees 6 billion pounds ($9 billion) as head of pan-European equities at Aberdeen Asset Management Plc in London and who says he isn't sold on the new platforms.
``I'm delighted trading costs are falling,'' Laing said. ``But it's nice to have big pools of liquidity, and I'm not sure fragmentation helps. Regulation, not competition, might do the same thing.''
To contact the reporters on this story: Nandini Sukumar in London at nsukumar@bloomberg.net; Joyce Moullakis in London at jmoullakis@bloomberg.net.
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