How do you say “Brexit” auf Deutsch?

I was in Frankfurt a couple months back to host a client roundtable and there was a palpable rubbing of hands in anticipation of a possible Brexit. It reminded me of the time I had spent in Frankfurt in the late 1980s, right after university, back when the only real skyscrapers in town belonged to Deutsche Bank. There was a real sense in that era that with the coming together of the European Union in 1992, Frankfurt stood to emerge as a global financial hub.

Obviously, London was to usurp that role. For reasons of language, geography, regulation and infrastructure, that ascendance seems in retrospect to have been inevitable. And yet now, with the UK vote in favor of Brexit, London’s preeminence appears to be at risk.

Jangled announcements of redundancies by a few large banks belie the fact that once the dust settles, financial institutions will shift into a wait and see mode. Yet to say that much remains to be determined is as interesting as saying that the original Star Wars movies were better than the litany of duds that followed.

I hate to fault my friends in Frankfurt, who have fostered the growth of a robust fintech sector and capital markets businesses, for seeing opportunity in the UK decision to step away from the Continent. Schadenfreude is after all, a German word. But I believe that Frankfurt’s aspirations are overdone. Wasn’t it just a few months ago that HSBC and a few other institutions were threatening to decamp Britain for Hong Kong and Singapore? Wisely, they decided to stay. The acquisition of the London Stock Exchange by the Deutsche Börse was another vote of confidence in London.

The ties between the UK and Europe are thick (London is home to second largest community of French citizens after Paris) and mutually beneficial. They are unlikely to be undone by this plebiscite. Yes, the vote will give heart to seccessionists elsewhere in Europe, and increase the fissiparous tendencies (look for another Scottish independence referendum) already present in the UK.

But it’s important to take the long view. The UK has survived, even thrived, in the wake of greater challenges, including strikes, war and the loss of global empire. It is a mature democracy that hosts a financial services hub unrivalled in the world history. Surely it can work through this Brexit.

Is exchange consolidation desirable for global markets?

The CEO of Deutsche Börse made some very interesting remarks at the recent IDX derivatives industry conference in London. He argued that the proposed merger between Deutsche Börse and LSE would aid the development of trading in global markets because it would unite and harmonize the European capital markets, which are more fragmented than those in the US and Asia according to him. However, in this author's view, the merger of two large global exchanges raises as many questions as it answers. While one can agree that there would be less fragmentation and more harmonization, the main issue is whether the European market has a high level of fragmentation when compared with its global counterparts. Due to the European Union, European capital markets are much less fragmented than the Asia-Pacific, Middle-East and Africa, and Latin America. There has been a great degree of harmonization over the years, driven both by common regulation and industry mergers & takeovers. It is difficult to argue that there is a pressing need for more integration at this point. Instead, the main argument for the merger of LSE and Deutsche Börse is the fact that it would create a larger exchange that would be able to take on the likes of CME, Nasdaq and some of the leading Asian exchanges more easily. The expected reduction in headcount would also make for a more efficient, streamlined, and competitive exchange. But there are concerns that remain from an antitrust point of view and it is quite likely the Deutsche Börse CEO was trying to assuage these when he spoke about the positive effect of such a merger on global markets. If the merger does go ahead with regulatory approval, the advantage for other leading exchanges would be the higher possibility of such mergers and takeovers being approved in the future as well, since these could well be expected in an industry that is undergoing heavy consolidation due to economic and technological factors.

The battle for the soul of exchange-based equity trading?

The recent statements by Nasdaq regarding the possible use of a trading delay by the proposed IEX Exchange puts the spotlight on a battle for supremacy not just between rival exchanges, but very different philosophies regarding what the ultimate role of exchanges in the global capital markets should be. The established exchanges, willingly or unwillingly, represent the status quo in terms of how exchanges should function. IEX on the other hand hopes to represent the interests of those trading participants who believe that they have been left behind in the race for speed in today's capital markets, especially the retail participants and the smaller buyside. It seems like an inevitable outcome in the aftermath of the global financial crisis, which has stoked the debate on economic inequality and the unfair advantage that a select group of trading participants have over others due to their advanced technological capabilities and use of highly sophisticated financial products. 
Getting back to the objections raised by Nasdaq over the SEC proposal that any delay of less than a millisecond could qualify as immediate, which would enable IEX to operate in the way it wants, there is certainly some substance in Nasdaq's argument. The SEC would have to come up with a solution that is acceptable to both sides, and does not leave it vulnerable to legal challenges. It is going to be an interesting couple of months for industry obervers as they follow the debate over the fairness and validity of the SEC proposal, and the decision on the IEX application.

Run, hide, partner, or buy: Fintech, automation, and disruption in wealth management and capital markets

Readers of a certain age may remember Frankfurt's aspirations of surpassing London as the world’s leading banking center. While that vision has not come to pass, Frankfurt remains a powerful hub for global finance. Home to Deutsche Bank, the European Central Bank and the Deutsche Börse exchange among others, Frankfurt’s importance is reinforced by its location at the very heart of Europe.

With this in mind, Research Director Brad Bailey and I are excited to bring the next Celent Wealth and Capital Markets roundtable to Frankfurt on Tuesday, May 10th. Of particular interest will be the role played by fintech firms in disrupting an ecosystem long dominated by large financial institutions. Brad and I will share ideas and examples from recent research, while senior executives with banks and asset managers and other large institutions from Germany, Switzerland, the UK and Italy will offer their perspectives on the disruption and the technology strategies they have adopted in response.

To maximize the participatory nature of this event, Celent is capping attendance at 20 individuals. At present, we have a few seats still open and would love to hear from other clients interested in joining us.

NSX: The (old) new kid on the block

The business of stock exchanges has been making news for some time. The issue of market structure and market practices in the US has been a topic of much discussion for the last 18-24 months, especially since the launch of Michael Lewis’ book Flash Boys, and the subsequent bid by the IEX to launch a new exchange in the US. Across the Atlantic, the possible merger between the London Stock Exchange and the Deutsche Borse groups has reignited the discussion on further consolidation in the exchange space and more broadly its implications for the future of exchanges. Largely unnoticed amidst this fanfare, a new exchange has been launched (or relaunched) in the US that could also have significant and far reaching impact on the industry. This is the story of a group of industry veterans, discontent with the current market practices and lack of actions to remedy them, who have come together to found a new exchange that looks to address the issues with a market based solution.

This is the story of the National Stock Exchange (NSX) even though it sounds a lot like that of IEX, its more publicized competitor that is currently waiting for regulatory approval. The NSX is actually one of the oldest stock exchanges and was originally founded as the Cincinnati Stock Exchange in 1885. It became fully electronic in 1976, moved to Chicago in the 1990s when it took the name NSX, then moved to Jersey City, NJ, was acquired by the Chicago Board of Exchange in 2011 before shutting down operations in 2014 due to failure to attract adequate volumes. A group of individuals with experience in the capital markets came together and formed National Stock Exchange Holdings in 2014 and took over the ownership of NSX. Leveraging the NSX’s existing technology assets but with new ownership and management team and fresh round of capital, the NSX was relaunched in December, 2015.

In a marketplace already crowded with 11 stock exchanges and many more alternative trading venues, NSX has identified a clear differentiator for its business model: access fees. The issue of access fees charged by the exchanges has been a topic of contention for some time now. In particular the issue of exchanges offering rebates to broker-dealers for providing liquidity has raised questions around conflicts of interest and investor protection. While there have been a lot of debates on this topic, concrete measures to address this have not been forthcoming. This is where NSX is looking to differentiate itself by offering a simple flat fee structure at significantly lower rate by simply charging liquidity takers 3 cents for every 100 matched shares and zero cents for liquidity providers. Notably, the exchange also looks to maintain a level playing field by not offering co-location facility, in a significant departure from current market practices where other exchanges offer members speed advantage charging a co-location fee.

The success of any trading venue depends on the amount of liquidity it is able to garner by bringing both liquidity providers and takers together on the platform. Many market participants, including some of the largest asset managers, have been asking for some time for a trading venue with low fess and level playing field for all investors. While NSX has taken the initial steps towards establishing such a marketplace, its success will greatly depend upon its ability to attract an array of participants to create a viable liquidity pool. Still in its early days, the exchange has been focusing on this issue and talking to a number of market participants to get them on board. If it gets traction in the market, it would be interesting to see how the incumbent players react. The large exchange groups of late have been busy focusing on numerous areas of the business, such as adding new asset classes, expanding into clearing services, growing market data and index business, as well as driving economies of scale through large scale mergers and acquisitions. As a result, focus on innovation in the traditional equities trading business has failed to keep pace with some of the other priorities exchanges have been focusing on lately. NSX’s initiative, along with that of IEX’s (with somewhat similar goals but different means), has the potential bring the focus back on the equities exchange business and re-ignite the next round of evolution in this space.

ICE ices other exchanges in picking up major market data provider

Intercontinental Exchange (ICE) has agreed to buy market data provider Interactive Data Corporation (IDC) from its private equity owners for $5.2 billion in cash and stock from Silver Lake and Warburg Incus. Bringing together a large exchange complex like ICE and approximately the third largest provider of market data is a very interesting merger, but ultimately makes a lot of sense. The need for market data is increasing across asset classes, and this is a particularly good fit for ICE given that it trades in so many of the commodity, equity and fixed income products. The synergies for an exchange in acquiring a major market data is strategically logical as exchanges rely more and more on market data in their revenue models. One area given the strength ICE has in credit brokerage and clearing, and the increased move to electronic trading across fixed income products, is the IDC continuous pricing tool which is becoming an important part of the means of pricing bonds in an increasingly electronic world.

Fixed income markets and ‘self-trading’

The interesting insights from a recent regulatory report into the operation of the US fixed income market on October 15 2014 continue to intrigue observers and raise important questions about how the market trades. A remarkable point referred to the high proportion of ‘self-trading’ between mainly prop traders’ own automated systems. This was 14.9% for the 10-year cash Treasuries and 11.5% for the futures equivalent. While this might not have been the leading reason for the high levels of volatility on that day, it is certainly an attribute that requires careful attention. Logically speaking, such self-trading can lead to artificial market levels and prices that are quite different from what they would be without high levels of self-trading. Price volatility can also be affected by high proportion of self-trading. Prop traders often have several independent algorithms running in the market and therefore are more liable to be affected by this phenomenon. The regulators’ report also noted how other participants such as banks and hedge funds did not have much self-trading. While the jury is still out on the undesirable effects of self-trading, and how responsible it was for any price swings, we can agree that it cannot really be desirable for the markets. Some exchanges and trading firms have already taken steps to curb such trading, but it is important that the firms that are more susceptible to undertake such trades try to stamp them out on their own, even if it means slowing their trading a little for the sake of reducing lower systemic risk overall.

NYSE glitch hurts, but no one felt it

Shooting yourself in the foot has to be painful. Thankfully, I have not done the fundamental research on this; Let’s just assume that it really hurts! The important thing about shooting yourself in the foot is that the pain is your own. We do not have to look very far to see some very notable examples of self-inflicted pain at companies with their technology. Software and hardware are glitchy and things go wrong. Nothing is better, though, when things go really wrong and no one else is hurt. Other technology failures in the financial markets have hurt many other companies, as well as many individuals. In some of these cases, pain rippled out from some point in a firm’s technology infrastructure and gained strength, as others in the networks were run over by the particular software or hardware failure. That is not really the case with the 3+ hour NYSE halt on Wednesday (July 9, 2015). The NYSE went down, and I am not saying it was not a big deal for NYSE. That’s a lot of nanoseconds to be off-line. However, it was just the loss of one small node in the entire U.S. equity trading network. There was concern at first that it might have been part of a cyber-attack (which is really scary, and who knows, what will be found out as forensic analysis continues but we will leave that to another discussion). A single point of failure in a robust network of dozens of equity trading venues, did very little to change trading. And it was a busy day, with Grexit and Chinapocalyspe in full swing. Plus, the Fed minutes were released while this was all happening! I was busy with a client when Bloomberg News reached out to ask me what was going on at the NYSE, minutes after the halt began. My mind began reeling – was it a cyber-attack? I quickly started thinking about the many experiences I have had with these types of situations: flash crash, failed IPOs, destruction of a firm. I reached out to my network to see what was happening. Yes, NYSE was down, but the other exchanges: (NASDAQ, BATS) were up; the network of darkpools, broker crossing engines, buyside crossing engines were trading. Even NYSE ARCA was up. This is what to I expressed to Pimm Foxx on Bloomberg TV. Something happened, but it was not a disaster, and people could still trade stocks. The robust and competitive web of interconnected venues can be a model for the market structure in other asset classes. The gun went off and wounded one small part of the system, but the fragmented network held.

IPOs for leading Indian exchanges?

The recent discussion of the possible pressure on the Indian government to list the leading Indian bourses can be considered in many ways including as a clash of civilizational management cultures. With a history of foreign rule, Asian countries that became independent relatively recently are generally suspicious of foreign interference and see control of the large domestic institutions such as exchanges (often termed national jewels) as vital. This is an important reason for the monopolistic or duopolistic vertical exchange market structure in these countries. It makes it easier for the government and the capital market regulator to control the activity of the exchange. Ironically, in the west, after the financial crisis, the need for control and stronger regulation has become an important focus of the respective governments and leading financial regulators, for obvious reasons. Listing the Indian exchanges would make their performance not only transparent, usually a desirable trait, but also more amenable to market forces and pressures from both the domestic and the international investment community, which can sometimes run counter to the respective national interests of the exchanges in which the countries are based. The Indian government and the capital market regulator SEBI would have to take a call on whether they see listings as the best way of making these exchanges transparent. The firms that have invested in the exchanges by taking minority stakes should be in a position to sell these stakes at any point in time, and hence an IPO is not the only way for them to realize their gains on past investments. If the exchanges are indeed listed, it has to be in order to make them more efficient, transparent and globally competitive. Of the two exchanges, probably the BSE which has tried to list in the past would be the most favorable to the process since this might put it in a better competitive position vis-a-vis the leading competitor in the NSE. The NSE would probably not want to disturb the status quo, or do it in a very controlled fashion if at all. But these are internal market dynamics the regulator would not bother much about, and it would mainly focus on issues such as systemic risk management in a post-listing scenario. The final decision, while not a ‘make or break’ one some vested interests are making it to be, would still be of interest to the casual observer of India’s journey as an important emerging global capital market.

Is the Saudi Arabian equity market the last emerging market frontier?

The Saudi Arabian equity market, the Tadawul, has recently begun  the process of easing access for foreign investors. A late entrant on the global equity scene, the market itself is not something to be scoffed at, being larger than the likes of the Mexican, Russian, and Indonesian equity markets in terms of market capitalization. And this is without the Saudi oil firms, which are state-owned. However, there are some significant restrictions on foreign investment such as limits on the minimum asset size a firm should have, the percentage a foreign investor can own in any one stock, and the T+0 settlement period which is a challenge for any foreign investor. The opening up has been a gradual process. Some investors such as HSBC have shown their hand by moving early, but most leading global investors seem to be taking a wait and see approach. Also, some foreign institutional investors are in the process of completing their application for the Qualified Foreign Investor license. So while it will be some time before the Tadawul becomes as important as some of its other emerging market counterparts in the international context, it seems to fit the bill of the last frontier for global investors among the large emerging markets. A possible bright spot for an asset class that has been under the weather of late..