Aussie rules: the Oxera Trading and Post-trading Monitor

Agenda Advancing economics in business The Oxera Trading and Post-trading Monitor Aussie rules: the Oxera Trading and Post-trading Monitor Over the past two decades, the competitive structures of stock markets across the world have undergone considerable change. In many new markets, new trading platforms compete with national stock exchanges, and in most European markets investors and traders can choose from several competing central counterparties (s) for the clearing of equity transactions. Oxera has updated its analysis of the costs of trading and post-trading services, with a focus on Australia The disappearance of technical barriers and the liberalisation of securities markets have dismantled the natural monopoly of national stock exchanges. New trading platforms have entered, first in the most established financial markets the USA, UK and several other European countries and then in the expanding financial centres of Canada, Australia and Japan. This wave of entry has not yet finished: various trading platforms have announced plans to launch in other financial centres such as Brazil and South Korea. In other countries such as Australia, the debate has now started to focus on the structure of the market for post-trading services. Competition is not a goal in itself but a means to an end in large financial centres such as the USA and the UK, competition between trading platforms became the norm several years ago, with the aim of reducing the costs of trading and improving service offerings. At the same time, international precedent suggests that there are potential costs to having more than one trading platform (and clearing house), such as the additional regulatory costs of supervision and monitoring, and the costs to brokers of connecting to additional infrastructure providers and investing in new IT infrastructure. To understand the potential for further fee reductions as a result of introducing competition, it is useful to compare the charges for trading and post-trading services over time and across financial centres. This article discusses such a comparison recently undertaken by Oxera for a large number of different financial centres. Developments in Australia Financial centres can be grouped into three broad categories: i) those that are well established as large financial centres, such as the USA and the UK; ii) those that have emerged more recently as large financial centres, such as Australia, Hong Kong and Canada; and iii) smaller financial centres, some of which could be on the cusp of dynamic growth, such as India, Mexico and South Africa. A common trend observed internationally is that, as a financial market grows, there is increased pressure to establish, or at least allow, competing trading venues, and the incumbent national stock exchange is exposed to competition. Often, such regulatory changes come after pressure from users and/or potential new entrants that have identified the scale of the market as sufficiently large for multiple trading platforms to compete efficiently. In 2009 the Australian Securities and Investments Commission (ASIC) issued a regulation that allowed for alternative trading systems to enter the Australian market, and transferred supervision of markets from the incumbent infrastructure provider, Australian Securities Exchange (ASX), to the ASIC. In 2011, Chi-X Australia was the first entrant to the market. The debate has now started to focus on whether it would be desirable to introduce competition for clearing (see the box overleaf for an overview of clearing models around the world). In December 2012, the Council of Financial Regulators in Australia prepared a report for the Australian government analysing This article is based on Oxera (2013), The Oxera Trading and Post-trading Monitor, note prepared for ASX Group, April, available at www.oxera.com. See also http://www.asx.com.au/cs/international-cost-comparisons.htm. Oxera Agenda 1 September 2013

Different models for post-trading services Around the world, there are a number of models for post-trading services. A single and multiple trading platforms in the USA, there is a single (DTCC) that is used by multiple trading platforms. DTCC is user-owned. Vertical model in various countries the trading platforms own their. Examples are Germany, Spain, South Africa and Brazil. User choice model in Europe, various trading platforms allow for clearing on multiple s. For example, trades executed on the London Stock Exchange can be cleared on LCH-Clearnet or X-Clear, and trades executed on BATS-Chi-X Europe can be cleared on EMCF, Euro, LCH-Clearnet and X-clear. 1 Vertical model Open access model in Australia, brokers trading on the new entrant trading platform, Chi-X, can clear their traders using the owned by the incumbent exchange (ASX). In practice, there are combinations of these different models. For example, LCH-Clearnet is currently owned by the London Stock Exchange (and could be seen as a vertical model), but operates to some extent independently of the London Stock Exchange and also clears trades from other trading platforms. Furthermore, there may be one or multiple central securities depositories (s) for example, as shown in the vertical and user choice models illustrated below. Multiple trading platforms interoperability net transfers User choice model Open access model interoperability net transfers Note: 1 For a more detailed discussion on the user choice model, see Barnes, R. (2010), Counterparty Clearing House User Choice: an Evolving European Landscape, Agenda, March, available at www.oxera.com. responses to a discussion paper on competition in the clearing and settlement of Australian cash equities. 1 The Council found that views were mixed on whether competition in clearing would deliver net benefits to the Australian financial system, and therefore recommended a cautious approach to the introduction of competition. In particular, it advised that a decision on any licence application from a seeking to compete in the Australian cash equities market be deferred for two years. During this two-year period, ASX intends to work with stakeholders to develop a code of practice for the clearing and settlement of cash equities in Australia. To facilitate effective dialogue with stakeholders, ASX has created a website, 2 which includes an international comparison of the charges for trading and post-trading services offered by infrastructure providers. 3 International comparison of costs: methodology The prices of trading and post-trading services can be assessed in one of two ways: through a user profile approach, in which representative user profiles are applied to the pricing schedules of different infrastructure providers to estimate the total charges that each user in each financial centre pays; through revenue analysis, in which the average unit cost paid by users for trading and post-trading services is measured according to the revenues (divided by the number or value of transactions) of the service providers. Oxera Agenda 2 September 2013

Each approach has advantages and disadvantages, but, when conducting a like-for-like comparison across financial centres, a user profile approach has certain important advantages. 4 This is because user costs can vary between financial centres due to differences in price and in the way brokers and investors use infrastructure providers. In the revenue analysis approach, it would be difficult to assess the extent to which cost differences across financial centres are due to differences in price or in the user profile. In the user profile approach, however, the profile can be kept the same across all financial centres so that any cost differences are due only to differences in prices. The user profile approach also allows the costs of different types of investor (retail and institutional) and broker (small and large) to be estimated. Oxera therefore applied the user profile approach to measure the cost of using trading and post-trading services provided by infrastructures in Australia, and to compare these with the costs paid in other financial centres. This is an update of the analysis Oxera undertook in 2012 for the Securities and Exchange Commission of Brazil (SEC). 5 The analysis for SEC used 2011 pricing schedules, whereas this updated analysis uses pricing schedules as at January 2013. The user profiles have also been adapted to reflect more closely the investors and intermediaries active in the Australian cash equities market, rather than the Brazilian equivalent. An international comparison is subject to certain limitations. For example, the trading and post-trading services offered in different financial services are not necessarily exactly the same. Differences in both the scope and the quality of the services may explain some of the differences in costs paid by users. However, in most financial centres, these differences are likely to be relatively small. Where they are significant, they should be taken into account to ensure a like-for-like comparison. 6 In addition, the ability to benchmark at a more disaggregated service level may be constrained in a number of jurisdictions where vertically integrated post-trading infrastructure providers charge a bundled post-trading fee rather than distinct fees for and services. International comparison of costs: findings Figure 1 presents the fees paid for trading and post-trading infrastructure services for two very different user profiles active in the Australian stock market institutional investors using large Figure 1 Fees for trading and post-trading infrastructure services (bp) 10 9 8 7 6 5 4 3 2 1 0 USA: NYSE Chi-X Europe Canada: Toronto SE UK: London SE Germany: Deutsche Börse Hong Kong: Hong Kong SE Australia: ASX Brazil: Bovespa Spain: BME Italy: Borsa Italiana India: National SE South Africa: Johannesburg SE Singapore: Singapore SE Mexico: BMV Indonesia: Indonesia SE Poland: Warsaw SE Australia: Chi-X Argentina: Buenos Aires SE Retail investor using small intermediaries Institutional investor using large intermediaries Note: The retail investor is assumed to hold (on average) a portfolio of 14 stocks, and to trade seven days a year. Each time the retail investor trades, it sells one stock and purchases a new stock, thereby trading in two stocks at a time, with a value of A$12,000 in each. The small intermediary is assumed to trade (on average) 1,000 times a day, with an average trade size of A$10,000, and to hold a account of A$63m. The institutional investor has assets of A$100m, a trading velocity of 200%, and an average order size of A$125,000. The large intermediary is assumed to trade (on average) 100,000 times a day, with an average trade size of A$10,000, and to hold a account of A$39 billion. For an overview of the infrastructures considered in each financial centre, see Oxera (2013), The Oxera Trading and Post-trading Monitor, note prepared for ASX Group, April. Source: Oxera (2013), op. cit. Oxera Agenda 3 September 2013

intermediaries, and retail investors using small intermediaries and presents the following findings. The range of costs incurred by different investors and intermediaries in the same financial centre can be substantial. For most financial centres, the infrastructure providers charges for trading and post-trading services vary by about 1 2 basis points (bp) according to the characteristics of the investor, broker and custodians used. However, for some financial centres, such as Spain and Poland, the variation in fees can be more extreme, even up to 7bp. The range of costs between different financial centres can be as wide as 9bp. The financial centres in Figure 1 are ordered by value of trading, decreasing from left to right, and the total charge for trading and post-trading services is typically larger in the financial centres on the right (ie, the smaller ones). This suggests that there is some evidence that economies of scale may be a driver of the variation in cost, a trend that is explored further below. Economies of scale Figure 2 below and Figure 3 overleaf present the relationship between the total user cost associated with infrastructure trading and post-trading services, and the value of trading on each stock exchange, for a number of financial centres with different market structures for trading and post-trading services. These figures show some evidence of economies of scale. For both types of investor, the cost for trading and post-trading services provided by infrastructures generally decreases as the size of the financial centre increases. Surrounding this general trend, there is some variation, with the total cost of trading and post-trading services in some smaller financial centres being lower than the size of their financial centre might suggest (particularly in the case of costs incurred by institutional investors). This could reflect a strategic decision by such financial centres to develop their markets and encourage more activity by institutional investors. The general trend of economies of scale can also be distorted where multiple trading venues share Figure 2 The relationship between the cost and the value of trading and post-trading institutional investors using large intermediaries 5.5 5.0 4.5 Indonesia: Indonesia SE Singapore: Singapore SE Trading and post-trading fees bp 4.0 3.5 3.0 2.5 2.0 1.5 South Africa: Johannesburg SE Brazil: Bovespa standard fee Poland: Warsaw SE Brazil: Bovespa day trader fee Spain: BME Australia: Chi-X Australia: ASX 1.0 0.5 Mexico: BMV Hong Kong: Hong Kong SE Italy: Borsa Italiana Germany: Deutsche Börse UK: London SE India: National SE Canada: Toronto SE Chi-X Europe 0.0 0 500 1,000 1,500 2,000 2,500 Annual value of trading A$ billion Note: For user profile descriptions, see the notes to Figure 1 for the institutional investor and large intermediary. For each of the financial centres considered, the value of electronic order book (EOB) trading on the relevant trading venue during the 12-month period ending January 2013 (the latest period for which data is consistently available) is reported. To increase the scale of the chart, Argentina has been excluded as the costs of 9bp in that country are much higher than for the other financial centres considered. Similarly, the USA has been excluded, in this case because the value of EOB trading on the NYSE is much higher than for the other financial centres considered. Source: Oxera (2013), op. cit. Oxera Agenda 4 September 2013

Figure 3 The relationship between the cost and the value of trading and post-trading retail investors using small intermediaries 6.5 6.0 Poland: Warsaw SE Indonesia: Indonesia SE 5.5 Trading and post-trading fees bp 5.0 4.5 4.0 3.5 3.0 2.5 2.0 Singapore: Singapore SE Brazil: Bovespa standard fee South Africa: Johannesburg SE Brazil: Bovespa day trader fee Italy: Borsa Italiana Australia: ASX Australia: Chi-X Canada: Toronto SE Mexico: BMV 1.5 Germany: Deutsche Börse UK: London SE 1.0 India: National SE Hong Kong: Hong Kong SE Chi-X Europe 0.5 0.0 0 500 1,000 1,500 2,000 2,500 Annual value of trading A$ billion Note: For user profile descriptions, see the notes to Figure 1 for retail investor and small intermediary. For each of the financial centres considered, the value of EOB trading on the relevant trading venue during the 12-month period ending January 2013 is reported. To increase the scale of the chart, Argentina has been excluded as the costs of 9bp in that country are much higher than for the other financial centres considered. Similarly, the USA has been excluded, in this case because the value of EOB trading on the NYSE is much higher than for the other financial centres considered. Source: Oxera (2013), op. cit. the same post-trading services. In such financial centres, the smaller trading venue may share the economies of scale achieved by the larger volume of activity processed by the post-trading provider. In sum, when comparing the costs of trading and post-trading services across financial centres, it makes sense to take into account the scale of the financial centres. Figures 2 and 3 show that costs are very low in some financial centres (such as in Germany, the UK, Canada, and the USA) owing to significant economies of scale and the effects of introducing competition. This price-comparison tool can be used to monitor the costs of trading and post-trading services over time using the costs in other financial centres as a benchmark. One would expect fees to come down further over time as a result of economies of scale, particularly in financial centres that are still growing significantly. Concluding remarks The introduction of competition for trading services has resulted in significant reductions in trading fees in a number of financial centres. In some of these centres, such those in Europe and Australia, the debate has expanded to examine the market structure for clearing services as well. Assessing whether the introduction of competition would result in net benefits requires a detailed analysis of the costs and benefits. On the one hand, introducing competition in clearing may result in lower fees for brokerage firms and end-investors. On the other hand, there could be additional costs, for example if brokerage firms connect to, and post collateral at, multiple s. Whether competition will be beneficial will depend largely on the potential scope for the reduction in clearing fees ie, the extent to which fees are currently above a competitive level. A price monitor can be a useful tool to measure the costs over time and across financial centres, thereby indicating whether fee reductions could be expected. In itself, the tool may also impose some pressure on infrastructure providers to keep their fee schedules competitive. Oxera Agenda 5 September 2013

1 Council of Financial Regulators (2012), Competition in Clearing Australian Cash Equities: Conclusions, December. 2 http://www.asx.com.au/cs/ 3 Oxera (2013), op. cit. 4 For previous analysis of the costs of trading and post-trading services, see, for example, Oxera (2011), Monitoring Prices, Costs and Volumes of Trading and Post-trading Services, report prepared for European Commission DG Internal Market and Services, May; and Oxera (2010), Costs of Securities Trading and Post-trading UK Equities, prepared for Euroclear, February 26th; both available at www.oxera.com. 5 Oxera (2012), What would be the Costs and Benefits of Changing the Competitive Structure of the Market for Trading and Post-trading Services in Brazil?, prepared for Comissão de Valores Mobiliários, June. 6 For example, in Brazil, the beneficiary owner rule means that the infrastructure provider holds accounts at the end-investor level, and therefore the security is delivered directly into the end-investor s account rather than the accounts of custodians, as occurs in most other financial centres. This difference was taken into account in Oxera s analysis for SEC see Oxera (2012), op. cit. 7 See also, for example, Oxera (2011), op. cit. If you have any questions regarding the issues raised in this article, please contact the editor, Dr Leonardo Mautino: tel +44 (0) 1865 253 000 or email l_mautino@oxera.com Other articles in the September issue of Agenda include: behavioural economics: making choices at the individual and firm level Annemieke Tuinstra-Karel, ACM energy market reform in Germany: what can we expect? Dr Michael Kraus, Oxera hide and seek: the effective use of cartel screens For details of how to subscribe to Agenda, please email agenda@oxera.com, or visit our website www.oxera.com Oxera, 2013. All rights reserved. Except for the quotation of short passages for the purposes of criticism or review, no part may be used or reproduced without permission. Oxera Agenda 6 September 2013