European Stock Exchanges under MiFID. Concerns and Cooperation

MiFID – the Markets in Financial Instruments Directive – came into force on November 1st, 2007. Its implementation will significantly change financial services regulation in the UK, the way firms operate their businesses and the way they interact with their customers. Many of the barriers within the European Union that have made difficult the trading of stocks will be eliminated, introducing individuals and companies to a more friendly and cost effective world of investing. The rules adopted after a gestation period of more than seven years will open the way for market operators (stock exchanges) and financial firms to compete with one another across Europe, force them to offer the best prices to their customers and outlaw that sort of national monopoly statute that stock exchanges still retained until recently.
The MiFID's expected arrival has already encouraged upstart trading operations to go after the business of established rivals, contributing to a wave of consolidation among the biggest European financial exchanges and their counterparts abroad. The creation of NYSE Euronext, the merger of the London Stock Exchange and Borsa Italiana or the transaction involving OMX and Nasdaq probably could not have taken place if we did not have MiFID.
On the other side, there are already two projects that are determined to take advantage of the new rules. Platform Chi-x intends to take a market share from big European exchanges such as Deutsche Borse and the London Stock Exchange. Separately, a consortium of nine mainly US investment banks is working to set up a rival platform called “Project Turquoise.” The emerging competition has pushed the established exchanges to protect their dominance, both by lowering prices and by merging with other European exchanges and overseas counterparts.
Thanks to compliance with MiFID, many of Central and Eastern European's smaller independent exchanges will start to face fresh competition. On the short term, the main challenge for the stock exchanges in CEE countries will probably not be the set-up of a new trading platform. But among the major changes that MiFID aims to introduce is the creation of systematic internalizers – banks or investment firms that can set themselves up as execution venues. In my opinion the competition from internalization will be the biggest issue for all exchanges, because it will remove the concentration rules that make it advantageous to trade on an exchange over an alternative execution venue. The consequence of increased competition from potential new entrants might force the traditional stock exchanges to cut their fees and commissions and could drive the extension of consolidation processes even to relatively small stock exchanges from Central and Eastern Europe.
Of course, such changes will not happen at once. I do not believe that local banks or investment firms are prepared to act as a “systematic internalizer” just yet because they do not know the exact means to do this and also lack a proper technical system. But this situation could change if we take into consideration that some local brokerage companies are in fact subsidiaries of foreign investment banks. If the “mother company” decides to start a business as a systematic internalizer on a developed stock market, the cost of extending such operations to another relatively small market (where it has a subsidiary) is marginal. It could be very painful for the local stock exchanges where liquidity is considerably concentrated.
Many stock exchanges from the CEE region have fewer than 10 companies that are heavily traded by foreign investors and if a systematic internalizer were to emerge it could result in a fall away of the deal flow. The only rational reaction for the stock exchanges is to reduce fees because small exchanges are not able to replace the lost revenue from other sources (e.g. information vending). Maybe the merger of stock exchanges in the region will not be the next step, even though this solution was considered right for big European stock exchanges and it does lead to an economy of scope and scale. But cooperation is a must.

Septimiu Stoica
President of the Bucharest Stock Exchange