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European Stock Exchanges Rattled by Upstarts

Just like the grand buildings in London and Frankfurt from which they operate, Europe’s oldest stock exchanges were sitting comfortably for decades, making trades with antiquated technology — and at high prices.

Trader at London Stock Exchange, England.
AP
Trader at London Stock Exchange, England.

Then a few years ago, unhappy customers such as banks and brokers started setting up their own exchanges. They quickly built up market share by offering faster and cheaper services across several countries.

Older exchanges, under threat, have been trying of late to reduce costs, upgrade their technology and improve relations with their clients. And in some cases, they are even seeking to cozy up to the upstarts.

“European equity exchanges need to find a new strategy” for a “fundamentally changed environment,” said Dirk Hoffmann-Becking, a senior analyst at Sanford C. Bernstein in London. “Because the competition is here to stay.”

Competition began build two years ago, after a European Union law to harmonize investment services across the region opened up the market. Lower-cost platforms sprang up, including Chi-X Europe, started in 2007 by the electronic broker Instinet; Turquoise, started by a group of investment banks including Goldman Sachs and Deutsche Bank, in August 2008; and others like Burgundy and BATS Europe.

They helped to increase liquidity by attracting some American and Asian funds that previously stayed away from Europe because of the cost of trading, which had kept equity volumes in Europe at a tenth of those in the United States. (The ratio is more or less unchanged because the recession has slowed activity in both markets.)

But they also shaved market share and revenue off the older exchanges. The L.S.E.’s share of trading in FTSE 100 stocks fell below 60 percent on Aug. 4 for the first time in its 208-year history.

Overall, the alternative platforms, also called multilateral trading facilities or M.T.F.s, accounted for 20 percent of the value of European equity trading in August, compared with 8.5 percent a year ago, according to the Federation of European Securities Exchanges.

Xavier Rolet, who took over as L.S.E. chief executive in May, conceded that “exchanges in general, coming out of a quasi-monopoly, underestimated the importance” of the rival platforms.

“The key to restoring our competitive position is to fix our technology, lower our costs, then deal with the excessively high costs of clearing and netting U.K. trades as well as repair the relationships with our clients,” he said.

The former Lehman Brothers manager has already lowered prices for trades. But some analysts said high operating costs limit how far fee cuts can go. L.S.E.’s operating costs are about 15 times that of an alternative exchange, Mr. Hoffmann-Becking said.

Much of the cost stems from clearing trades, and the clearinghouse that the L.S.E. uses charges higher fees itself. In addition, the newer exchanges have fewer employees and less costly technology to run.

The success some alternative exchanges have had with aggressive pricing undermined the traditional view that customers will accept a higher price for the greater liquidity that comes with a bigger exchange. Herbie Skeete, managing director of advisory firm Mondo Visione in London, said some traditional pricing models defied logic and were “like charging for electricity according to how many light bulbs you have.”

The older exchanges also started to work on repairing their fractious relationships with customers.

“Large exchanges have to start thinking like a small, nimble player,” said Mr. Skeete. “They must not resist change but be at the forefront of it. You can’t stick to how things worked 200 years ago.”

Some European exchanges are keen to emulate U.S.-based rivals in working with banks to build credit default swap clearing houses. Eurex, a futures market jointly owned by Deutsche Börse and Switzerland’s SIX, said in March it is eager to team up with banks to attract users to its clearing business for credit-default swaps.

Competition could trigger another wave of consolidation in the industry following the creation of NYSE Euronext in 2006 and Nasdaq OMX a year later, said Gurjit Kambo, an analyst at Numis Securities in London.

“Customers will want to see two to three strong competitors in the market place,” said Mark Howarth, interim chief executive of Chi-X Europe.

Indeed, despite their growing market share, some alternative exchanges have struggled to make their economics work.

Turquoise opened in August 2008, just before global markets crashed, but still managed to snare a 6 percent share of the trading on the FTSE 100. Nevertheless, Turquoise has failed to make a profit and put itself up for sale.

In a turnaround, the London Stock Exchange entered into exclusive talks last month to team up with Turquoise earlier this month to garner closer ties with customers.