19 April 2007

FT: Turquoise reality being fleshed out

The seven big investment banks working to create an exchange, so far dubbed Turquoise, said they had selected a newly formed subsidiary of the US-based Depository Trust and Clearing Corporation to provide post-trade services to the new platform.

The banks - Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley and UBS - are fed up with watching profit margins at the incumbent exchanges rise, while their own margins from equity trading continue to fall.

They account for about half of all equities trading in Europe and believe the new platform, being user-owned, will be much cheaper than the likes of the London Stock Exchange and Deutsche Börse.

Plans for such a platform were met with widespread scepticism when they were announced last November.

Exchanges dismissed them as an empty threat aimed at persuading them to cut tariffs. Some sceptics pointed out there had been seven similar initiatives in Europe in the past nine years, none of which dented the dominance of the LSE and its continental rivals. And the banks encouraged doubtsby saying little aboutTurquoise.

Until yesterday. News of a clearing and settlement partner marks a significant step towards turning their plan into reality.

'It is very important to note that Project Turquoise has not been sabre-rattling,' says one banker involvedin it.

The existence of a unified, user-owned post-trading system in the US, operated by the DTCC, is widely regarded as key reason why that market is far more competitive and cheaper than Europe's. But while the US system was launched by an act of Congress in 1975, there has been no such catalyst in Europe.

Clearing and settlement are the unglamorous businesses that do the heavy lifting of securities trading.

They allow counter-parties to trade anonymously, to confirm and match trades and to send payment instructions to banks, as well as securities to their new owners. They are effectively the plumbing system that holds financial markets together.

Europe's financial infrastructure was designed by individual countries mostly to serve trading of equities of each state by banks of each state.

The advent of the euro and the globalisation of capital markets, however, has launched an explosion of cross-border securities trading that has made the inadequacies of the current structure woefully apparent.

'It is the start of a huge change in the way we clear and settle in Europe,' says the head of electronic trading at one Turquoise participant. 'It will be like in the US where no matter how many platforms you have, you can compete.'

Trading costs in the US are estimated to be one-fifth to one-eighth those in Europe. In addition to lower post-trade costs, the nationwide system has been able to deliver lower tariffs for trading by allowing competing front-end platforms to grab new business with lower fees.

At present, BATS Trading, a US newcomer, is taking market share from Nasdaq and NYSE Euronext with its aggressive, high-speed, low-cost platform linked, like the other exchanges, into the DTCC.

That is music to the ears of the banks that are eyeing the 55.5 per cent profit margin at group level recently reported by Deutsche Börse, the 51 per cent profit margin reported by Euronext and the 53 per cent rise in basic adjusted earnings per share reported by the London Stock Exchange for the nine months ended December 31.

A new voluntary Code of Conduct between exchanges and post-trading systems, aimed at making these inter-operable was hammered out last year by the European Commission in consultation with the banks.

Exchanges, in theory, cannot refuse to clear share trades through the new competitor, to be known as EuroCCP.

In unveiling EuroCCP even before the banks have named a trading partner, Project Turquoise has demonstrated its ability to find a solution to what was widely agreed at the start to be the most complex aspect of the banks' desire to compete with exchanges and bring down costs.

'The fact is that the clearing and settlement is so much more important and complex [than trading systems], that when we found a solution, we felt we should announce it,' says one banker involved inTurquoise.

He adds that 'there are probably 30 people out there who could provide an electronic trading platform'.

Finding a partner for post-trade services thus became the primary focus of the Project Turquoise group.

Now, its main tasks are to choose a trading platform, select a chief executive and a senior management team, as well as obtain regulatory approval from the Financial Services Authority.

By Norma Cohen

© Financial Times