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September 10, 2007

Europe Overhauled

MiFID Pushes Trading into New Era

By Nina Mehta

In mid-November of last year, seven powerful investment banks announced they had formed Project Turquoise to create a new execution venue for European stocks. On the news, the share price of all the big publicly traded exchange operators in Europe dropped by 7 to 10 percent. Although the stocks recovered, the market activity showed the fear and uncertainty exchanges face as a new world order dawns on the European equities trading landscape.

Project Turquoise was created for the new MiFID world. Starting in November, the European Union's Market in Financial Instruments Directive is expected to transform trading.

As newly fashioned competitors get up and running, venues like Turquoise could grab flow from the established exchanges and threaten their businesses. Currently, more than 95 percent of European equities trading is consolidated in the hands of the seven largest exchange players.

"All things equal, if the price of a stock is the same on Turquoise as it is on a regulated market, we'll route to Turquoise because it will be cheaper," says Niki Beattie, European head of market structure for Merrill Lynch. She was recently named to Turquoise's board of directors. Other trading executives connected with Turquoise echo her comments.

MiFID comes into force on November 1. Although the change will be gradual, MiFID's top-down overhaul of cross-border European trading is likely to spur competition between execution venues, reducing costs and increasing liquidity. But whether MiFID-at least in the short run-will deliver actual competition or merely the benefits resulting from the threat of competition remains unclear.

More Liquidity

Right now most trading in European stocks takes place on the main exchange of a stock's home country. Countries have traditionally had different rules dictating where and how trades occur. "The European trading landscape is fragmented by country," observes Roland Bellegarde, head of European cash markets and a member of the management committee at NYSE Euronext.

The EU's MiFID is a set of sweeping regulations that lays the groundwork for a single financial market in Europe, where 30 segregated domestic markets previously existed. It does this by dismantling barriers to cross-border trading and creating a level playing field. Adopted in April 2004 by the European Parliament, MiFID is due to become law in the 27 EU member states as well as Liechtenstein, Iceland and Norway (see "MiFID in Brief," p. 42).

MiFID's myriad rule changes should catalyze algorithmic and quantitative trading and fuel the growth of dark liquidity. The end result, market participants say, will be increased volumes and lower trading costs. Bryan Koplin, director of electronic trading at Goldman Sachs, says trading volume in Europe could increase 25 to 30 percent in 2008.

Perhaps most important, MiFID abolishes the "concentration rule" operative in a number of countries, including France, Italy and Spain. This rule, permitted under the 1993 Investment Services Directive, the EU-wide regulation that MiFID replaces, enabled national regulators to require that all equities trading in domestic shares take place on the main domestic exchange. That prevented off-exchange trading in domestic stocks by broker-dealers in those countries and limited competition from other execution venues.