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September 13, 1995

STOCK EXCHANGE ELEPHANT TREMBLES AT TRADEPOINT MOUSE

By CBR Staff Writer

Certain men have recently been spotted in the City of London engaged in an operation that is cloak and dagger even by the standards of the Square Mile. Senior executives from a leading securities house have been going round major institutional investors claiming to represent the interests of the London Stock Exchange, attempting to dissuade investors from subscribing to Tradepoint, a new electronic alternative to the Stock Exchange to be launched on September 21, if a report in the Evening Standard is to be believed. Users of Tradepoint will be able to buy and sell shares anonymously by the push of a button or the click of a mouse. A company that is less than three years old with a target turnover of just ú5m would not normally be seen as a threat to an institution that has been around for more than 200 years, but that is what is being claimed by some members of the Stock Exchange. The response of the Exchange has been a lesson in trying to shut the stable door when the horse is a mere dot on the horizon. Tradepoint Financial Networks Plc was established in January 1992. It applied to the Securities & Investments Board in December last year and was granted Recognised Investment Exchange status back in April. The Office of Fair Trading gave Tradepoint the go-ahead a month later. And like a wildebeest in pursuit of a cheetah, the Exchange issued a consultative document to members on August 17 seeking suggestions of changes to its current rule book to reflect arrival of a second market.

Best execution

The Exchange said it will publish the findings this week. It argued that its ‘best execution’ rule, whereby members must go for the best price available for their clients, would force them all to sign up to Tradepoint. The Securities & Investments Board rejected that argument. However, it is likely that market-makers’ clients telling them that the best deals can be done on Tradepoint will force the market-makers to subscribe. The electronic investment exchange from Tradepoint, whose own shares are traded on the Vancouver Stock Exchange, will enable brokers and institutions to bypass market-makers by posting their buy and sell orders on the system though Windows-based software that the company says will run on most personal computers. Subscribers will advertise the price at which they wish to buy or sell shares. Of the 50 subscribers already signed, around 30 are thought to be investment institutions and the rest brokers. Their identities will be revealed on September 20, the company promises. Deals will be struck either through a continuous auction process or a periodic call-to-market auction. The continuous auction is designed for very liquid stocks, while the call-to-market auction is for stocks where the real-time matching of deals is not feasible. In this scenario, orders will be accumulated and matched at a balance price at the moment of the auction, which will probably occur about once a week. Any bids to buy above that price, or offers to sell below it, will be settled at the balance price. Tradepoint says users will have control over type of auction in which their orders are placed. The deals will be cleared through the London Clearing House, which also handles the London International Financial Futures Exchange, among others. The new system will provide competition to traditional market-makers, and normally, with competition comes price reductions.

By Nick Patience

Market-makers make their money by maintaining their spread between the prices at which they buy and sell shares. All their prices are advertised on the Stock Exchange Automated Quotations system, or Seaq, and investors deal with them directly. With the quote-driven system at the Stock Exchange, market-makers agree to commit their capital to buy and sell shares regardless of market conditions and then seek investors to deal in that stock. Tradepoint, however, is an order-driven system, whereby traders indicate their intention to buy or sell at a certain price and the two parties are matched by the system. The cost savi

ngs for investors look likely to be significant. Subscribers will be able to advertise shares for sale free of charge. Tradepoint will take 0.05% of the value of deals in FTSE100 shares and another 300 less liquid stocks from those accepting an advertised transaction. Traditional market-makers are thought to charge on average 0.19% of the transaction value, though their most active investors would pay a lot less than that. Tradepoint is committed to reacting to any cuts in market-makers’ margins and remaining the cheapest option, and is fairly confident of retaining that position. It is crucial to the company’s early development that it gets as many deals through its system as possible. Tradepoint estimates that it will break even if it reaches 2% of London’s share turnover in 18 months. It is aiming for a 10% market share within five years. But if price alone fails to lure investors away from market-makers, then other aspects of Tradepoint just might. One of the key attractions is likely to be the anonymity the system offers. The traders will have to be subscribers, but that is all each party will know of the other. Anonymity will also help prevent leakage of the order, which could result in the share price moving against the bidder before the transaction can be completed. Competition is all very well, but the effect on London’s reputation as one of the three great dealing centres in the world is difficult to predict. With the advent of Tradepoint, London will be the only major stock market with two quotation systems for the same stocks. This may seem a good thing for arbitrageurs, but it could also cloud the market, making it more difficult to follow exactly what is going on. But Tradepoint says it will police its system for any hint of market irregularities. One thing the system is thought likely to do is increase overall liquidity in London.

Liquidity

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However, Nasdaq Mark Two the system it is not, as there are several crucial differences that will prevent it from ever posing the kind of threat that Nasdaq proved to be to the New York Stock Exchange. Nasdaq was set up to offer a completely independent market in which to trade shares – shares dealt on Tradepoint must be listed on the London Stock Exchange – and private investors attracted to Nasdaq are often more willing to follow small companies and maintain a stock’s liquidity. If large institutional investors are the only ones trading on Tradepoint (and they are likely to find it cheaper to use market-makers for trading large blocks), then the increase in liquidity could be negligible. The longer term answer, of course, is to offer an alternative to the alternative, in the shape of the Exchange’s own order-driven electronic system. Since autumn last year, the exchange has been phasing in Sequence, a program that will eventually replace the existing information and trading systems. The sixth and final phase will be completed in summer 1996. According to the Exchange, the fourth phase, implemented in June contained a built-in order-driven element, but without anonymity. It is not up and running as the exchange said it would not impose it on the market. It would seem from recent activity that it is only as a result of Tradepoint’s arrival that an order-driven system is now actively being considered by the exchange. It seems that despite the Stock Exchange’s best efforts, share dealing in London is destined never to be the same again.

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