Alternative Trading Systems Are Emerging in Europe to Meet MiFID Best Execution Requirements

Alternative trading systems (ATSs) are rapidly proliferating in Europe as the continent prepares for the Nov. 1 implementation of The Markets in Financial Instruments Directive (MiFID), the regulatory framework that paves the way for electronic trading platforms to compete with traditional stock exchanges.

Altering the rules that require all trades to go through a stock exchange, MiFID allows investment banks to trade shares internally -- off the exchanges' order books -- but requires them to publish pre-trade prices of intended trades beforehand. And by eliminating the different concentration rules that require foreign stocks to be traded through local markets and local brokers, MiFID also introduces the concept of a multilateral trading facility (MTF), which is fueling an explosion in pan-European trading platforms that is analogous to the rise of ATSs in the United States.

While Investment Technology Group's (ITG) POSIT, the anonymous crossing network, and Liquidnet Europe, the buy-side block-trading marketplace, are the major players in Europe, newcomers are jumping in the market to stake out a position. Last November, Instinet, the global agency broker, formed Chi-X as an electronic alternative to the exchanges. Chi-X, which went live in January and claims to be 10 to 12 times faster than the traditional European exchanges, has attracted large sell-side firms, such as Lehman Brothers and Goldman Sachs, to post two-way bids and offers. Then there's Project Turquoise, a consortium of seven global investment banks that banded together to form their own alternative electronic trading platform with plans to launch in 2007.

"You're going to get an explosion of these alternative trading systems like we've seen over here," predicts Kevin Chapman, managing director and head of trading at Nicholas Applegate Capital Management (NACM). "We're looking forward to it. It should just help lower our trading costs and market implementation, and it should provide us with other ways to access the market without having to show our size to other people."

The new wave of ATSs is emerging in European equities to win order flow from the buy side, which is facing new best execution requirements. Under MiFID, asset managers are required to formulate a best execution policy, monitor all available execution venues at least annually and consider including other execution venues among its trading destinations.