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European reforms won't help retail investors - traders
March 20, 2012 / 12:57 PM / 6 years ago

European reforms won't help retail investors - traders

LONDON, March 20 (Reuters) - Retail investors will continue to miss out on lower trading fees if planned European reforms do not force brokers to show they are getting the best price for trades - as they must do for institutional investors, senior traders warn.

Under current European rules, brokers must demonstrate to clients and the regulator they made the best trade available, known as best execution. This involves linking to multiple trading venues in search of the best price - much like the price comparison websites used to search for insurance or mortgages.

But these principles are ill-defined for retail brokers trading on behalf of individual investors, meaning these brokers tend to link only to the primary stock exchange and their clients could miss out on cheaper stock.

“The retail model has no best execution. Has Mifid addressed the needs of the end retail investor? Not really,” said Kee-Meng Tan, head of electronic trading in Europe at Knight Equity Markets International.

The European parliament is currently planning changes to its 2007 Markets in Financial Instruments Directive (Mifid) to tighten up how banks and high-frequency hedge funds trade.

But the directive has not and will not in its next guise extend ‘best execution’ to retail traders, prompting calls for a rethink from some quarters.


The larger, tech-savvy trading firms would like retail clients to have the same opportunities to see they are getting the best deal that is currently enjoyed by investors like pension funds - because the firms see themselves winning business.

But rivals, who often lack the resources to offer this facility, argue the current arrangements ensure good returns for clients and that trading away from stock exchanges is risky.

Ian Cornwall, head of regulation at the Association of Private Client Investment Managers and Stockbrokers, said: “We are not picking up the message from our members that best execution is a big issue or that their clients are missing out on cheaper trades.”

Cornwall said best execution requires investment firms to take all reasonable steps to obtain the best possible result for their clients, before adding: “Dealing on a regulated exchange is attractive to retail customers because there are defined, default rules whereas different platforms have different rules.”

But some traders insist retail investors would benefit from best execution as much as institutional trading firms, but they have been overlooked because they are a much smaller group than the hundreds of millions of Europeans paying into pension funds.

“Mifid will not make best execution mandatory and there is no guarantee retail investors will benefit,” said Marie-Ange Marx, the Chief Operating Officer of retail broker Selftrade.

The UK’s Financial Services Authority raised doubts over whether retail investors were getting the best deals when it published in October a paper highlighting the practice of brokers choosing venues that offer them financial incentives.

The FSA argued some brokers were sending client trades to venues that were offering less competitive deals for the brokers’ clients in return for secret commissions pocketed by the broker itself.

“Where brokers are routing orders to only those market makers willing to pay for order flow, then the duty of brokers to act in the best interests of clients may be compromised,” the FSA wrote.

Brokers handle on behalf of their clients, which could be private clients or institutions such as pension or hedge funds, orders that they send to exchanges and alternative platforms.


Institutional trading in Europe has changed beyond recognition since Mifid took effect.

Previously, trade in European stocks was dominated by the large domestic exchanges such as the London Stock Exchange , NYSE Euronext and Deutsche Boerse which had effective monopolies over trading.

Mifid paved the way for a swathe of alternative venues, such as Turquoise and Chi-X, technologically driven, pan-European exchanges, which offered lower fees and cheaper shares than the incumbents.

The combination of best execution policies and viable alternative trading systems brought about a fragmentation of European share trading but this competition has been limited to the larger institutional market, rather than the retail business.

“Retail investors are still effectively only trading on the main stock exchanges,” said Michael Buhl, co-Chief Executive of the Wiener Borse, the Austrian stock exchange.


European regulators may be seen to be apathetic but Angela Fenwick, head of the retail hub at Banca IMI, the investment banking arm of the Intesa Sanpaolo Group, said client pressure is growing for retail brokers to embrace competition.

To this end, Fenwick said Banca IMI had started trading on Equiduct, the European electronic trading system for retail brokers part-owned by Citadel Securities and Knight Capital Group that claims to offer best execution.

“We have responded to customer pressure and now it is more than just theory, clients can see where the price has improved,” she said.

Niki Beattie, the Chief Executive of trading consultancy The Market Structure Partners, said that clients are likely to be the force for change over the short term at least.

“The regulators may not have woken up to it but clients are now starting to demand best execution and sort the better brokers from the rest,” she said.

The European Commission plans to finalise its Mifid reforms this year with a view to implementation next year.

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