The Hindu Business Line : More options on trading platforms

In recent years, financial markets have seen the emergence and growth of electronic trading platforms for securities and other financial instruments. Rapid advances in technology have permitted innovative participants in the financial markets to offer traditional services in new and more efficient ways, including by permitting electronic order-matching and trade execution outside the confines of a stock exchange. These new trading platforms, commonly referred to as alternative trading systems (ATS), provide a wide variety and combination of services, including dissemination of bid and offer quotations, order routing, trade execution, and clearance and settlement services.

Defining ATS

ATS are private companies that sell their services to clients/subscribers. There are no exchange rules and regulations approved by a supervisory agency for clients to comply with; instead, general business terms and contracts under private law are binding. Typically, ATS clients are institutional investors, securities houses, banks, and online brokers. In many instances, they are also owners. Global players are increasingly buying stakes in ATSs, with a view to influencing their strategic alignment and participating in potential profits.

How they function

Though ATS differ in the customised functionalities provided to clients, some common features of ATS are:

Orders are transmitted electronically using a special terminal, through a link to existing systems, or via the Internet.

If there are matching client orders, these corresponding orders are automatically brought together within the ATS.

There are no intermediaries involved in matching client orders.

The anonymity of the client is preserved.

Enables clients to view their limit order book via a terminal or the Internet.

ATS normally link up with third party clearing corporations to provide clearing and settlement facility for the trades executed on their platform.

Benefits: Securities regulators have generally recognised that alternative trading systems can bring substantial benefits to markets and investors. ATS have secured an appreciable share in the market by enabling cost-effective, order-driven, electronic screen trading that circumvents the usual intermediaries (market makers and specialists) and avoids the high spreads in some established markets. As private companies, ATS can also respond more rapidly to current developments and client wishes. Some of the benefits of ATS that have been recognised by the markets include Lower Transaction Costs, Best Execution, Rapid Execution, Customised Market Models and Anonymity.

Regulatory aspects: While it is generally agreed that ATS should be regulated in the interest of protection of market, regulating alternative trading systems such as exchanges would undermine the operations of such systems in several ways. The scope of exchanges goes beyond normal trading in securities.

Exchanges effectively work as SROs. They have listing requirements, continuous compliance by entities listed on them, member surveillance and audit, etc. ATS service providers act as mere infrastructure providers and burdening them with the responsibilities of an exchange would, in effect, kill innovation and competition. Internationally, ATS have become an integral part of the financial markets and seek to serve markets in equities, bonds, currency, derivatives and commodities. In most jurisdictions, the concern for regulation has been predominantly directed towards ATS serving equity markets. Some jurisdictions have enacted special laws for regulating ATS.

India

In India, there are no separate regulations for ATS, at present. However, there have been debates proposing shifting of all organised trading to exchanges. Equities are mandatorily traded on exchanges in India. The forex market, government securities market and money market are largely OTC markets. Traditionally these markets were voice or ‘telephone’ markets. In recent years, electronic dealing platforms catering to the specific trading needs of the participants in these markets have been launched. These platforms are owned by private/public institutions and have been successful in capturing a substantial portion of the voice market.

The success of these electronic trading platforms has established beyond doubt that trading can take place outside the normal confines of the traditional stock exchanges and without the services of exchange intermediaries. These systems cater to specific customer groups and their special needs. By acting exclusively as agents for their customers, these systems solve the very important conflict of interest problem that exists between customers and other market intermediaries, namely broker-dealer firms.

Some of the platforms facilitate a Straight Through Processing arrangement through links to guaranteed clearing and settlement services provided through Central Counterparty arrangements, eliminating settlement risk for trades done on those system and facilitating anonymity in trading.

While the trading platforms that are run by the stock exchanges are governed under the provisions of the Securities Contract (Regulations) Act, 1956 (SCRA) and the rules framed thereunder, viz. Securities Contracts (Regulations) Rules 1957, not all the electronic platforms may come under the category of ‘stock exchange.’ This is on account of the fact that the SCRA was enacted way back in 1956.

Although amended from time to time to meet various contingencies, its current provisions perhaps give little room but to look at all types of trading platforms within the term ‘Stock Exchange.’ Moreover, the scope of SCRA is limited to ‘securities’ as defined therein.

It is, therefore, important to examine related issues and evolve appropriate legal/regulatory framework for facilitating creation and oversight of such specialised electronic trading platforms to cater to specific markets. In order to be able to do so, it would be timely to review the current definition of ‘stock exchange’ as provided in SCRA.

Alternatively, a totally new regime of regulatory and legislative structure may be considered for ATS on the lines of those found in other countries such as Australia, Canada and the UK. Consideration of a similar dispensation for the Indian market would go a long way in migrating the related markets to a better and proven environment governed by appropriate comprehensive regulation.

RE-ASSESSMENT

The emergence of ATS has led to a re-evaluation of existing regulatory regimes in many of the world’s most significant capital markets — a review generally oriented toward assuring investors the benefits of new technology consistent with existing regulatory norms and market expectations.

The adoption of electronic information dissemination and execution can reduce the costs of order execution significantly compared to traditional exchanges. Regulators have responded to these market changes by adopting appropriate regulation while at the same time ensuring innovation and competition. India too would have to address these issues in times to come.

Global experience

The US was one of the first countries to accord recognition to Alternative Trading Systems. On the equity side, 10 per cent of equity trading on the NYSE and 30 per cent of Nasdaq volume are handled by ATSs. The figures are expected to rise to over 50 per cent in the coming years. As per the 2006 review of electronic transaction systems for Fixed Income Markets by the Securities Industry and Financial Markets Association (formerly the Bond Market Association), there were about 74 electronic platforms operating in the fixed income market accounting for about 50 per cent of the daily cash volumes. Some of the other systems operating in the Eurozone are EuroMTS, BondScape, Coredeal, Bondvision and TradeWeb. In 2003, there were over 20 UK-based ATSs, active in markets for equities, bonds, financial derivatives and commodities. Some of the major ATS operating in the UK fixed income market include EuroMTS Ltd, Brokertec Europe Ltd, Tradeweb Europe Ltd and ICAP Intercapital Europe Ltd

(The authors are with CCIL. The views are personal).

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