The pros and cons of opening up trading platforms

By: Eurointelligence

One of the few salutary effects of the credit crisis is that people no longer take liquidity or market infrastructure for granted.

 

With this is mind, the news that MTS, the most important government bond trading platform in the euro area, is planning to open its euro area government bond electronic trading system EuroMTS to hedge funds should perhaps be considered in a different light than it would have been two months ago. One of the question that needs to be asked is how would such a system cope if market liquidity dries up? Another one is how resilient such a system would be to fraud or abuse.

 

The future of inter-dealer tradings platforms is one of the most heavily discussed issues among market participants at the moment. One of the big questions in this debate is the extent to which hedge funds and other non-banks should be allowed in. Under the current market making model, investment banks which are members of EuroMTS, are under an obligation to quote euro area governement bond prices several times a day. When non-banks are allowed in, the market-making model would have to be dropped in favour of an order-driven environment.

 

MTS is not the first one to open its platform to outsiders. Last month, GFI, one of the large inter-dealer brokers, also decided to let hedge funds participate in its foreign exchange platform, though it said that it is currently not considering to widen access to other platforms.

 

The rationale for opening up EuroMTS to hedge funds is part of the long-run trend towards deregulation. There is nothing wrong with that in principle. Hedge funds are the most active traders, and it is no surprise that hedge funds like Citadel, Vega, or DRW Holdings would like part of the action, and break the investment banks’ oligopoly. Furthermore, hedge funds and investment banks look increasingly similar, so that the old classifications are no longer as sensible. There is also a move by derivatives exchanges, such as Eurex, to offer liquid markets for over-the-counter products, leading to more competition. Furthermore, in the US, it is common that hedge funds have access to bond dealing platforms, and this has not proved to be the end of the world as we know it.

 

So what are the objections? The European Primary Dealers Associations says that opening up the market to hedge funds would make abuse much more likely, for example through rogue traders. That is an important, but not insurmantable objection. It raises the question of the system’s proper regulation.  A further question is how will this affect competition between platforms. It is possible that investment banks, who are reluctant to share the platform with hedge funds, might set up alternative trading platforms. It is is also possible that governments may raise objections to hedge fund involvement for good or bad reasons.

 

There is in our view no problem in principle to open up any market that would include trading platforms. But the events of recent weeks have reminded us that the resilience of the financial infrastructure matters, and that it should not be taken for granted. The government bond market is critical for the success or failure of the euro area as a cohesive economy.

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