DEMAND FOR OFF-EXCHANGE TRADING SYSTEMS: TRADING PREFERENCES OF INVESTORS ON THE LONDON STOCK EXCHANGE

Abstract

The London Stock Exchange (LSE) faces rising pressure in its efforts to maintain its position as a favored market of institutional fund managers and professional investors. Customers are satisfied with the current state of the LSE market, but member firms are pricing institutional brokerage and market making services below economic cost. The LSE's position will be significantly damaged when the effective subsidy ends, and commissions and dealing spreads reflect the costs incurred by members firms. Competition in the supply of trading services has increased, and a range of alternative, off-exchange trading systems could draw order flow away from the Exchange market. These trading mechanisms provide order matching, crossing of basket and portfolio trades, and reduce investors' commissions and trading spread costs. Fund managers in the U.S. are using the systems more actively, and the result has been an erosion of the position of the New York Stock Exchange. The LSE's customers are also using an expanding range of portfolio management techniques, many of which require low-cost trading, and do not demand immediate order execution, as traditionally provided by London's market makers. The Exchange needs to respond to the changes in fund managers' demand for trading services, and to the growing competition in the supply of off-exchange trading services. Enhancements to the existing LSE market structure are the best response to these threats.