Chi-X, European Dark Pool Wants to Enter Derivatives Space

Chi-X is a dark pool for equities in Europe. They also have an operation in Asia. The NYSE/Euronext ($NYSE), NASDAQ OMX($NDAQ), and the other cash equity exchange the general public really doesn’t know about, BATS, are all trying to buy it. Strategically, many feel this is the last chance to enter Europe. BATS doesn’t have a European presence.

Why the ardor for Chi-X? They do a ton of volume. The victor will have a larger influence on European trading than old traditional exchanges, London Stock Exchange (LSE) or DeutscheBorse (DB).

Chi-X CEO today said that they would like to enter the derivatives space. Derivatives is much more lucrative than cash equities or options.  The derivatives space in Europe are dominated by Euronext/LIFFE and Eurex, arms of the NYSE and DB respectively.  It is unclear how they would enter and compete without being a “me too” product.  Exchange competition as a “me too” always degenerates into price competition.  When this happens, there is not generally a value add to the marketplace.

On a side note, it’s important to note that price in trading doesn’t just involve the commission you pay.  You also have to take into account the slippage on any order and the width of the bid/ask spread.  If spreads are wider, and the volume size at each price is smaller, the trader actually is paying more in commission regardless of the publicized commission transaction fee.

If Chi-X really wants to enter the market for derivatives, it should be innovative and offer a new kind of product. If it can get some liquidity and volume, then it will be tougher for existing exchanges to list their product and take it.  In futures, once an exchange achieves critical mass in a product, it is very tough to steal it away.

The question then becomes where could it innovate? A lot of this will depend on government regulation.  For example, it would be extremely smart of governments to allow a futures market in water.  But currently, the water market is extremely regulated.  Single stock futures are another good place for a futures market.  But, the governments margin and tax them like cash equities, so they don’t provide much value to the market.  Lobbyists for the cash equity markets killed SSF’s.  Futures on ETF’s, mutual funds, and cross commodity spreads are good places to innovate.    The financial sector is one of the most innovative in the entire marketplace.

Why an exchange like CME Group ($CME) has not leveraged its purchase of NYMEX and CBOT by listing cross commodity spreads that are either positive or negatively correlated is beyond me.  Corn and Crude Oil are related because of the ethanol trade.  Eurodollars and Fed Funds.  Proteins and Grains.  A Dollar Index and Commodities.  Spreaders build volume in the market place.

Strategically, Chi-X CEO Alasdair Haynes is correct when he says “exchanges can’t be one trick ponies”.  They need to eventually have a foot in all three, or even four segments of the market.  Cash Equities, Cash Options, Futures, and OTC derivatives.  The chess board is starting to move again in the exchange space.  Traditionally, the moves start in Europe, come to the US, and then go to Asia.

The pace of the movement also hinges a lot on government regulation.  How governments regulate marketplaces says a lot about how aggressive exchanges will be to go after one another.  For example, in the US it doesn’t really pay to buy a dark pool, since it’s easy to enter and set up a new one. It’s better just to set your own up and compete.  There are a plethora of dark pools set up to trade stocks.  They are set up to benefit the entities who run them, not the counter parties whose orders get funneled to them.

  • Anonymous

    BATS do have a UK presence, in fact about 8-10% market share compared to 25-30% for Chi-X and 55-60% for LSE.

    Also, I disagree that Chi-x need to offer a new product to enter the derivatives market as a way of innovating. Their rather innovative model to-date has been to offer a simplified approach at lower costs and faster speeds. I don’t doubt that would be attractive in the derivatives.

    However, that all said I thing you need to look a little deeper at any talk of entering a new market when they are in discussions to be acquired. I would have thought it was about applying a little pressure to would-be suitors…

    • Yes, you are correct they do. I doubt if Chi-X can steal any meaningful volume in the contracts that are dominated by the LIFFE or Eurex.

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  • DonW

    Any point in CME taking a look at Chi-X. I don’t know if CME has a European presence or do they need to stalk larger game?

    • CME is working on getting the clearing started in London. My fear for CME is that they are a one trick pony. Futures. Every foray into clearing OTC products has been met with stiff opposition. They have done a good job with OTC energy, but that business was already there.

      They are the 800 pound gorilla in futures. Competitors may fritter at their edges, and they are vulnerable to a change in legislation.