"We are focusing primarily on the political outcome of the Brexit"
Europe's largest stock exchange, CBOE Europe, is equipped for the Brexit and could open an office in Dublin or Amsterdam. CEO Mark Hemsley said in an interview with Börsen-Zeitung that Cboe Europe wants to expand its market share in block trading. It rejects the criticism of a lack of transparency in Periodic Auctions. Hemsley could even envisage a cooperation with Deutsche Börse in the area of index derivatives - if this opens up access to its clearing.
Mr Hemsley, how has your business developed since the introduction of the European Financial Markets Directive Mifid II?
Very well, particularly in Periodic Auctions. A year ago we traded about 50 million euros a day on our periodic auction book. Immediately after the introduction of Mifid II, turnover rose to around 350 million euros per day, and after the introduction of the double volume caps it increased further to over 1 billion euros per day. However, this is still only a 2% share of European equity market volume, so it is still early days for the product.
Periodic auction systems have come under criticism, particularly in the European Parliament, because they would run counter to the transparency objectives of Mifid II. What do you say to that?
We have already spoken to regulators such as the FCA and other regulatory authorities. There are different types of periodic auction books. Ours is very well designed. The first technical standard for Esma's periodic auction systems states, that periodic auction systems must indicate indicative prices and the indicative amount at which price they execute a transaction. This is the case with us, we meet the requirements under Mifid II to a high degree. However, there may be other periodic auction systems that calculate prices differently or announce them at other times or do not spread them so widely. If the regulators think that they did not get Mifid II right, then this is another question.
So your stock exchange is not in the focus of investigations?
I think our system gets the most attention because it is the largest on the market. However, it has been in existence since October 2015 and only achieved a breakthrough in trading volumes under Mifid II. The problem is that some competitors thought that under Mifid II a part of trading turnover would be redirected to "continuous lit order books", i.e. completely transparent order books in the regulated market. Some trades also ended up in periodic auctions. These are also "lit books", but they are not continuously traded as on other exchanges. From a regulatory point of view, however, both are transparent books.
What exactly is the definition of "lit"?
There is a price and quantity shown before the transaction is executed. That is why our periodic auction system is also one of the "lit books".
Turnover statistics with Dax stocks shows that Cboe Europe now processes a turnover volume that is higher than that of Deutsche Börse via the so-called Approved Publication Arrangement or APA.
APA records all off-exchange reported sales, including transactions through systematic internalisers or over-the-counter transactions. Cboe Europe’s APA is the largest equities trade reporting platform in Europe. It is not directly comparable to the Deutsche Borse lit on exchange market.
So the execution does not have to have been carried out by a system from Cboe Europe?
No, any market participant can report trades to our APA. For example, systematic internalizers can report their transactions through our reporting system. This also applies to different transaction types. Right now many people are looking closely at the volume that is being reported by systematic internalisers. This is currently also being discussed by the regulators with the financial industry. For example, it should be clear whether this is really a risk transaction by SIs that shows real liquidity, or only a transaction that occurs for reasons of settlement or shifting positions between SIs or banks. A consistent codification of the data would make sense here, so that purely operational transactions of SI that do not influence the price, or transfers of baskets, for example for managed futures, can also be excluded.
How satisfied are you with the introduction of Mifid II?
Generally it went quite smoothly. There are still discussions between regulators and banks regarding transaction reports. Take a systematic internaliser: Should all transactions be reported or only those transactions that involve risk? With the Double Volume Caps, however, data collection was much more difficult than initially intended by the regulator and was delayed.
Mifid II has increased transparency, but the market has also become more complex.
You get used to the complexity. Most proprietary trading companies that are operating as systematic internalisers still trade small volumes, the majority of systematic internalisers are currently still the banks that have created their SIs to assume their internal risks or customer risks. Regulators are now looking at how banks have implemented their SIs, because there are a number of different ways in which they have done so. In the "old" market, a share of around 40% was settled over the counter. Today, half of these transactions are genuine SI trades, the other half are OTC give-ups, i.e. operational trades that are non-addressable liquidity. This categorisation only looks more complex, but is a better definition of what is traded between banks. Broker Crossing Networks have been largely replaced by SI.
Can you leverage possibilities out of Mifid II?
We saw MiFID II as an opportunity. While there was certainly a lot of work we had to do to prepare for the new regulation, we really saw a good opportunity to bring new products and ideas to the market. For example, our Periodic Auctions book and our block trading platform, Cboe LIS. These were both specifically designed for a post-MiFID II world and the response to both of these new offerings has been very positive.
What have been some of the most significant changes under MiFID II?
Brokers Crossing Networks had previously undertaken matched principal trading, which =allowed them to offset their client transactions in a pool. They had algorithms and more control over the timing of the transaction. Under Mifid II, banks are no longer allowed to do this because it is a no-risk trade. They must therefore first trade the buy or sell orders against their own balance sheet. That's why banking business needs to be differentiated. One is an agency broker function, which then sends the trade to my systematic internaliser, i.e. it is a risk book. So in theory. The question is how this is actually implemented.
What could be the problem there?
The supervisors will see if it really is a risk transaction. The supervisors must first understand how SI’s are being implemented and then set the framework conditions to determine whether the implementation is also Mifid-II-compliant. They must be true on-risk trades.
With regard to the tick-size regime, i.e. the minimum price change on trading venues, Esma has stated that this also applies to systematic internalisers. What is your opinion?
I think that's fair. The SIs can be'on tick'. You could also work with half a tick. Because trades are executed in the middle of tick, i.e. at half a tick. If they have to be executed on the tick, there is a strange situation that only with an even number of ticks a price can be formed at midpoint. In certain market situations, when the spread is narrow and the bid and ask range is an odd number of tick (eg, 1, 3, 5, 7), half ticks are not possible. But not being able to set a midpoint price for odd ticks is crazy. Everyone in the market should be able to set a price for the midpoint, including systematic internalisers. The other exception applies to large trades. When it comes to a basket swap for an equity futures contract, prices outside a tick should also be possible.
Should this be regulated by law?
Maybe. It will be a consideration to what extent a technical standard can be binding, or whether an amendment, because if it is in the law, must always go through the European Parliament.
As far as your business strategy for the future is concerned, where does most growth come from?
We are currently focusing primarily on the political outcome of the Brexit and what we need to do here. We have declared Amsterdam and Dublin as possible locations for an EU-based subsidiary. Ireland is interesting for us because of the legal framework comparable to Great Britain, Amsterdam would be because of the large number of market-making firms based there. That would at least bring us a little closer to Frankfurt (laughs)...
So you are prepared for all eventualities of a Brexit?
Yes, we'll adjust our business. One point is the timing of what a transition period could look like. This is probably the most important point for the equities business at the moment. In other areas we see strong growth in foreign exchange trading. We have restructured here, improved liquidity for our clients and simplified execution via our Cboe FX platform. We launched bitcoin futures in the US, which is a very useful tool for giving customers exposure and hedging this in dollars. So you don't have to invest directly in Bitcoin. The forward futures price in the middle of the Bitcoin bull market has also shown that the Bitcoin price will weaken - which has also happened. That may have somewhat dampened the overenthusiasm. We are not sure if the futures were responsible, but there is at least a correlation with a slightly more sensible pricing.
Can we expect a similar product in Europe?
On the derivatives side, we're doing all this via the US. As far as futures contracts in Europe in general are concerned, the issue is clearing, not trading. Shortly before the implementation of Mifid II, the European market supervisory authority has suspended Esma 'open access' for clearing houses for a certain period of time.
Why does this play a role in connection with crypto futures?
We need to be able to clear them somewhere.
However, you have a selection of clearing houses. It's not just Eurex.
The only derivatives clearing provider currently allowing open access is probably LCH. That would be where we could potentially go in the short term. But it could also be that we only let the clearing run via the USA. At the moment we only have one product that is tradable around the clock. If you can clear in the USA, you can also trade in the USA.
Are there any difficulties in meeting the European benchmark regulation for crypto contracts?
No, we have the license for our own benchmarks like Cboe Europe 50. We see a lot of interest here, but it is still a very young product. We are also undergoing the approval process for our US indices. Our bitcoin futures are not based on an index. It is based on the settlement prices of the Gemini trading platform in the USA. The benefit of using Gemini is that as a market maker for a futures contract, you want to use an exchange price as a basis for hedging. The futures price must be consistent with a physical hedge.
Deutsche Börse has declared its intention to expand the index business, but at the same time finds prices for such providers too high. Would a cooperation here be conceivable from your point of view?
Maybe. Stock exchanges also lease each other's products. If Deutsche Börse opens its clearing, we could perhaps do something with it in the area of index derivatives.
What about volatility products? You had indicated that you would also start such a product in Europe, but the VIX of your parent company recently came under heavy criticism because of its alleged susceptibility to manipulation.
We don't have that at the top of the list right now. First we want to make sure market participants have a clear understanding of how the VIX works. We are working on bringing more liquidity into some option series which are included in the calculation of the VIX.
Do you have other projects or products in the pipeline?
We will further strengthen our Periodic Auction System. This is the second major project besides the Brexit.
Where would you buy?
We are always examining possibilities. However, we are focused on transferring the Cboe derivatives markets to the Bats technology platform. In 2019 we will migrate the largest market, C1, the CBOE Options Exchange, to Bats technology.
With your strong presence in Europe and the USA, you can offer your customers in London who are affected by Brexit a lot?
We have a very strong trading platform with high capacity in the derivatives market, we have regular exchanges between our European and US teams, including in equity derivatives and currency products.
They also have a solution for executing large-in-scale-transactions. How's it going there?
The large-in-scale business is growing strongly. Asset managers can place contingent orders here, and control this order up until the point of execution, which minimizes the potential market impact. However, you still use your broker to execute the trade. We believe that block trading will further increase its share of total trading volume. We also see an increase in Germany. We can bring together buyside and sellside traders via our LIS platform and have a very strong pipeline of potential customers in the US and Europe who want to come to our platform. We also expect to be able to expand our market share here.