Liquidity and best execution in the UK: A comparison of SETS and Tradepoint
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John Board* is Reader in Accounting and Finance at the London School of Economics.
Stephen Wells is Research Fellow in the Financial Markets Group at the London School of Economics, and was previously Chief Economist at the London Stock Exchange. Both authors have substantial experience in researching and advising on the structure of financial markets, transparency and trading costs. They are currently completing a major review for the Financial Services Authority on the effects of market fragmentation. *Department of Accounting and Finance, London School of Economics, Houghton Street, London WC2A 2AE, UK. e-mail: [email protected]
Abstract This paper examines the relative attractiveness of the execution currently available on the two UK stock exchanges, by considering the extent to which better prices are, or appear to be, available on one or the other. Although the explicit focus is on the extent to which brokers’ obligation to provide best execution for investors is being met in a world of multiple trading venues, the results have a direct implication for professional investors’ choice of venue. Best execution, the requirement that agents obtain fair prices for their clients, is not simple to define when there are many trading methods and venues. Regulators in the UK and US have adopted different approaches to the definition of best execution: in the US, the approach is to leave the definition of best execution ambiguous and to require the participants to demonstrate compliance, while in the UK the regulator specifies exactly the conditions under which this obligation is discharged. We examine the impact of the UK’s definition on the trading on SETS and Tradepoint, the two competing order books in the UK. As part of this, the paper also examines the relative prices available on the two systems, both in terms of the best offered prices and trade prices. During the period analysed, SETS was vastly more active than Tradepoint. SETS had 1.4 million trades, while Tradepoint had only 1,500. There were similar, but less marked, differences in the numbers of orders (2.9 million on LSE and 755,000 on Tradepoint). The level of activity on Tradepoint reduced dramatically when one participant withdrew from the market, which suggests that Tradepoint has a limited depth of investor participation as well as trading activity. Tradepoint volumes are equivalent to approximately 0.2 per cent of LSE trading. SETS had a very high availability (generally, over 95 per cent of the period) of bid and ask prices for almost all of the 135 stocks analysed. Tradepoint had high availability for fewer than 30 stocks for part of the period and very restricted availability of a
344
Journal of Asset Management
Vol. 1, 4, 344–365
䉷 Henry Stewart Publications 1470-8272 (2001)
Liquidity and best execution in the UK
two-way market at other times and for other stocks. The best bid–ask spreads on SETS were generally between 0.4 and 0.8 per cent, while those on Tradepoint were generally twice as wide (between 1.0 and 1.25 per cent). Tradepoint
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