Lynn Strongin Dodds examines how fragmentation of the listed derivatives market in Europe is increasing complexity and costs that inhibit growth, as revealed in a recent report.
Despite a sophisticated and mature market ecosystem, European listed derivatives, particularly options, have stagnated over the past five years due to fragmentation and a dearth of retail trading. By contrast, the US market has gone from strength to strength, according to a recent Acuiti report – Optimising European Listed Derivatives Market Structure – in conjunction with Cboe Europe Derivatives or CEDX.
EU vs US and the role of on-screen trading
The figures say it all. In 2023, European equity options markets volumes were 23% lower than their high in 2012 while in the US, they scaled new heights, increasing over 200% during the same time period.
The report was based on interviews with senior executives and trading heads at 57 US and European firms. It said that currently, the European market structure for options is resulting in lower competition, increased costs and complexity as well as margin inefficiencies.
It pointed to on-screen trading as the key to further bolstering risk management capabilities in European markets. This is reflected by 71% of respondents say they would prefer to execute onscreen but are prevented from doing so due to prevalence of liquidity in OTC markets.
“In order to improve the investing experience in Europe efforts must be made to improve the options market across Europe by promoting on-screen trading, attracting retail investors, and reducing fragmentation,” says Ross Lancaster, head of research at Acuiti.
Cultural drivers and fragmentation
Around 62% of survey respondents blamed the siloed nature of the European market for impacting their trading strategies, causing half to allocate to other regions. The biggest challenges included dealing with multiple venues and clearinghouses as well the need to develop the infrastructure to handle a myriad of pre and post trade workflows.
Around a quarter or 25% pointed to the fractured European regulatory landscape as another major problem hampering growth. Although there has been a push for the Capital Markets Union, first mooted in 2015, progress has been slow with the report noting it remains more of a concept than a reality. In other words, the status quo continues with national authorities, attitudes and approaches to trading varying significantly.
As for retail trading, many of the drivers are in fact more cultural although this may be about to change. Outside a small number of regional exceptions, investing in listed derivatives is muted to non-existent. Many prefer contracts for difference (CFDs) or warrants to gain exposure, but they are on the regulatory hotseat with many clamping down due to concerns over losses and counterparty risk.
Last year, Spain was a recent addition to a growing list of European countries set to introduce new restrictions on instruments aimed at retail investors, which would ban the promotion of CFDs and restricting leverage on other instruments.
The report noted that these measures have the potential to drive retail activity toward exchange traded derivatives (ETDs) which are more transparent, have tighter spreads and limited counterparty credit risk due to central clearing. This move could also be facilitated if the costs and complexity of trading in listed markets is reduced.
Market structure enhancements needed
Just having the regulation is not enough though. The report recommended that they must also be supported by market structure enhancements and questioned whether policymakers’ reversing MiFID II’s open access policy for ETDs under MiFIR was a good idea .
“Increasing interoperability in the clearing of ETDs would allow derivatives exchanges to compete through technology, functionality, and product innovation while increasing post-trade efficiencies and choice,” it added.
It noted that Europe has the opportunity not just to replicate the US options market structure but to go further in its innovation. “Open access to CCPs will go a long way to reducing friction and increasing competition but there is also scope for European CCPs to pursue cross-margin agreements between positions at other CCPs to promote capital efficiencies when investing in European ETDs.”
However, the European market will have a long way to go before it catches up or even comes close to the US where it is estimated that retail participation is between 20% and 40% of total daily volumes over the past two years. This is not only because the US is a harmonised market, but individuals are much more involved in their wealth and pension management as well as savvy on the technicalities of options trading than their European counterparts.
In addition, at the moment, the US offers day traders the lure of the double-digit performing technology stocks, in particular the magnificent seven – Nvidia, Meta, Amazon, Microsoft, Alphabet, Apple and Tesla. These type of growth stocks are notable by their absence from European markets, but they offer a much more diversified range of options.
Related Reading:
ETDs: Old School Options Get A New Lease Of Life
Trading Strategies and Need for Front Office ETD Data
Carbon Trading – Sowing the Seeds for a Greener World
