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Business Outlook: Blatant abuse is just the tip of the problem

ORDER-DRIVEN TRADING, the coal industry and zeneca's problems
Experience with the stock exchange's new order driven trading system seems to be going from bad to worse. To begin with, the system seemed open merely to ridicule; now it appears to be open to manipulation and abuse too.

Since the launch of Sets on 20 October, the stock market has been notably more volatile. In part, that is down to more pronounced worldwide volatility in equity markets. However, in Britain the new system has greatly enhanced the problem, creating some local difficulties all of our own.

At first it appeared that the effect of this was just to confuse. Oh, and, of course, to disadvantage the poor old retail investor, but whoever cared about him? This nonetheless might be seen as bad enough. Prices have been yo-yoing about all over the place, and even for big institutional investors, it has become increasingly hard to know what the going price is or ought to be. Now we have growing evidence of much worse - abuse of the system.

Precisely what happened last Friday when the price of some leading pharmaceutical stocks was driven down at the end of the day will have to await the judgement of regulators. However, the suspicion must be that there was a deliberate attempt to influence the closing level of the FTSE 100 index, probably for the purpose of bolstering a separate hedging futures contract. Whatever the details of this particular case, the point is that the new system makes it generally easier to indulge in questionable practice of this type.

The great bulk of orders tend to get withdrawn towards the end of the day, because with increased volatility in world markets, nobody likes to leave them on the system over night, lest they get disadvantaged the next morning. That makes it easy to drive through bargains towards the end of play at silly prices; there's no one around to trade at a more sensible level. The silly price thus becomes the one that gets used to calculate the closing FTSE index.

This type of obvious abuse is only the devious tip of a much wider problem, however. Agency brokers claim that the system is generally open to manipulation by the big market makers, who place and withdraw orders to suit their own books. As a result, only 40 per cent of trades in FTSE 100 stocks are through the new system. The rest go through the old quote driven system. Unfortunately, the old system has ceased to work as it once did, since market makers are no longer obliged to deal at the quoted price, if indeed they are quoting one at all. The market makers have, as a consequence, never had it so good. The rest of us have rarely had it so bad.

At this stage it is not entirely clear what the stock exchange can do about all this. It is no longer possible to pass off these difficulties as mere teething problems. So much has been invested in the new system in terms of ego and money, that abandoning the new and going back to the old would no longer seem an option. It must be possible to make the new system work better than it has, but it is clear the Exchange will have to go much further than the little bit of tweaking here and there it has attempted so far. One thing is certain. Whatever happens, the small retail investor will as always be the loser.