L&G warns London Stock Exchange of City exodus

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LEGAL & GENERAL, one of the UK's largest fund managers, yesterday warned that the inefficiency and high cost of dealing on the London Stock Exchange could prompt leading institutional shareholders to quit the City and move to Europe.

David Rough, the L&G investment director, said that unless the LSE moved swiftly to address the concerns of large investors, the Square Mile could witness an exodus of institutions within the next three years.

Mr Rough, who manages around pounds 80bn-worth of equities, accused the new Stock Exchange Electronic Trading System (Sets) of increasing volatility in the prices of most blue-chip companies and making it easier to manipulate share prices.

L&G is the first large UK fund manager to publicly attack Sets and his comments are a blow to the LSE at a time when it is negotiating a crucial alliance with its Frankfurt counterpart.

The system, launched 18 months ago, electronically matches buyers and sellers of stocks in the index's top 125 stocks, allowing traders to deal through their computer screens. Sets, which replaced the quote-driven system where stocks were dealt by phoning an appointed marketmaker, was designed to lower dealing costs and increase transparency.

However, Mr Rough said that most of the Sets stocks suffered from a lack of liquidity - not enough trades - which increased volatility in the prices.

"Volatility makes it difficult for investors to deal and know they have achieved the best price for a stock when prices are leaping up and down. Worse still, there are concerns the market may be manipulated by judicious timing and construction of orders."

Price uncertainty and the inability of the system to cope with big orders made it virtually impossible to deal in large quantities of stocks through Sets.

The L&G fund manager said that Sets was caught up in a "vicious circle" as institutions avoided the system and dealt through old-style marketmakers, further reducing liquidity.

L&G said that, apart from the top 15 stocks, the bulk of FTSE 100 trades went through old-style marketmakers, forcing fund managers to pay commission and deal at second-best prices.

Mr Rough said that unless the LSE introduced a central counterparty - a clearing system to guarantee liquidity and support large orders - disaffected shareholders would quit the City.

"If you have a pan-European stock exchange, institutions will migrate to the most liquid market. My concern would be that if in two to three years' time the UK has not got the greatest liquidity then there will be emotional challenges [for institutions tempted to leave London]."

The LSE rebuffed Mr Rough's criticisms. A spokesman said that over the past 18 months the FTSE100 was one of the least volatile among global indexes. He added that the LSE was aware of the benefit of a central clearing system and had issued a consultation paper to its members a forthright ago.

The spokesman said the central counterparty could be included in the link-up with the Frankfurt bourse.