Market makers will face tough new regime

Stock Exchange: Top City watchdog demands an end to `anti-competitive' trading privileges

JOHN EISENHAMMER

Financial Editor

A tough new regime for stock exchange market makers will be announced on Wednesday by the central City watchdog, the Securities and Investments Board. The guidelines will effectively amount to instructions by the SIB to the London Stock Exchange to reduce market makers' current privileges.

The SIB has come down clearly on the side of the Office of Fair Trading, which in March described these privileges as anti-competitive.

The system which the regulators are targeting allows market makers to hide big trades and gives them the exclusive right to act as inter-dealer brokers. This dates back to the days before Big Bang when the market makers were independent firms of jobbers.

Today, the market makers are mainly large financial conglomerates - the integrated investment houses, divided internally by so-called Chinese walls and offering a whole range of services to clients.

The SIB shares widespread concerns that these conglomerates increasingly abuse the privileges to trade under cover on their own accounts.

The new SIB guidelines are expected to provoke considerable discontent among the market-making establishment, which includes the most powerful members of the Stock Exchange.

"We need to redefine market making much more precisely, drawing a distinction between what is being done for the market and what is being done for a firm's own proprietary trading, so that the privileges are not abused," said a regulatory source.

The guidelines are contained in the SIB's wide-ranging Equity Market Review, to be published on Wednesday. The fruit of 18 months of consultation among the market and investors, it is an attempt to complete the unfinished business of Big Bang in the mid-1980s, adjusting practice and regulation in the City to the different conditions of the 1990s.

The other factor driving the SIB's new thinking is a fragmentation of the financial markets. Where ten years ago investors seeking equity risk would go to the cash market, they can now also use warrants, convertibles, and over-the-counter derivatives - in addition to trading on Liffe, the financial futures exchange. That diversity makes it all the more essential that price information between these different markets is more transparent.

The curb on market makers, which totally dominate securities trading on the London market, is also a challenge to the Stock Exchange itself. The SIB has sympathy for the OFT's call for obstacles to be removed from the development of the order-driven systems common in the US and on the continent, to compete with the market-makers' quote-driven system of the Stock Exchange.

The SIB has just given final approval to Tradepoint, a new screen-based order-driven exchange, which will begin in August as the first competitor to the Stock Exchange.

This means that structures built on the basis of one central market will now have to adapt to another player. "It will be a bit like BT and Mercury," said a regulatory insider.

The Stock Exchange has come under strong pressure both from investors and other financial markets such as Liffe to curb the non-disclosure privileges of market makers.

The justification for allowing market makers to hide trades for a time is that they would not risk large capital sums without protection to lay off these risks.

Now the SIB believes these privileges are being spread beyond their original justification, to cover extensive proprietary speculation and to facilitate bids by clients.

The controversy intensified during the recent bid by Trafalgar House for Northern Electric, when large stakes were apparently built up under the cover of Swiss Bank Corporation's market-making privileges.

The SIB is also expected to side with Liffe over claims that the privileges accorded market makers mean that other markets suffer price disadvantages.

The Stock Exchange last month shortened the time for which market makers' trades were exempt from disclosure and increased the size of trades to which such privilege apply.