Outlook: The fiasco at the Stock Exchange

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THE Stock Exchange has received a right old roasting over its new order- driven trading system, Sets. Hardly anyone's got a good word to say for it. Going back to the old, quote-driven system is no longer a realistic option, if only because the Exchange has invested so much in the newer alternative. Furthermore, this is not actually what the big investing institutions want. It was they who pressurised the London stock market into change in the first place. So what should the Exchange, which is now reviewing the whole set-up, do about it?

The major problem with Sets as it stands is not enough liquidity, or to put that in layman's language, not enough people using it. Little more than 30 per cent of trading volume is at present passing through the new order book. The rest is taking place either off market altogether or through a grossly unfair and inadequate version of the old quote driven system. The big market makers are as a consequence making money as never before. For them what has happened is the perfect outcome. The new system doesn't work, which means everyone has to fall back on the old one. But the onerous obligations of the old system on market makers have since been abandoned. Party time.

How then to get the institutions to start using the new system in sufficient quantities? One of their major gripes is that trading on Sets is transparent and it is therefore immediately apparent who's buying and selling stock. For example, if you want to find out who's trying to sell that big line of BTR shares you can see on the screen, all you have to do is buy a few and you'll immediately be told the name of the seller. Because big buyers and sellers do not like to give away their hand, the effect of this is to drive them off market where their identity is likely to remain secret for that little bit longer.

So why doesn't the stock exchange introduce post-trade anonymity, so- called "blind" trading? Perhaps the most convincing argument why not is credit risk. There is a degree of comfort that accompanies the knowledge that you've bought your shares from one of the world's largest investment houses and not from Joe Sixpack in the back end of beyond.

Dig a little deeper, however, and there appears no good reason, other than the spirit of glasnost, for such transparency. First of all, the exchange applies strict capital adequacy rules to its members, so in the end it doesn't really matter who you are dealing with. Second, there is an insurance policy that covers all exchange members in the case of default. Finally, the exchange could solve the credit risk problem once and for all by acting as a central counterparty - essentially guaranteeing trades - although this could be a complex and costly solution.

A move to blind trading would go some way towards appeasing the major houses. The present situation is such a fiasco that the stock exchange certainly has to do something. Blind trading looks like the neatest way of salvaging something from the wreckage.