View from City Road: A smaller failure

WARBURG'S decision does not mark the end but the beginning of the end of market making in smaller companies. This became inevitable once market makers found it uneconomic to devote capital to this end of the corporate spectrum, and it has been made possible by the introduction of the bulletin board.

Market makers have been caught by a commitment they gave two years ago that two of them would make a market in each stock. As Winterflood Securities made markets in virtually all the stocks affected, this meant one of the big firms had to stand alongside in each case. They divided up the market between them.

The measure, which was designed to stem criticism of the Stock Exchange, proved ineffective and trading volumes in smaller companies failed to pick up. As a result it has been hard to trade in many smaller stocks at posted prices.

The bulletin board, which allows dealers to tell each other what orders they have, is the exchange's latest attempt to get round the problem. So far it has proved no more effective at lifting volumes.

The failure of two measures suggests that the problem is not structural but intrinsic to the stocks themselves. In recession there is little, if any, interest in smaller companies.

The demise of market making for smaller companies will be hastened when the Stock Exchange launches its long-promised plans for splitting the market into two - the European wholesale and the national markets. The former will use market makers as now, but the latter will, initially at least, combine quote-driven with order-driven systems.

Warburg's decision puts pressure on the exchange to clarify its plans.

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