Why the Stock Exchange is a national disgrace

Jeremy Warner on why everyone is up in arms over the Stock Exchange, and why one regulator gets more praise than another
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The Independent Online
IT HAS not been a good week for Gavin Casey, chief executive of the London Stock Exchange. First came a survey of leading fund managers which found many to be damning in their criticism of the exchange's new "order-driven" trading system. Then Tradepoint, a competitor to the exchange, said its research showed considerable dissatisfaction among institutional investors with the new set-up.

But the coup de grace came from Philip Augur, group managing director of Schroders Securities. "The Stock Exchange should consider very carefully whether the 30 per cent market share for SETS (the new order-driven system) and the apparent worsening of spreads for institutional investors is consistent with its duties and will be sufficient to prevent an Office of Fair Trading inquiry", he said in one of the most damning letters about the exchange I have ever seen aired publicly in the City.

How is it that the exchange, whose purpose it is to provide a public service system for the trading of securities, has come to attract such criticism, some of the fiercest since it was forced to abandon fixed commissions and dual capacity in the mid 1980s?

Actually, there is nothing wrong with the new system as such. Technically it works just fine, and despite early concern that it badly disadvantaged small retail investors, it is now bedding down in a way which is probably mildly beneficial to them. Ironically, the problems are occurring with big institutional investors. Since it was pressure from them, and the threat that they would move their business to the order-driven systems of the Continental bourses, which caused the exchange to introduce the new system in the first place, this is something of a turn up for the books.

The Stock Exchange claims that retail trades are typically being done under the new system on a spread (the difference between the offer and bid price) which is 15 per cent better than the old, quote-driven way of trading. But according to Mr Augur's letter, that is not the case for institutional investors, who on his calculations have seen the spread roughly double in size since the new system came into being.

Partly as a result of this, the order book has failed to gain the level of trade and liquidity required to make it attractive to those dealing in larger blocks of shares. Since the order book is not allowing institutions to deal in the quantities they require, they are forced to fall back on the old quote-driven system, or to deal off-market entirely. The order book is for many becoming little more than a sounding board for market makers and others to find out who's buying and selling. The main business is then done away from the book.

So what's all the fuss about? If institutions don't like the new system, there's always the old one to fall back on, isn't there? Unfortunately the old system, which obliged market-makers to deal at published prices, is no longer being enforced, officially because the exchange wants to encourage use of SETS. Market-makers can pick and chose who they deal with, and because prices are no longer transparent, they can deal at whatever level the market will take. Market-making is suddenly a highly profitable business. Meanwhile, everyone else is being ripped off.

In essence, the Stock Exchange has become a hostage to three or four powerful market-makers. It is their interests, rather than those of the investment community as a whole, which the exchange now serves. The situation is a disgrace and demands government action. The Office of Fair Trading is already investigating the City's underwriting cartel, but the sums involved here are an irrelevance set alongside the huge amounts being traded through the market each day. Come on Mr Bridgeman. Do something about it, because the Stock Exchange certainly doesn't look as if it is going to move on its own.

THE MOST striking thing about John Battle's advertisement yesterday for the first energy regulator, taking in both gas and electricity regulation, was not the fact of the announcement at all. Rather it was in what the minister for science, energy and industry had to say about the two present incumbents as head of gas and electricity regulation.

First, Professor Stephen Littlechild, director general of electricity supply. Mr Battle positively overflows with praise for the bearded Prof. "I would like to put on record my strong appreciation of his contribution made over many years" ... blah-blah, blah-blah. Can Mr Battle really be referring to the same man? Stephen Littlechild is best remembered in the City and elsewhere as the regulator who so profoundly misjudged his first review of prices in the electricity industry that within months he was forced to re-review the review, which had been generous in the extreme to the companies and their shareholders. Furthermore, he chose to announce this slap bang in the middle of the Government's sale of shares in PowerGen and National Power, thus causing the City to think, albeit briefly, it had been sold a pup. Indeed, it is him Mr Battle has in mind.

To be fair, Professor Littlechild is not entirely without his good points. He is the man who originally invented the formula on which all price regulation of utilities is based in the UK. The concept has since been much used elsewhere in the world.

Furthermore it has been instrumental in yielding massive price reductions across the utilities, enormously improving the efficiency of these industries and thus the competitiveness of the UK economy. So we owe him a debt as a thinker. It was in the practice that he may have left something to be desired. The judgement of history is a harsh one; fortunately for Prof Littlechild, Mr Battle's is not.

With Clare Spottiswoode, director general of gas supply, it is rather the other way round. She's the one who sent roses to a senior civil servant at the Department of Energy, is invariably described as the laughing regulator, and British Gas liked to depict as clean round the bend. Her achievement is that she took on British Gas and won. That was good not just for the consumer, but arguably for British Gas as well. Both halves of the since demerged group - distribution and sales - seem to be thriving on their own.

This is what Mr Battle has to say about her. "I should also like to acknowledge the work of Clare Spottiswoode, whose five-year contract as director general of gas supply comes to an end on 31 October." There's a bit more than this, but not much. Presumably there's something personal here, for of the two regulators, Ms Spottiswoode seems to have the better record. Perhaps Mr Battle would care to tell us about it.