Institutional investors now dominate the free float holdings of listed companies and exchanges need to adapt to this enduring change in market structure and investor needs, according to Norges Bank Investment Management, manager of the $818 billion Norwegian sovereign wealth fund.
Norges Bank, which itself owns around 1 per cent of the world’s listed stock, says that exchanges remain critical to well-functioning markets and provide a valid function as listing venues and as the final arbiter of prices discovery process.
However they need to adapt and innovate to enhance their attractiveness to institutional investors which have supplanted the many retail investors that the system was set up to serve.
One of the implications of the change in investor base is there are fewer but larger trades.
A Central Limit Order Book, which his pre-supposing the existence of continuous two-way liquidity supply and demand, may no longer be the optimal mechanism for price discovery.
“Block-crossing venues, the increasing attractiveness of end-of-day auctions, and changes in the intraday volume distribution are all an expression of the need, and the willingness of institutions to give up continuously clearing markets in favour of on-demand but more sizable liquidity events.
“Fortunately equity markets are a long way off from the type of ownership concentration seen in many corporate bond markets. However, we believe that equity markets may be able to learn something by monitoring developments in fixed income markets, rather than the other way round.”
Norges believes one of the key propositions of exchanges is they ensure the “liquidity risk premium” is safeguarded and enhanced by encouraging private firms to go public.
However evidence shows that the number of listings has been decreasing with the number of listings in the US dropping 20 per cent in the 10 years from 2004 to 2013, and 30 per cent on the Euronext and Deutsche Borse over the same period.
Meanwhile there is a significant portion of the equity market that is not listed – from 40 per cent in the UK to more than 80 per cent in Southern and Eastern Europe.
In a whitepaper on the topic, Norges says the technology developments have provided a robust platform for exchanges to ensure efficient price discovery, even in periods of extreme volatility.
However the current latency race is ultimately a dead-end, the paper says.
“We welcome initiatives taken by exchanges to increase availability of liquidity in size. Supporting the developments of batch auctions and experimenting with size versus time priority models are all initiatives in the right direction, in our view.”
Norges Bank has started to shift to more block executions, a reflection of increased willingness to take on opportunity cost in exchange for lower market impact cost.
To access the white paper click below