Japanese poised to halt the City’s honeymoon

Press, 13 May 1987, Page 47

Japanese poised to halt the City’s honeymoon

Six months on, the London Stock Exchange’s Big Bang has claimed few casualties. Only Greenwell Montagu has so far fallen from the equity market

making field which lined up at the starting post on October 27.

together, Nomura can afford to spend time and money carving out its market share. Mr Hitoshi Tonomura, head of the 400-strong London operation, is on record as saying: ‘Tn some areas at certain times we will certainly sacrifice profitability for market share.”

ciently the London markets were regulated. Scandals in the Lloyd’s insurance market in particular damaged the image of London markets in general. The most visible sign of the Big Bang on October 27 was the Stock Exchange Automated Quotations system (SEAQ). The front end of an £BO million (about SNZ232M) investment in new technology by the Stock Exchange, it meant that for the first time everyone had access to competing prices and trading information which had previously only been available on the Stock Exchange floor. SEAQ was one of the early casualties. The first two days saw the system collapse and trading effectively halted for several hours. Old hands said it was the natural result of relying on computers. The Stock Exchange pointed out that demands on the system had more than doubled in 24 hours. Now the computer boffins in the Exchange can point to SEAQ running at 99.8 per cent of its scheduled service and are moving on to create new systems. The increase in trading volume has been far greater than anyone predicted ahead of the Big Bang. Customer trading (that is the buying and selling of equities by outside clients rather than straight dealing between brokers) has more than doubled from an average £6433 million (about SNZ 1.866 billion) a day in the first nine months of 1986 to £1466M (about $4,255 billion) in March of this year.

Talk to the players at the centre of the revolution that has taken place in London and almost unanimously they express surprise at just how well things have gone over the last six months. None display other than confidence about the future. But it must be remembered that the current players have had two major factors in their favour. First, the London stock market has enjoyed an almost non-stop rise (even the recent correction was short-lived) since the Big Bang. Second, the international securities houses from Japan and the United States who were free to enter the London market after Big Bang have yet to show their hands in a really large way.

Meanwhile, the London firms can be said to have had a fairly easy ride.

Mr Peter WilmotSitwell, joint chairman of Warburg Securities, says:. “It is extraordinary how well things have gone. There is a much greater freedom in the securities industry, with market makers able to take much bigger positions than they did before.”

The Big Bang grew out of the Government’s 1983 challenge to the Stock Exchange’s restrictive practices: the charging of fixed commissions on share dealings and the principle of single capacity, whereby the same firm could not both make markets in shares and act as agent to outside clients.

Nomura, Japan’s largest stockbroker and the largest securities house in the world, became a member of the London Stock Exchange just over a year ago. Since its arrival in London in 1964 the firm has risen to dominate the underwriting of Eurobond issues and is one of the top market makers in this field.

In the three years that Stock Exchange chairman, Sir Nicholas Goodison, was given to put its house in order the Big Bang grew to encompass far more. In particular it gave the City the chance to tackle emerging problems. The growing internationalisation of securities markets meant that London had to make out the strongest possible case in order to occupy the slot between the world’s two biggest finance centres, Tokyo and London.

Its move into the equity market has been carefully measured. As the principal channel through which Japanese funds have moved into European equities Nomura has been a heavy buyer of leading British blue chips, notably the privatised British Telecom and British Gas. It is also building up a strong research department which was the first to warn investors about the over-enthusiasm for Wellcome’s Aids drug, Retrovir.

The International Dateline was clearly on London’s side, but the actual customs and practices of the London market were still seen by some people as “olde worlde.” The single capacity system was unique and had little commercial justification. There were also considerable doubts over how effi-

At the same time that represents only just over half the daily business going through the stock market. The growth in deals between market makers has been phenomenal and now makes up 44 per cent of turnover.

But the challenge which sends a chill of apprehension around the City is Nomura’s imminent move into British equities market making. With a capital base greater than all the British clearing banks put

London’s market makers — Greenwell excepted — have come through the City Revolution unscathed. But the shadow of Japan’s Nomura, which is steadily dominating global stock markets, is only now lengthening over London. Nick Goodway, of the “Observer,” reports.

Another example of the efficiency of the new system in coping with exceedingly high volumes of trading came with the flotation of British Gas in December.

Dealings began simultaneously in London and New York at 2.30 p.m. Greenwich Mean Time on December 9. In the three hours which followed before London’s close more than 800 million shares were traded — a feat which would have been impossible before the Big Bang. SEAQ also gave the Stock Exchange the chance to rank shares by quantity and quality, giving the most heavily traded the labels of alpha and beta stocks. The numbers in both categories have been increased recently. “We have the technology,” may be the Stock Exchange’s cry. But it has been up to the individual member firms to make the most of it. With the 31 market makers in the equity market compared with four large jobbers and half a dozen smaller ones before the Big Bang, and 21 gilt market makers against eight jobbers, there is still a stunning amount of excess capacity.

The increase in trading volumes might mean there is more to share around the enlarged pool. But at the same time it means the profit margins on dealing have fallen.

Now that fixed commissions have gone it appears that around 50 per cent of all deals are transacted at “net” prices — i.e. no commission is paid. That applies to the large institutional players in the market who are buying hundreds of thousands of shares at a time. The private investor has not gained so much. Some broking firms have introduced no-frill dealing services at low cost, although Kleinwort Greiveson was recently forced to close down such an operation. And there l is a current likelihood of a significant rise in the Service charge that the Stock Exchange makes on member firms. The minimum charge for small deals, which had already risen from £l5 ($43.54) to £2O ($58.05), will probably rise to £25 ($72.56). Among , the market makers themselves there is a great deal of confidence. Most claim to be making money and only Greenwell Montagu has given up. But researches among the top institutions indicate that business is beginning to polarise.

In terms of success in making markets the new financial conglomerates which bought large jobb-

ing firms — BZW, Mercury and Smith New Court — seem to have the edge on those firms which decided to build their own market making operations

from scratch. But some of the newer entities, including Philips and Drew and Kleinwort Grieveson, look like survivors.

James Capel, the stockbroking firm which decided to specialise in agency broking and to ignore market making, also appears to have made a smart decision. Capel’s business is described as very healthy while other firms are beginning to look seriously at how much their business warrants employing teams of highly paid research analysts. Fall-out in research and paring of the mega-salaries looks bound to occur soon. In the gilt-edged securities market the Big Bang has been supervised by the Bank of England under the Governor, Mr Robin Leigb Pemberton. While there is no denying that six months in it is early days, all 27 of the original applicants are still making markets and the belief is that things have gone much as expected.

The bank monitors market makers on a day-to-day basis, following them rather more closely than the Stock Exchange does players in the equity market. Like the share market, gilts have shown a remarkable increase in volume since the Big Bang. The value of daily gilt bargains in January touched £4 billion ($11,611 billion), compared with £1.37 billion ($3,976 billion) in. the first three-quarters of 1986. But trading between market makers accounts for slightly more than half the volume.

Where the gilt market'has the edge of the stock market is in the backroom. It is no good having an efficient dealing system if the ensuing settlement system cannot match it.

Many of the new market makers admit that they were caught unawares with the increase in volume, and while their dealers could cope with it on the trading screens they built up severe backlogs in actually sending out settlement notes and share certificates in the back offices. The Stock Exchange is well aware of these problems and is planning new technology systems to help out. By the end of this year it hopes to introduce SAEF, which will enable orders up to 1000 shares a time to be executed automatically by computer. This will. followed by Blox, which will let market makers put up prices in the very largest numbers of shares.

By 1989 the Exchange plans to introduce a system called Taurus, which will be a fully paperless system cutting out the need for share certificates and considerably reducing the amount of administration.

That will not be early enough for some firms. When Wall Street experienced its version of Big Bang in May 1975 the first casualties did not appear for some nine months. Admittedly that was during a bear market. But it seems inevitable that the second six months after Big Bang are likely to prove tougher than the first six for many people. —Copyright, OFNS.