9.5 SEAQ and Equity markets

Question 1

What is the Stock Exchange Automated Quotation System (SEAQ)?

Answer 1

The Stock Exchange Automated Quotation System (SEAQ) is a screen based, competitive market making system used for the trading of shares, as well as corporate bonds. SEAQ acts as an electronic price list, displaying market makers’ firm two-way quotes to the market.

Question 2

What is a firm quote?

Answer 2

A firm quote is one that is binding on the market maker.

Question 3

How is a SEAQ trade conducted?

Answer 3

Should another market marker or broker dealer wish to trade on a quote displayed on SEAQ, the trade is conducted over the telephone.

Question 4

What are market makers?

Answer 4

Market makers are broker dealers that have volunteered to provide quotes. Market makers provide liquidity in the marketplace.

Question 5

What can a member firm choose?

Answer 5

A member firm may choose in which securities it wishes to make a market. For instance, a firm might wish to be a registered market maker in A plc and B plc, but not C plc.

Question 6

How many market makers should be registered for each stock on SEAQ?

Answer 6

There must be at least two market makers registered for each stock on SEAQ.

Question 7

What is the mandatory quote period?

Answer 7

Once a firm has registered as a market maker in a security, it is obliged to display continuous two-way prices during market hours. This is the mandatory quote period.

Question 8

What is the bid/offer spread?

Answer 8

Market makers will display prices at which they will buy (bid) and sell (offer) a stock. The difference between the bid and the offer is the bid/offer spread.

Question 9

Can market makers limit the size of trade at which the quoted prices are ‘firm’ (or binding)?

Answer 9

Market makers can limit the size of trade at which the quoted prices are ‘firm’ (or binding). However, the exchange does not allow them to limit this size below the exchange market size (EMS) of the share.

Question 10

What is the EMS on the quote screen image attached to this question and what does it mean?

Answer 10

In the example, the exchange market size (EMS) is 5,000. This means the market maker quotes must be firm on any order up to 5,000 shares. For orders above 5,000 shares, the market maker can use the displayed prices as indicative prices. Some market makers are happy to make their prices firm for higher volumes. This will clearly be stated in the bottom half of the screen.

Question 11

What is the exchange market size (EMS) a measure of and what is it based on?

Answer 11

Exchange market size (EMS) is a measure of liquidity provided by the exchange and is based on the average number of shares traded per day.

Question 12

What do the top and bottom half of the quote driven screen show?

Answer 12

The top half of the screen displays the stock code, normal market size, trading currency and historic trading information.

The bottom half of the SEAQ screen (below the ‘touch strip’) shows an alphabetical list of market makers registered in ABC. Each market maker is displaying a bid offer spread (e.g. 100-105) and a volume quote.

The touch strip itself shows the best bid and offer prices and identifies the market makers offering those prices.

Question 13

What does SETSqx stand for?

Answer 13

SETSqx stands for the Stock Exchange Electronic Trading Service – quotes and crosses.

Question 14

What is SETSqx used for?

Answer 14

SETSqx is used for the trading of domestic listed securities that are not traded on SETS.

Question 15

What kind of system is SETSqx?

Answer 15

SETSqx is a hybrid system combining a central order book displaying buy and sell orders with two-way prices quoted by market makers.

Question 16

What is the minimum number of market makers for SETSqx?

Answer 16

0! There is no required minimum number of market makers (there could be zero for a certain stock).

Question 17

What is the role of marker makers in SETSqx?

Answer 17

If there are market makers, they provide continuous liquidity throughout the day with a mandatory quote period running from 8.00am to 4.35pm. These must quote firm prices up to the normal market size for the share.

Question 18

How are orders executed on SETSqx?

Answer 18

There is no continuous order book trading on SETSqx. Execution on the central order book happens during five uncrossing periods (periodic auctions) throughout the day which are designed to concentrate liquidity. These occur at 8.00am, 9.00am, 11.00am, 2.00pm and 4.35pm.

Question 19

As well as exchange-traded and pure over-the-counter trades, there are a range of alternative trading venues. What are the 3 distinct types of the main venues?

Answer 19

1. Multi-lateral trading facilities (MTF)
2. Dark pools of liquidity
3. Systematic internaliser

Question 20

What is a multi-lateral trading facility?

Answer 20

A multi-lateral trading facility is a privately owned market place that provides an alternative execution venue for buyers and sellers. Most run an order driven market, much the same as SETS.

Question 21

How does MiFID impact multi-lateral trading facilities (MTF)?

Answer 21

The Markets in Financial Instruments Directive (MiFID) treats multi-lateral trading facilities (MTFs) as it treats an exchange. This means that any pre- and post-trade disclosure requirements must still be met. It also means that the price transparency regime and best execution needs to be applied.

Question 22

What are the major benefits of multi-lateral trading facilities (MTF)?

Answer 22

The major benefits of these systems are availability and accessibility. As they do not need to be recognised by a regulator, whereas an exchange would, they are quicker and cheaper to set up. This means that although a country may not have an established exchange on which companies can raise capital, there may well be an MTF. This creates the benefits of exchange-traded without the need for an exchange.

Question 23

What can a multi-lateral trading facilities (MTF) be seen as?

Answer 23

A multi-lateral trading facility can be seen as a mid-point between exchange-traded and over-the-counter.

Question 24

What is the new category of trading venue introduced by MiFID II?

Answer 24

MiFID II introduced a new category of trading venue called an Organised trading facility (OTF).

Question 25

What is an organised trading facility (OTF)?

Answer 25

An Organised trading facility (OTF) is a multilateral system that is not a regulated market or MTF.

Question 26

How does an organised trading facility (OTF) work?

Answer 26

Within an Organised trading facility (OTF), multiple buyers and sellers of bonds, structured finance products, emission allowances or derivatives are able to interact in a way that results in a contract. Equities are not permitted to be traded through an Organised trading facility (OTF).

Question 27

What transactions will come through an organised trading facility (OTF)?

Answer 27

The introduction of Organised trading facilities (OTFs) means that many transactions currently categorised as off-venue will come within a multilateral trading environment.

Question 28

What is a key difference between organised trading facilities (OTFs) and multi-lateral trading facilities (MTFs)?

Answer 28

A key difference between organised trading facilities (OTFs) and multi-lateral trading facilities (MTFs) is the ability and requirements on an organised trading facility (OTF) to use discretion when matching buying and selling interests – provided the use of discretion is in line with fair and orderly trading and with best execution obligations to clients. This helps to provide liquidity and price transparency in asset classes that have traditionally been less liquid.

Question 29

What is the benefit of having as off-venue transactions coming within a multilateral trading environment?

Answer 29

1. Increase overall market transparency
2. Reduce the prevalence of opaque market models and products
3. Increase the quality of price discovery, investor protection and liquidity

Question 30

What are dark pools?

Answer 30

Dark pools of liquidity, or simply dark pools, are another privately owned market place providing an execution venue for buyers and sellers. However, where a dark pool differs from a multi-lateral trading facility is in the transparency of the market.

A dark pool allows investors, usually large funds, to place large orders on an order book, but, unlike SETS for example, no price is revealed. This allows block trades to be placed and executed without the price of the order or the identity of the firm being revealed to the open market.

Question 31

What is the primary advantage of dark pools?

Answer 31

They reduce the price impact of the orders.

Question 32

What type of transaction are dark pools?

Answer 32

Due to the lack of transparency on these markets, dark pools are still considered over-the-counter.

Question 33

What is meant by systematic internaliser?

Answer 33

Members of the London Stock Exchange have the capacity to act as both broker and dealer (if the firm were to regularly act as dealer, dealing in principal with its clients and linking clients together through cross trades). The Markets in Financial Instruments Directive (MiFID) created the term systematic internaliser to make this role distinct from other trading business and harmonise the rules followed by these firms with those of an exchange or multi-lateral trading facility.

Question 34

Summaries the 4 alternative trading venues by providing:

• A description
• Their purpose
• The operator
• The benefits

Answer 34