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Why the big exchanges need to visit Amsterdam

My friend Nandini Sukamar at Bloomberg broke a story yesterday that Eurex is to compete with CME Europe by offering competitive FX contracts. So it looks like we are going to see a few more spats as the big boys vie for control over the European exchange-traded derivatives market. The CME is looking to launch its own competitive products to Eurex, and NASDAQ NLX is taking on both NYSE Liffe and Eurex with its own interest rate products. These are interesting developments, as history shows that few such attempts are successful. Lack of fungibility between competing contracts means that it is pretty tricky for a newcomer (however large) to wrestle the open interest away from an incumbent. This is crucial, as a deep pool of open interest is essential for traders so that they can easily exit any positions they take.

Whilst the jury is still out on whether the big boys will successfully knock lumps out of each other, a small Dutch venue looks like it is showing how it should be done. Intriguingly named, TOM (The Order Machine) has been taking on NYSE Liffe in the Dutch equity options market. To be fair it had a natural advantage in that the Dutch options market is uniquely retail, but it also developed two other effective strategies besides just being cheaper. First, it offers best execution and so is prepared to route orders onto NYSE Liffe if it is showing a better price. This ensures they get to see the flow in the first place. Second, in the event that TOM is forced to route an order to Liffe, its market makers effectively net this out so that the pool of open interest remains and grows with TOM.

As a result, in less than 2 years TOM can claim an effective market share of more than 25% in those contracts in which it competes with NYSE Liffe.

I don’t know what they're smoking in the cafés of Amsterdam these days, but maybe it's time some of the global exchanges paid them a visit.


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