It is possible that the bifurcation between order book-provided price discovery and off-book-provided quantity discovery will sharpen. On the other hand, if the NYSE’s new market structure better facilitates the handling of large orders, the two processes may be brought into closer harmony. Before attempting to peer into the future, let us first take a broad look at off-exchange trading and then obtain some perspective on the current importance of fast market, order book trading at one exchange, Germany’s Deutsche Börse, where the primary focus is on electronic trading.
104 P. Davis et al.
the division of the order flow between trades that go through an exchange’s order book (on-book trading) and trades that by-pass the book (off-book trading) for one other country, Germany. The German order book data include trades made on Germany’s physical trading floors, but Deutsche Börse’s main trading platform is electronic, and on-book trading is predominantly fast market activity directed to the Exchange’s Xetra system.
Currently, there is no trade reporting requirement in Germany and, consequently, the actual amount of off-book trading (and even off-board trading) in German stocks has not been known. Our approach to estimating the importance of on-book trading should conservatively be viewed as a “best guess effort.” It involves the use of Cascade settlement instructions data from Clearstream, the major settlement service provider for German stocks.
On-book trading in Germany offers speed and strict time and price priorities.
But participants have alternatives, and we emphasize that the on-book market share (the metric that we focus on) is not a measure of Deutsche Börse’s overall market share. Orders can be sent directly to Xetra (an on-book order), or can be reported directly to the clearing and settlement system (an off-book order), or can be entered through Xontro, the Exchange’s electronic order routing system that offers both on- and off-book entries for normal-sized orders and block trading. There are no specific block trading arrangements on the Xetra order book, no trade-through rule that prevents a block from executing outside the spread, and no requirement that a block trade be printed.
Deutsche Börse has provided us with monthly order book trading volume for 160 actively traded stocks on the Deutsche Börse, as well as a proxy for off-order book activity obtained from the Clearstream settlement instructions (with all broker and customer identifications suppressed) for two evaluation periods: the month of January 2006, and July 2003 through June 2005. 11 The Cascade settlement instruc- tions include entries that are non-trade related position shifts which, fortunately, for the most part, are not included in our data. 12 We have employed an (albeit imperfect) way of assessing the magnitude of any potential double counting of trades and, as will be discussed below, conclude that it is not substantial enough to unduly distort our conclusions regarding the division between on-book and off-book trading. 13
Our measure of on-book trading is to some extent more accurate. As noted, it includes all trading on Deutsche Börse’s electronic trading system, Xetra, and on various physical trading floors (primarily in Frankfurt and, to a far lesser extent, in Munich and other German exchanges).
11 Special thanks to Robert Urtheil and Miroslav Budimir of the Deutsche Börse for making these data available to us.
12 Regarding non-trade related position shifts, reliable estimates are not available, but anecdotal evidence suggests that securities lending and repurchase transactions are very small compared to aggregate OTC trading volume. Additional details on non-trade related position shifts are availa- ble from the authors upon request.
13 More details on the specific algorithm used in the present analysis are available from the authors upon request.
We assess the relative magnitude of order book trading using both value- weighted and equally weighted averages across all stocks in our sample. The value-weighted average reflects the division between on-book and off-book trading for the representative euro value of trading. The equally weighted average reflects this division for the representative firm. We present statistics for both averages but, because the value-weighted average is heavily influenced by a relatively small number of firms with large trading volumes, we direct our attention mainly to the equally weighted average.
Exhibit 8.1 shows, for the month of January 2006, the percentage of the euro value of trades that goes through the order book for the 160 companies that com- prise four major German stock indexes (denoted as “All 160” in the graphs), and for the stocks in each of the indexes: the 30 DAX large cap stocks, the 50 mid cap MDAX stocks, the 50 small cap SDAX stocks, and the 30 TECDAX technology stocks. The euro value-weighted market share statistics are displayed: (1) using the adjustment procedure noted above to eliminate double counting, and (2) based on the “raw,” unadjusted Cascade data.
We see in Exhibit 8.1 that the value-weighted averages for adjusted on-book activity are uniformly higher than the value-weighted averages for the unadjusted data – the percentage point differences range from 3 to 10 (43% vs 40% for SDAX stocks and 49% vs 39% for DAX stocks). This is not surprising given that the adjusted data are explicitly intended to eliminate the double accounting of trades associated with OTC dealer operations. For both the adjusted and unadjusted meas- ures, the on-book market share is similar for the DAX, MDAX, and SDAX stocks, and roughly 20 percentage points higher for the TECDAX stocks.
48.7% 47.7%
42.9%
66.0%
49.1%
39.3% 38.4% 39.7%
59.1%
39.8%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
DAX MDAX SDAX TECDAX All 160
Adjusted On-Book Unadjusted On-Book
Exhibit 8.1 January 2006 German On-Book Market Share by Trading Volume in Euros (value- weighted, both adjusted and unadjusted)
106 P. Davis et al.
While our adjustment procedure may help correct the over-statement of off-book trading, the value-weighted averages may be excessively influenced by a relatively small number of heavily traded stocks. To assess this possibility, in Exhibit 8.2 , we contrast the value-weighted and equally weighted averages for the unadjusted data. All of the equally weighted on-book trading averages are higher than the comparable value-weighted averages. For all 160 stocks, the equally weighted average is 54%, while the value-weighted average is 40%. This contrast suggests that off-book trading is more prevalent for the larger, more actively traded stocks.
The on-book market share averages for both the adjusted and unadjusted data, and for both the equally weighted and volume weighted averages, range from 38%
to 60% (with the exception of the stocks in the TECDAX index, for which the on- book averages are between 59% and 66%). Overall, our four different ways of assessing the percentage of on-book trading portray a roughly consistent picture. It appears from the January 2006 data that a reasonable market share estimate for order book trading in Germany is 50%. 14
But data for just one month may be noisy. Accordingly, in Exhibit 8.3 , we further report equally weighted averages for the 2-year sample period (July 2003–June 2005)
14 The relatively high on-exchange TECDAX market share might have been inflated by some non- recurring trading activity in a particular sub-sector of technology stocks during January 2006.
Exhibit 8.2 January 2006 German Unadjusted On-Book Market Share by Trading Volume in Euros (both value-weighted and equally weighted), in terms of Cascade Settlement Volume
39.3% 38.4% 39.7%
59.1%
39.8%
45.2% 47.5%
59.7% 63.7%
53.9%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
DAX MDAX SDAX TECDAX All 160
Value-weighted On-Book Equally weighted On-Book
based on unadjusted data. In so doing, we are implicitly assuming that data adjust- ments for the longer period would be relatively small, as they are for January 2006. 15 In Exhibit 8.3 , the finding for “All 160 Stocks” of 56% is virtually the same as the comparable equally weighted average of 54% shown in Exhibit 8.2 for January 2006. But, in contrast with Exhibit 8.1 and 8.2 , the 160-firm aggregate statistic in Exhibit 8.3 masks considerable variation across the four major German stock indexes. Over the 2-year period, for the 30 large cap DAX stocks only 41%
of euro volume occurred on-book, while a more substantial 68% of trading in the smaller TECDAX stocks was on the book.
Across the four indexes, Exhibit 8.3 reveals a clear size-based difference between on-book and off-book trading percentages that is implicit in the relationship between the simple and value-weighted averages shown in Exhibit 8.1 and 8.2 . Larger cap stocks trade more heavily off the book, roughly half (48%) of mid-cap volume goes through the book, and a clear majority (65%) of smaller cap stocks trading goes through the book.
Our finding that larger stocks experience more off-book trading is reasonable.
Large institutional investors, who are typically more active in the larger cap issues, are less likely to direct their block orders to the book, and retail orders for the larger cap stocks are more likely to be netted and internalized by German banks and brokers.
15 Adjusted data are not available for the two2-year sample.
41.1% 47.8%
64.8% 68.3%
55.7%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
DAX MDAX SDAX TECDAX All 160
Exhibit 8.3 July 2003–June 2005 German Unadjusted, Equally Weighted On-Book Market Share by Trading Volume in Euros, in terms of Cascade Settlement Volume
108 P. Davis et al.
Turning to how the market share of on-book trading has changed over time in Germany, Exhibit 8.4 shows how the unadjusted, equally weighted average statistics for all 160 stocks has varied over our 24-month sample period. The graph displays substantial variation in the statistics over time, with the on-book market share hit- ting a peak of 63% in January 2004 before falling to a low of 45% in May 2005.
For the 2-year sample period, the monthly on-book market share had a standard deviation of 4% around its mean of 56%. No particularly meaningful trend is evi- dent in the data shown in Exhibit 8.4 .
Overall, Exhibit 8.1 – 8.4 show that, over an extended period, off-book trading accounts for a very substantial portion of trading in a major country’s equities. Of course, this pattern could, in part, be attributable to Germany’s unique market struc- ture, regulatory environment, and history. Nevertheless, our findings suggest that a further investigation of off-book trading in an electronic environment would be desirable.