2   Are Banks Becoming More "Efficient" Running Stock Exchanges?

William Krehm

It took and very painful stretch of history to get the world out of the Depression of the 1930s. Financing the Second World War, and thereafter the reconstruction of the world battered out of shape by ten years of Depression finally brought to a close by six years of the Second World War, and then a generation of reconstruction and catch-up. What turned the trick was restricting the banks severely to banking, with ceilings imposed on what rates of interest they could pay or charge. Above all they were forbidden to acquire positions in the other "financial pillars" – stock brokerage, insurance, and mortgages.

The reason was obvious enough. The art of banking – that can so readily slip into black magic – consists of lending out several times the money in the banker’s vaults, or even possession, and yet being able to honour the claims of those who have deposited their spare funds with them. Obviously the first time a banker fails that test, there is a danger of a run on all banks. That is why the notion of a deregulated, and globalized bank is an engraved request for first-class trouble.

That invitation has not gone unanswered. The banking system in the US at this very moment is wrestling with syndicated parcels of mortgages, which can be purchased supposedly packaged according to the risk involved. That, too, was peddled as an efficiency since, it saved the banks in their new roles as mortgage-writers; under the new system they felt it unnecessary to check the financial data on the loan application. It appeared to save oodles of money by skipping all that. That multiplied the "lie loans." Since a single bank – the Bank of Montreal – does 9% of the banking in the Chicago area alone, the mortgage business as well as the banking of the two countries are closely interlinked.

However, not only have our banks taken over by far the greater part of the stock brokerage firms in Canada, but they are now setting up their own stock exchange. By settling trades amongst their own clients, a group of six large banks are working together on the project of settling stock trades originating with the clients of the group. They will be able to spare the commission of the Toronto Stock Exchange and other such independent exchanges. Lower commission prices are equated with greater efficiency, but putting such "alternative stock exchanges" under the control of the banks inevitably increases the interpenetration of banks and the stock market, just as the sub-prime mortgages has done between the inadequately processed mortgage risks and the banks, and the continued rape of our environment is multiplying insurance hazards of insurance to unaccustomed heights. Add up these things and their intertwining and the structural and moral strength of our banks crumbles.

That is why the words "greater efficiency" when it relates to banking should be used with extreme caution.

Now let us go to The Globe and Mail (3/05, "Canada’s big banks to set up rival to TSX" by Sinclair Stewart and Soyo Erman): "Canada’s six largest banks are banding together to create a new stock trading platform that will compete directly with TSX Group Inc. and potentially redefine the way the country’s large institutional investors trade equities. The group, led by the brokerage arm of The Royal Bank of Canada, hopes to launch its Alternative Trading System next year, according to officials briefed in the matter.

"The banks will appoint a separate management team to operate the ATS, and are expected to commit approximately $100-million in capital to get the system running.

"‘This is about reducing the cost of trading,’ said one financial executive familiar with the plans in Canada. ‘There will be a big pool of capital there, and they will throw their trades into it.’

"Bank-owned dealers typically avoid exchanges and try to save money on trade-matching internally – taking buy and sell orders that come to their desks and matching them. They carry out the remainder on an exchange.

"By grouping at least six dealers together to match buy and sell orders, the firms believe they can substantially cut down the fees they must pay for the trades they route through the Toronto Stock Exchange.

"It’s not the first challenge the TSX Group backed by banks. Pure Trading, a venture for Canadian Trading and Quotation System Inc. that has investors such as UBS AG, has been working for about a year to get its ATS up and running but has hit numerous roadblocks. The move to ATS models mirrors similar efforts in Europe and the US that are electronic markets that match, buy and sell orders.

"Last summer TSX cut trading prices as a pre-emptive strike, betting that the rising volume would outweigh the lower per-trade revenue. The TSX is also trying to get a piece of the action by launching its own order-matching system known as ATX as soon as it gets approval from the Ontario Securities Commission.

"Some veteran equities professionals aren’t so sure this latest challenge will do much to undermine the entrenched position of the TSX.

"In the US, the systems are known as electronic communications systems (ECN). There has been an explosion in the number of these alternative markets because of the relative ease with which they can be set up. Archipelago, an early entrant, was recently acquired by the New York Stock Exchange. But for every ATS that an exchange buys, eliminating competition, another pops up, often backed by banks."

William Krehm

– from Economic Reform, June 2007