World's Largest SWF Blasts Exchanges

Chasing ever-faster data transfer speeds are a “dead end” for stock exchanges, Norway’s sovereign wealth fund argues.

Stock exchange operators should abandon the race for faster data systems and concentrate on innovating for a changing investor landscape, according to a white paper from the world’s largest sovereign wealth fund (SWF).

Norges Bank Investment Management (NBIM), which runs the $874 billion Norwegian Government Pension Fund—Global, argued that the “race to zero” among stock exchanges to reduce data transmission speeds distracts from more important issues: primarily, liquidity.

In the past 18 months, reports have detailed plans from some exchanges to set up networks of lasers and microwaves across the US to shave microseconds off of data transfer speeds.

“Institutions make fewer, but larger, trading decisions than a heterogeneous set of retail investors holding the same number of shares. This means that the likelihood of two matching natural orders appearing at the same time is lower than in a world of many small investors.” —NBIMNBIM said it believed such plans were “a dead end” and would be “to the detriment of all financial market participants”. It expressed support for efforts to discourage such “overinvestment” by removing regulatory and structural complexity.

Instead, the SWF argued that regulators and exchanges should adapt and innovate to cater for a greater proportion of large institutional investors placing large block trades. These include the growing number—and increasing size—of defined contribution pension funds such as 401(k)s in the US, and the “explosive growth” of exchange-traded funds.

NBIM—which holds on average 1.3% of every listed company in the world in its equity portfolio—reported that 80% of free float stock in the US large cap market was held by institutions in March 2015, according to regulatory filings. In 2000 this figure was 50%.

“Institutions make fewer, but larger, trading decisions than a heterogeneous set of retail investors holding the same number of shares,” NBIM said. “This means that the likelihood of two matching natural orders appearing at the same time is lower than in a world of many small investors.”

The report cited the difference between the investor base of consumer technology giant Apple and insurer National Interstate Corporation, both constituents of NBIM’s US equity benchmark. NBIM owned 0.73% of Apple, and 0.04% of National Interstate Corporation at the end of 2014, according to its website.

Apple was held by 3000 institutions and managers in March 2015 as well as significant retail investor ownership, NBIM said, meaning “at any given point in time, it is likely that there are natural orders on both sides of the market”. National Interstate Corporation, on the other hand, was held by roughly 100 institutions. “The likelihood of matching natural orders is much lower,” NBIM said.

“We do not believe economies benefit when going public simply means cashing in, rather than raising capital.”“Equity markets are a long way off from the type of ownership concentration seen in many corporate bond markets,” NBIM said. “However, we believe that equity markets may be able to learn something by monitoring developments in fixed-income markets, rather than the other way round, which has been the approach over the last few years.”

In addition, the SWF expressed concern that the number of company listings had fallen in recent years. There were 30% fewer new listings in 2014 on the Euronext and Deutsche Börse indexes compared to 2003, NBIM reported, as private equity and venture capital funds took a greater share of ownership.

“We do not believe economies benefit when going public simply means cashing in, rather than raising capital,” NBIM said. “We encourage exchanges to develop new solutions in this area, be they in the form of new listing classes, or potentially even a return to local exchanges.”

NBIM also highlighted positive developments in the stock exchange sector, several of which involved reducing operators’ reliance on per-trade fees. It also praised the “recent trend of exchanges purchasing index businesses”, such as the London Stock Exchange buying Russell last year.

Read NBIM’s full report, “Role of Exchanges in Well-Functioning Markets”.

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