As the U.S. market continues to lose some of its luster, more investors are looking to Europe for opportunities. This is occurring as the European market is going through economic unification, technology upgrades and better transparency.

"Over the next few years, these trends will create a more efficient landscape for investors and asset managers," according to a TABB Group report, "European Institutional Equity Trading 2007: The Buy-Side Perspective." TABB Group interviewed 70 traders at buy-side firms trading European equities located in 20 countries, including the EU-15 and the U.K.

European markets are attracting a lot of attention due to improvements in fragmented regulatory landscape and economies of scale, said Senior Analyst Adam Sussman at Westborough, Mass.-based Tabb Group during a webcast last week.

"Regardless of where companies are based, Europe will be a greater area of importance over the next few years," Sussman said.

Currently, however, Europe is very heterogeneous, as cultures and regulations vary from country to country. Once Markets in Financial Instruments Directive (MiFID) goes into effect on Nov. 1, it will allow for less disparities, but they will not disappear overnight.

Since MiFID is policy-based, firms have flexibility as to how they will fulfill the requirements.

MiFID is being pushed through regulation now, as the European markets are doing well and it will be easier to pass, Sussman observed. Twenty-four percent of firms interviewed stated that MiFID would not change the way they trade, with 55% stating it would.

The European markets have performed well over the past few years, which has caused the European asset management industry to rapidly expand. European regulators need to concentrate on making it easier to market cross-border funds, such as offering a single product for investors in Germany, Italy and France, according to the report.

The average assets under management for mutual funds in the U.S. are around six times greater than mutual funds in Western Europe, but changes to Undertaking for Collective Investment in Transferable Securities (UCITS) guidelines are bringing about changes on that front, and once in place, it "will be the precursor to truly global investment management products," TABB Group observes.

Technology is also going to have a huge impact on connecting and standardizing Europe. "Even while compliance, clearing and settlement rules differ from country to country, Order Management Systems (OMS) act as a hub, connecting the various pieces of functionality needed to handle the increasingly global nature of asset management," the report states.

Trading desks are becoming more complex, as asset management companies use hedge-like strategies such as market-neutral funds and 130/30s. In order to handle the increased volume of trades, OMS and transaction cost analytics are being implemented more.

Europe is prepared for the rapid growth and has begun to change how it communicates orders from the current phone system to an OMS or an Electronic Management System (EMS). The number of orders routed one of those ways increased 39% to 44% over the last two years and is expected to reach 55% by 2009.

As European equity markets outperform the U.S., independent service vendors and execution vendors will focus on tools geared toward European funds, Sussman said. "There will be more choice, accompanied by fragmentation."

The buy-side is forever looking for ways to increase liquidity and employing different tactics to find opportunities. Twenty-seven percent of firms stated liquidity-related issues are the number-one challenge facing the buy-side. "It is widely available and cheaper in Europe," Sussman noted.

Indications of interest (IOIs) are a way to source liquidity because they help avoid market impact.

Firms in Southern Europe are expecting that IOIs will be involved in 39% of all trades in 2009, an increase from 33% this year.

An issue with liquidity is the trader has to question whether they should ask the broker to take the position onto his books to get the trade done. Capital commitment is an important value-added service that the buy-side looks for from their bulge-bracket brokers, the report states.

In the U.S., capital commitment is used mostly for trades in less-liquid stocks, such as small- and mid-caps or when an order is very urgent. However, capital commitment is widely used throughout Europe. Compared to the U.S., in Europe, 66% of small firms use it versus 27% in the U.S.

This could be due to "structural issues such as off-exchange trading, but also because European brokers are much more likely to offer capital to smaller funds," the report states.

Additionally, local brokers face similar threats in Europe that agency brokers do in the U.S. Many firms will consolidate broker relationships and concentrate more commission dollars among top-tier firms since local brokers often don't have the capital to complete deals, Sussman said.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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