European traders brace for man vs machines war

By Sophie Hares

LONDON (Reuters) - European stockbrokers may find it hard to escape unscathed as sweeping regulatory changes lead to a boom in the use of high-tech systems designed to remove the human element from trading and radically reshape markets.

Complex algorithmic computer systems -- designed to monitor thousands of stocks and independently identify and execute orders in milliseconds -- are revolutionizing Wall Street and demand is quickly catching up across the Atlantic.

"We're looking to take humans out of the equation where it makes sense," said John Lowrey, European head of execution services at Lehman Brothers, striding past hundreds of dealers glued to their screens on the bank's vast London trading floor.

The November introduction of Europe's Markets in Financial Instruments Directive (MiFID), aimed at boosting competition between banks and exchanges and cutting costs for investors, is proving a major catalyst for the switch to algo trading.

The far-reaching regulatory changes will oblige firms to offer "best execution" on client orders, and see stock exchanges face competition from banks and brokers who will be allowed to trade shares in-house.

"People are going to increasingly need algorithms to work in an environment that seems likely to be more complex as a result of increased competition between trading venues," said Richard Balarkas, head of Advanced Execution Services sales at Credit Suisse.

"MiFID doesn't remove barriers which are there stopping people using these tools, it acts as a catalyst so things are already moving and will move faster under MIFID."

Changes which have forced fund managers in the UK to "unbundle" research payments from execution costs have also put additional emphasis on cutting the price of trading.

"It's simple today, there's one place to trade any given stock, it's going to be more complicated next year when we're trading in five or six places simultaneously," said Steve Vandermark, European head of algorithmic trading and analytics at Lehman. "But from a client's perspective, they're just getting good execution across a fragmented landscape."

LIGHTNING SPEED

Market estimates calculate algo trades currently account for about 40 percent of volumes on the London Stock Exchange (LSE.L) which recently launched a new electronic system to execute 10 millisecond trades as volumes jump and competition intensifies.

In the United States, Boston researcher Aite Group says around a third of U.S. equities trading is already done using algorithmic systems and expected to grow to 50 percent by 2010.

As well as executing trades at lightning speeds, algos with names such as snipers, guerrillas or sniffers are programmed to hunt out rivals' strategies, disguise trades and take advantage of market anomalies.

Others seek out so-called dark pools of liquidity -- the private trading networks which enable both buyers and sellers to remain anonymous until trades are executed.

European hedge funds, proprietary trading desks, broker dealers and regular fund managers are opting for algos, despite some pointing out the relative lack of liquidity in the region versus the U.S. and the smaller universe of tradable stocks.