Pension funds clash in City revolution

JOHN EISENHAMMER

Financial Editor

Britain's powerful pension funds placed themselves on a collision course with the City's big market makers after throwing their weight behind Stock Exchange proposals for a radical reform of share trading in London.

The pension funds, which own some 35 per cent of UK equity, support introducing automatic order-driven dealing - which electronically matches bids and offers - to the leading FT-SE stocks. "The investment committee would be very content to see an alternative method of dealing on the Stock Exchange, and if it is order-driven then we believe it will offer lower prices," said the National Association of Pension Funds.

"Effectively what we are after are lower costs and an effective dealing system," said a leading insurance fund manager.

The Stock Exchange yesterday published its long-awaited consultation document about exactly what sort of order-matching dealing system is wanted by most market participants and how it should be introduced. It sets out detailed options of how the fully automatic order-driven facility might take over from - or be combined with - London's traditional system, in which market-making firms use their capital to quote firm buy and sell prices for shares.

The published document differs in one important respect following the sacking last week of Michael Lawrence from his post of chief executive of the Exchange. His preference for a "hybrid", combining the two systems on the same screen, has been markedly toned down. The big market-makers, which played an important role in Mr Lawrence's ousting, argued that this option was impractical. "Putting the two systems together on the same screen will have the inevitable effect of capital being withdrawn from the FT-SE 100. Of course investors can say they would like a choice of competing systems for the same stocks, so they can pick the cheapest, but the question is whether practitioners find it worth their while to participate in that. I think not," said a leading market-maker.

The tone of the consultation document points rather to the more radical of the options, which is to replace the traditional quote-driven system with an order-matching facility for all stocks. Alongside this new system there would be a so-called block trading facility, which the market makers could use to trade large blocks of shares off the market. This is the mechanism which is successfully operated in centres such as New York and Paris.

The document also offers the option of an order book for some stocks and a quote book for others. "Ask a fund manager and he will want order- driven for the big stocks to get cheaper dealing costs and quote-driven for small stocks to make sure he can always deal. Ask a market maker and he will want it precisely the other way round. That is the dilemma to be overcome," said a top market maker.

Private client brokers and small investors have strongly urged keeping some form of market-making in the smaller stocks. The Stock Exchange said that small investors should benefit from cheaper dealing in popular stocks with an order-driven facility.