1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1  SETS  SEAQ  SETSqx 27cis Lesson 27:  How shares are traded on the London Stock Exchange

2. Evolution of trading on the London Stock Exchange The LSE has been trading for more than 300 years. Its trading methods have evolved from deals being done over casual encounters, through a formal system of open outcry, to electronic trading  In 1986, the LSE moved from open outcry to a screen-based trading system with market-makers  Market-makers would quote two-way prices (i.e. buy and sell) for the stocks for which they were registered market-makers  Brokers wishing to buy or sell a stock would look at market-makers prices on the screen and phone the market-maker if they wish to deal

3. MiFID – catalyst for change In 2007 the EU implemented its Markets in Financial Instruments Directive (MiFID). This placed an obligation on brokers to achieve “best execution” for their clients when transacting an order to buy or sell a security The LSE’s response to MiFID has been a major revamp of its trading system to facilitate price discovery and execution Best execution is defined as the optimal mix of:  Price  Speed  Likelihood of being able to complete the whole order Total transaction costs in EU states

4. Trading on the LSE today SETS combines electronic order-driven trading with the additional provision of market-maker liquidity The underlying trading system of the LSE is called TradElect  TradElect supports a number of trading platforms that serve different sectors of the market  The main trading platform is the Stock Exchange Trading Service (SETS), which is used to trade shares contained in the FTSE All Share Index o The FTSE All Share Index contains around 98% (by value) of all UK-listed shares  The SETS system guarantees two-way prices for the most liquid and international securities London Stock Exchange test / development servers

5. SETS With SETS, member firms of the LSE (investment banks and brokers) input orders via computer terminals  The orders may be for the member firms themselves, or on behalf of their clients  The order might be set with a price limit o In which case it waits in a queue until the price limit has been reached  The order might be “at market” o The buyer or seller is willing to accept the current price, and the trade is executed immediately A large, liquid stock will have a long queue of would-be buyers and sellers, with a range of different price limits  Priority in the queue is first given on the basis of price  The highest price buyer is at the top of the Buy queue  The lowest price seller is at the top of the Sell queue  Then if prices are identical, priority is given on time (first come, first served)  This is regardless of the size of the order o If inputted into the system a fraction of a second earlier, a small order will still get executed before a large order with the same price limit

6. SETS (cont.) A typical SETS screen might look like this: Note that the order to buy 19,250 shares is higher up the queue than the order to buy 44,000 shares at the same price, so it must have been input earlier. The same applies to the order to sell 1,984 shares at 126p. In effect, the SETS order queue is saying this:

7. Trading in illiquid shares Some shares are “illiquid” – daily trading volumes are very thin, or trading is sporadic SETSqx combines periodic auctions with quotes from market makers This enables trading to take place throughout the day Illiquid shares on the LSE are not traded on SETS. They are traded on a system called SETSqx (“Stock Exchange Electronic Trading Service – quotes and crosses”)

8. Trading via SETSqx (cont.) When there is no registered market-maker, the yellow strip will show the best bid and offer prices available. SETSqx is a quote-driven system with market makers providing liquidity during the trading day. It combines periodic auctions with quotes from market makers The SETSqx strip displays the best bid (buy) and offer (sell) price for the security, based on the market-maker quotes only

9. Trading via SEAQ If a security is not traded on either SETS or SETSqx, it will be traded via SEAQ – the Stock Exchange Automated Quotation  SEAQ is used mainly for some AIM-listed shares, and fixed income securities, such as bonds  It is a quote-driven system, which harks back to the way all trades were conducted in the late 1980s and 1990s

10. SEAQ (cont.)  If a member of the LSE spots a quote for a security on a market-maker’s SEAQ page which is attractive, he / she will contact the market-maker by telephone to buy or sell the security  The market-maker has to honour the prices and quantities that it is displaying on the SEAQ page With the SEAQ system, market-maker display lists of securities for which they are willing to make two-way prices, and the quantities in which they are willing to deal