Market-makers to keep perks

Exchange shake-up: Big guns will retain most of their privileges in the new regime, while sub-underwriting fees find support

Powerful market-makers will keep most of their dealing privileges, notably exemption from stamp duty, when the City revolutionises the way it trades shares from next year.

The controversial privileges have been the subject of urgent talks with the Treasury and the regulatory authorities, after which the Stock Exchange can proceed with the final, detailed consultation on the introduction of the order-book dealing system.

A convergence of interests between the Stock Exchange, market-making firms and big institutional investors has blunted tentative efforts by the regulators, and most notably the Office of Fair Trading, to use the introduction of the new dealing system to get rid of most of the privileges.

It is understood that stamp duty on share-dealing will remain, despite renewed talk of abolishing it, and that the new-style market-makers will continue to enjoy exemption from payment.

Sources also indicate that the compromise reached last year on the delays permitted to market-makers before publishing big trades will in effect be transferred to the new dealing system.

"The whole issue of privileges is a very fraught area. They are meant to be there for market-makers taking risks in exchange for certain obligations. But everyone knows they are in fact abused for their own proprietary trading," a regulatory source said.

There were calls from the OFT for all the privileges to be scrapped, but one senior regulatory executive said: "This was seen as too great a risk when making such big changes."

Next summer the Stock Exchange plans to introduce an electronic order book for the top FT-SE 100 stocks, where buy and sell orders will be automatically matched on screen. Initially, at least, the market-makers will continue London's traditional system of quoting firm buy and sell prices for the smaller stocks.

But many powerful institutional investors made clear their concern that the order book should also have next to it a facility guaranteeing liquidity for trading large blocks of shares through all market conditions.

The Stock Exchange also became increasingly concerned to preserve liquidity in the top stocks for fear that if the reforms got off to a poor start, it would provoke even more fragmentation in and disintermediation in the market than it already faces.

These concerns converged with the lobbying of the market-makers to maintain their privileges, if they were still to be expected to commit large amounts of capital to keep shares trading.

Under the new system, market-makers are expected to be called registered principal traders. "You can call them what you like, but they will just be market-makers by another name," one senior investment banking executive said.

In return for their continued privileges, the market-makers will be expected to act as "liquidity providers of last resort". There will be no obligation to provide quotes in the FT-SE 100, but there will be an obligation to make a price for client orders above a certain size that cannot be satisfied by the order book. However, the old obligation to deal with other market- makers will fall away.

"There needs to be a certainty of liquidity both inside the order book and outside it for block trades," a regulatory source said.