Banks set to increasingly trade in-house: FSA

LONDON (Reuters) - Investment banks in Europe are poised to do more trades internally, by taking a customer's buy or sell order and filling it in-house instead of sending it out to the exchange, Britain's financial watchdog said on Tuesday.

European Union rules set to take force in November 2007 will legalize internalization across the 25-nation bloc under the Markets in Financial Instruments Directive (MiFID).

In some EU states, exchanges have benefited from a concentration rule requiring all share orders up to a certain size to traded on the exchange.

"MiFID opens up the possibility to compete with the exchange," said Thomas Huertas, the FSA's director of wholesale firms at the Reuters Investment Banking Summit in London.

In September a group of nine of the world's biggest investment banks said they plan to set up their own system for reporting share trades, bypassing major European stock exchanges.

The group, which includes Citigroup, Goldman Sachs, HSBC, Merrill Lynch and Morgan Stanley, said the platform would create significant cost savings for its participants.

"It's a positive development and will add to the competitiveness of the market," said Huertas. "Internalization will continue, look at what has happened in the United States."

In the United States, where internalization is already permitted, consulting firm Celent estimated that internalization accounted for 50 percent of 2004 Nasdaq Stock Market transactions, up from 25 percent in 2000.

Big investment banks are expected to internalize because the system will come with conditions too costly for small firms to comply with, such as having to publish to the broader market the price of a proposed in-house trade before the transaction is completed.