Home Field Advantage for Foreign Equities on the Trading Floor

It is becoming easier to buy equities of foreign companies. Private investors do not have to turn to the respective domestic exchanges if they want to include the shares of Nokia or Microsoft in their depots. With the high-quality service provided by the Frankfurt Stock Exchange, price differences between the domestic market and Germany are becoming smaller. This is enabled by the so-called reference market principle: the price of a foreign share on the Frankfurt Stock Exchange refers to its current price on the respective domestic exchange, the reference market. Thus, private investors in Germany are guaranteed fair pricing.

The reference market principle applies to US titles included in the DJ Industrial Average 30 and Nasdaq 100, as well as for the equities of the prominent European indices DJ Euro Stoxx 50 and DJ Stoxx 50. For the US shares, NYSE and Nasdaq represent the reference markets, respectively. For the European shares, the corresponding domestic exchanges serve as reference markets.

The reference market principle is a service offered by all lead brokers on the Frankfurt trading floor. They have committed to offering in Frankfurt the spreads between bid and ask prices of shares from their respective domestic exchanges. “We track the domestic market of a share in floor trading and are thus able offer private investors fair trading conditions“, explains Jan Vrbsky of Baaderbank who supports several US titles on the Frankfurt Stock Exchange.

The advantage for private investors: the lead brokers align their prices to the market with the highest level of liquidity – the reference market. Investors benefit from narrow spreads between bid and ask prices. This advantage is even greater if the reference market is open at the time of the transaction. “We can offer a narrow spread to private investors if trading takes place on the domestic market at the time, for there is a lower risk that we ourselves have to buy at a totally different price.”

The US stock markets open at 3.30 p.m. CEST, just as Germany is taking a coffee break. At 8 p.m., the Frankfurt floor closes, while there are two more hours to go for traders in New York. In Europe, there is parallel trading on the respective reference markets between 9 a.m. and 5.30 p.m. After that, most European stock markets are closed, while in Frankfurt, trading in shares from London, Paris, Madrid or Amsterdam goes on until 8 p.m.

An example: an investor would like to buy shares of US software company Microsoft. He/she places the order when Nasdaq – the reference market for this title – is still closed. Yet, the order can be executed at the usual speed. The price fixed by the lead broker aligns to the share’s closing price of the previous trading day. In that case, the lead brokers on the Frankfurt floor offer a spread that depends on their estimation of the market. On the other hand, the investor might incur an additional risk fee, since the lead brokers themselves can only buy shares after Nasdaq has opened again. “However, the cost will not rise above a certain maximum spread in the future,“ says Kai Jordan of Steubing AG, a lead broker supporting around 900 foreign shares on the Frankfurt floor.

Of course, a price difference remains: the lead brokers have to pay country-specific fees such as taxes and trading fees on the respective exchange. This results in a reasonable fee that is added to the prices of foreign shares in Frankfurt. Of course, this is not comparable to the effort and cost of trading via a German bank or broker on the foreign exchange.

Moreover, investors should note that titles that are not quoted in euro – but can be bought in the single European currency – are subject to the usual price fluctuations and additional currency risks.