Market Fragmentation: Even the Playing Field
Traditional exchange markets in Europe have been buffeted in recent years by regulatory changes and new advances in trading technology. Market fragmentation has been the result, in which trading concentrated on traditional exchanges has given way to a new landscape of trading venues and execution facilities. In Europe, 46 percent of trades are now executed in some sort of off-exchange venue.
But allowing new trading venues without uniform regulation hasn’t been without problems. In particular, our newly released research The Structure, Regulation, and Transparency of European Equity Markets under MiFID(PDF) suggests that market transparency has suffered as a regulatory patchwork creates different disclosure obligations for different venues. Quite simply, depending on where a trade is directed, the visibility of prices, trading interest, and executed trade details can be quite different.
So-called “dark” venues aren’t without some benefit. In particular, investors seeking to trade large positions may find some advantage to opaqueness. But the integrity of capital markets depends on robust price discovery, whereby the information that is relevant to the price of a security is readily available for synthesis by buyers and sellers to arrive at a market price. Surely, supply and demand for securities figures prominently in the price-discovery process.
Market transparency influences investor confidence, and our research supports the linkage between transparency and liquidity. We examined key European markets and constructed transparency measures: for those markets with high degrees of transparency, spreads tended to be narrower.
Going back to a world of highly centralized exchanges isn’t likely. What’s needed is synchronization of pre-trade and post-trade reporting requirements, so that whether a trade is exchange-traded or OTC), lit market or dark, investors have the same opportunity to assess overall supply and demand in deciding at what price to trade. The current European Commission consultationon the review of the Markets in Financial Instruments Directive (MiFID) offers the opportunity to begin the necessary reforms to level the playing field across all trading venues.
Find out more about the market fragmentation and transparency issues in this short Financial Times video segment produced on 21 January.