Stock exchanges have been at the forefront in the news recently not least following the recent failure of the proposed merger between the London Stock Exchange and Germany’s Deutsche Bourse. As in other areas of finance there is increasing focus on the need for greater transparency for investors across all of Europe’s stock exchanges and for a more level playing field for all participants.
Key to this is the establishment of a process that allows all participants to find the best price when trading. Fingers are often pointed at exchanges putting the needs of High Frequency Traders (HFTs) over those of long-term investors. HFTs usually start the day flat, finish flat and trade madly in between as they chase profits, attempting to capture the best prices. This is a long way from the retail investor who places trades through brokers. As a result, there is now widespread support for a change in market structure. Critics believe that high frequency trading disrupts markets and is unfair, while the traders believe they are just taking advantage of a market structure that allows them to buy and sell stocks ahead of retail and institutional customers who cannot compete on speed.
To counteract this lack of visibility, in September last year, an anti-HFTs trading platform, IEX, was approved as an exchange. Built on the belief that every investor is entitled to the same right to trade on equal terms on every trade, IEX is on a mission to level the playing field by eliminating unfair advantages from the markets. All participants on IEX are treated the same and are all charged the same price to trade. They are all subject to the ‘speed bump’, a 350-microsecond delay for orders. The idea is that this thwarts HFTs’ ability to race ahead of slower investors to take advantage of price changes before they formally update. Everyone plays by the same rules on IEX, which supports displayed and non-displayed trading, and the routing of orders to other trading centres. It’s all about making a fair market.
But HFTs are just one part of the problem. In Europe, unlike the US, numerous exchanges (known as venues) mean it can be difficult to establish a clear and precise picture of market activity – both pricing and volumes – across multiple markets. The US has one consolidated tape (an electronic program that provides continuous, real-time data on trading volume and price) called the SIP, where investors can see the trading tapes of all venues. That’s not without its problems though as the SIP has a delay – so while in theory it’s real time, in practice it’s not. But in Europe, without a consolidated tape, investors lack cross-market transparency and have to pay to access numerous venues.
There’s been little action or urgency on this from the regulator, which is waiting for the industry to come up with its own solution. One of the unintended consequences of the EU’s original Markets in Financial Instruments Directive (MiFID I) pan-European financial regulatory framework when it came into force in 2007 was data fragmentation in European equity markets. The segmentation of markets provided a whole series of different sources for the same data. As these data sources developed, it became increasingly necessary to reference more than one single share price, which historically only required prices from the main (and often only) domestic exchange.
The lack of a consolidated tape has frustrated buy-side firms as, without a consolidated source of pre and post-trade market data, it can be difficult to establish a clear and precise picture of market activity across multiple venues.
With MiFID II due for implementation in January 2018, the European Securities and Markets Authority (ESMA) has given the industry two years from that date to come up with its own solution.
If history is anything to go by, this will be difficult. Previous attempts to create a consolidated tape have failed. Most recently the COBA Project, an independent organisation established in 2012, attempted to rally interested parties – buy-side institutions, brokers, and exchanges – to come up with an industry-led solution. However, the lack of engagement from all the necessary parties led to the project ending a year later.
ESMA has already published a consultation paper on the technical standards for several consolidated tapes for non-equity financial instruments as part of the MiFID II regulations. In the equities market, there appears to be little economic motivation to find an industry-led solution and it may be that having one imposed by the regulator is the best way forward. This would ensure against duplication, lower costs and create an easier process to enforce.
We believe a consolidated tape covering Europe’s exchanges would increase transparency, providing a more complete picture of a given security’s liquidity and pricing. This would in turn make price discovery and assessment of executions and venues far simpler.
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