ICFR Breakfast Briefing: “Competition between Trading Platforms and Market Liquidity”.
20 Jan 2010
On 20 January the ICFR hosted a breakfast seminar at which Professor Thierry Foucault of the leading French HEC School of Management gave an enlightening talk looking at the changes in competition between trading platforms and the effects on liquidity, transparency and price discovery.
London, UK
Apart from being Professor of Finance at the HEC, he is also a research fellow for the CEPR, has taught at a number of leading institutions around the world, is widely published in leading financial journals and currently serves on the scientific committees of the AMF authority in France which is in charge of financial regulation. Coming just ahead of the next round in the review of Mifid, and at a time when some “dark pool” operators are shining light on part of their business, the EU is mooting new price disclosure rules and in Asia, more market players are investing in new technology to participate in these new trading platforms, Professor Foucault’s thoughts are particularly instructive. He was also able to highlight some fruitful areas for further research to be pursued by the ICFR in this field.
Professor Foucault’s talk opened with a brief review of the state of competition between trading platform in Europe and put this in the context of similar developments in the US in earlier years. He then went on to pose a series of questions based around the issue of whether or not market fragmentation is good or bad for liquidity, volatility, price discovery and the cost of capital. In theory, fragmentation is bad for liquidity due to economies of scale and network effects but it should encourage inter-market competition and innovation, lowering trading fees and more efficient trading technologies. This of course raises questions about best to regulate in circumstances of rapidly changing innovation in trading options. Should fees be regulated, who owns market data, how should it be priced , how much transparency is “needed”, and the costs and benefits of high frequency trading.
To illustrate some of the issues, Professor Foucault used the example of the Introduction of EuroSETS by the LSE in the Dutch market in 2004. In a detailed discussion of the practical impact of the EuroSETS introduction on the frequency of “trade-through” and use of smart routers, there was an animated debate between Prof Foucault and a number of the participants about the practicalities of trading during the early phases of a new entrant into a trading environment.
Many issues arose from this briefing some of which the ICFR considers worthy of further research:
- The need for more studies along these lines covering the period since the introduction of Mifid at the end of 2007
- More examination of the prevalence and impact of high frequency trading
- What is the best approach to regulating inter-market competition. Is this necessary or as one participant questioned, does ill-considered regulation dampen the efficiency of price signals in determining preferred trading providers?
- What is the elasticity of orders relative to the changes in fees?
- Echoing the call of the EU regulator, can we get access to reliable and timely data to be able to answer these questions?
The ICFR will be actively seeking out research partners or individuals already working in these fields in order to “shine some light” in this key area of the regulatory debate.
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