The BVFA Institute has published a new study into prevailing concerns about market transparency and the operation of a regulatory level playing field within the fragmented trading landscape of European equity markets.
The study comes ahead of the Markets in Financial Instruments Derivative (MiFID) consultation closure on 2 February 2011, and within the context of increasing market fragmentation.
The study examines the structure of European equity markets and the regulatory framework applicable to the different types of trading venues (bilateral and multilateral), focusing on the transparency requirements which apply to each one. Further, the report finds empirically that higher degrees of transparency are associated with lower bid-offer spreads – so investors stand to benefit from more trading transparency.
Although ‘dark pools’ only make up a small percentage of overall trading activity (approximately 3%), a significant amount of trading still takes place on an over-the-counter (OTC) basis, which is only made transparent after deals are executed. As a result, only 54% of all trades, on average, take place on lit markets. Given the noted transparency benefits, the report recommends that the primacy of trading on transparent venues should be paramount, and policy measures should support this goal.
Analysis of transparency measures for select European markets – France, Germany, Spain, the United Kingdom, and the Netherlands – suggests that high average transparency scores broadly correlate with low average bid-offer spreads and stable levels of transparency correlate with stable spreads. This means that transparency can help keep trading costs low for investors and can support investor confidence in the markets.
In most months, spreads typically narrow when transparency metrics increase. Four out of the five European markets examined in this study – France, Spain, the United Kingdom and the Netherlands – support this assertion.
The CFA Institute study finds that not all venues engaged in similar activities across the EU are subjected to the same rules which leaves open the opportunity for regulatory arbitrage. Consequently, not all investors have access to the best prices in the market.
To support the transparency goals above, CFA Institute recommends two major policy measures
Firstly, regarding market structure, more trading on transparent organised trading venues is encouraged in order to halt the ‘slide’ towards using OTC and dark pools (which are less transparent).
Secondly, regarding the regulatory framework, a level playing field is advocated so that all venues conducting similar types of business, and orders of similar types and sizes, are subject to the same rules, and regulatory arbitrage is mitigated.
Rhodri Preece, CFA, Director, Capital Markets Policy, CFA Institute, and author of the report, says: “An uneven playing field can have adverse effects on the transparency of the markets as certain types of trades and trading venues are subject to different obligations. Furthermore, it may also encourage regulatory arbitrage towards execution on opaque or more lightly regulated trading venues which may harm price discovery, the provision of liquidity, and the efficient functioning of markets. Ultimately, more transparent trading can improve market quality for investors.”
Charles Cronin, CFA, Head, Standards and Financial Market Integrity, EMEA, CFA Institute, adds: “The report will contribute to the ongoing policy debate. From an investor perspective there is a desirability to encourage trading on transparent organised trading venues, as well as the need to impose similar regulatory requirements on all venues to level the playing field and mitigate regulatory arbitrage. It also supports the need to improve both the quality and utility of post-trade data through the introduction of a Consolidated Tape. These are elements we hope to see incorporated in the revisions to the MiFID legislation.”
