Over the counter and under the radar

An interesting report on liquidity fragmentation was released last week, but the International Organisation of Securities Commissions (IOSCO) gave it such a boring title you might have missed it.

‘Regulatory issues raised by changes in market structure’ could have been about almost anything but it actually considers the appropriate regulatory response to growing fragmentation in global equity markets over the last decade

It’s more than ten years since IOSCO issued its initial report on transparency and market fragmentation so, with a little prompting by the G-20 and the Financial Stability Board, the securities watchdogs’ trade body charged its Committee on Secondary Markets (C2) to conduct some research and put together some recommendations to help regulators respond effectively to growing fragmentation.

Though market fragmentation has undoubtedly increased in many markets over the last decade or so, the picture drawn by C2 is markedly nuanced. In some markets fragmentation has gone into reverse, while in others it is yet to take hold. And everywhere evidence of damage to the price formation process remains elusive.

Appendix A of the report provides a summary of the progress of fragmentation across the world’s equity markets in recent years, based on inputs from IOSCO member organisations. Despite being home to 90 alternative trading systems and numerous brokers offering over-the-counter trading, the US equities market has seen a decline in off-exchange equities trading, with the 16 securities exchanges registered with the Securities and Exchange Commission accounting for 69.7% of volume in 2011 compared with 65.9% in 2009. US trading in exchange-traded derivatives tells a similar story.

While MiFID undoubtedly wrought significant change in Europe, the experience of markets across the continent has been far from uniform. The impact of MiFID on the UK was dramatic, with London Stock Exchange dominance replaced by 2011 with a three-way split across regulated markets (36%), multilateral trading facilities (24%) and over-the-counter trading (35%). In France, by contrast, the impact of MiFID has been more muted, with OTC trading of CAC40 stocks benefitting slightly at the expense of regulated markets between 2009 and 2011, with MTFs stabilising at 13-14% over the same period.

In Asia, the picture is more varied still. As a result, IOSCO’s recommendations largely encourage its membership to step up their efforts to monitor the impact of fragmentation on market integrity and efficiency “to ensure that the applicable regulatory requirements are still appropriate to protect investors and ensure market integrity and efficiency, including with regard to price formation”.

But IOSCO’s other recommendations could be interpreted as a dig in the ribs for European regulators. The report notes that “a key tool” for offsetting the potential adverse effects of market fragmentation on price discovery is “regulation that ensures the widest access to trade data and that promotes comprehensive data consolidation and timely dissemination”.

As such, IOSCO recommends that, where fragmentation already exists, “regulators should seek to ensure that proper arrangements are in place in order to facilitate the consolidation and dissemination of information as close to real time as it is technically possible and reasonable”.

The report – released on the same day that the COBA project called a halt to its efforts to create a European consolidated tape citing ongoing regulatory uncertainty – calls for comment and feedback from all interested parties by 10 May. One hopes that the team behind COBA share its experiences with IOSCO and that the mounting profile of this issue is noted in Brussels as MiFID II reaches its final drafting stages.