It has long been argued that the number of intermediaries that operate in the financial markets between the issuer and the investor has the potential to reduce the efficiency of capital allocation and limit the willingness or ability of investors to act in the long-term interest of the firms they own. Moreover, the more diverse the trading practices, investment strategies and business models operating in the equity markets, the more varied will be the level of importance accorded to corporate governance and other long-term considerations to the organisations that own - however briefly - stakes in listed companies. But have the equity markets undergone such a fundamental change in recent years to require a rethink to corporate governance regulations? And are those changes in market structure also acting as a disincentive to potential issuers, cutting off the supply of new blood to the equity markets?
These were some of the questions asked in a recent OECD corporate governance working paper, 'Who cares? Corporate governance in today's equity markets', co-authored by Mats Isaksson and Serdar Celik.
The two economists consider liquidity fragmentation and high-frequency trading (HFT) as two of the most significant developments in the recent evolution of equity markets, neither wholly beneficial. They scrutinise the twin threats to long-term investment for their capacity to erode investor incentives, to 'crowd out' long-term ownership and to reduce the appeal of primary markets to issuers.
Reviewing the case for prosecution, Isaksson and Celik note the growing popularity of dark pools may lead to a "breaking point" for the price discovery process at which there is more trading taking place in dark pools than in the lit venues from which they take their reference prices. They also observe that the business models of HFT firms rely on access to premium dedicated data feeds while for most market participants fragmentation has made it "harder and more expensive for market participants to monitor markets" - hardly the kind of level playing field required to bolster investor confidence. In terms of crowding out long-term investment, the OECD suggests that the investment in and growth of HFT, there may be "fewer resources in aggregate spent on fundamental analysis of the long-term value creation potential" of issuing firms. It also posits that institutional investors may either quit equities in response to the onslaught of HFT or adapt in such a way as to further reduce the influence of long-term investment strategies.
Convinced that fragmentation and HFT are further straining the link between issuers and investors, thereby weakening the effectiveness of corporate governance rules? Neither are Isaksson and Celik, who give the impression they find the evidence circumstantial at best. Yes, institutional investors' share of global equities markets has fallen 5% since 2008, but that could equally be blamed on macro economics as high-speed trading.
One easily endorsed OECD conclusion is that the complexity of today's equity markets is that effects of different forces "cannot be analysed in isolation". Another is that HFT is the product of regulation - NMS and MiFID - as much as technology. In a complex market where the outcome of rule changes is often unpredictable, the question for regulators is: do you stick or twist?