The TRADE predictions series 2023: Market structure and regulation, part one

Regulatory reform, payment for order flow, market transparency, UK/EU divergence and of course consolidated tape are the hot topics of 2023, according to our market experts.

By Editors

Natan Tiefenbrun, president, Cboe Europe: EU capital markets face a reckoning of sorts in 2023, as policymakers crystallise their plans for reforming MiFIR. This review has become a key vehicle for reversing the fortunes of EU markets, which have become less competitive vis-à-vis other regions in recent years.

The early signs are positive: A real-time pre and post-trade consolidated tape for equities has already gained strong support across key EU institutions, and is something we at Cboe have long advocated for to help drive investment and improve the resilience of markets. In the area of equity transparency, the bloc has a choice: Pursue an approach, supported by incumbent EU exchanges, of forcing market participants into low latency central limit order books, in the naïve belief that this will enhance institutional investor outcomes; or realise that the best way to attract investors to Europe is by catering their diverse needs and offering different trading mechanisms for price and size discovery.

The UK is embracing the latter approach, and we are hopeful EU policymakers will follow suit to restore its competitiveness and promote open, competitive and pan-European markets, which ultimately benefit end investors. Elsewhere, we believe brokers will continue to migrate their passive, displayed liquidity to pan-European venues that offer higher execution certainty and lower costs, as well as to alternative mechanisms such as pre-trade transparent Frequent Batch Auctions that help minimise price slippage.

Les Woolaston, head of business development, Ediphy: Readying for MiFID II came at considerable cost and diligent effort by market participants. The question then and since, “What benefits have we seen from the work undertaken”. Improved investor protection was not a meaningful enough outcome – the industry should have expected more.

Improved transparency is elusive – why? Trade reporting remains fragmented, not standardised and APA data is difficult to access. But hope exists! Amendments to MiFID II in 2021 lifted the technical and commercial impediments to a CTP emerging. The glass is starting to look half full.

Dissenting voices remain from those seeking to protect entrenched positions. Those in support of the CT need to up their efforts to present the benefits. Peering into 2024, I predict the CT will encourage growth in market participation, reduced market data costs and improvements in data products: liquidity analytics, TCA, pricing engines and portfolio valuations.

In 2023 [I predict] we will see political agreement on the legislative framework affecting market transparency. Q3 will mark the start of The CT tender process and by year end a CTP will be appointed. The CT will be one run as a market utility not as a data monopoly.  Surely, this is the fairest way? 

“The best way to predict your future is to create it,” Abraham Lincoln.

Adam Conn, head of trading at Baillie Gifford: T+1 settlement – coming to a market near you? Assuming the US and Canada go live in 2024, I imagine the full impact of mismatched settlement dates; funding costs and the ability to trade settlement FX become more apparent to market participants. Will the UK and EU follow suit? I don’t want to spoil the surprise. 

Matt Short, equity trading desk manager, BNY Mellon Pershing: Regulatory reform of global capital markets will continue to influence the trading landscape in 2023 and beyond. Cost transparency and payments for order flow (PFOF) is a growing focus for regulators around the world but differing opinions on dark pools and alternative trading systems is creating divergence that will ultimately lead to increased market fragmentation in the year ahead.

Market data pricing is another priority for regulators, but standardising data across jurisdictions requires consensus from regulators, exchanges, SROs, broker-dealers and third parties – a highly complex undertaking and a process that will result in a lack of harmonisation between markets (e.g., UK and EU) as they build out their own agendas for capital markets growth. This increasingly complex, and in some cases fragmented, regulatory agenda will have a disproportionate impact on smaller firms, with the time, tech and expertise it takes to be compliant increasing fixed costs and subsequently impacting the bottom line.

Therefore, heading into 2023, we expect to see more mid-sized firms turning to outsourced solutions to build efficiencies and avoid the rising cost of high-quality execution, focusing instead on fiduciary obligations to clients.

Linda Gibson, director and head of regulatory change, BNY Mellon Pershing: Resilience and adaptability will be essential strengths for firms through 2023. Trading professionals need to be cognisant of the shift away from the predictable regulatory agenda they are used to as UK and EU regulatory bodies step up their often politicised post-Brexit battle to lure financial services to their respective shores. To date, we have seen UK and EU regulators take different approaches to operational resilience, CSDR and MiFID II, and divergence on rulemaking should be seen as a given moving forward. Politics will continue to shape the UK-EU relationship for financial services, with the UK taking a principles-based approach to regulatory reform while the EU adopts a more prescriptive plan of action. For example, the UK is looking to remove the share trading obligation (STO) and double volume cap (DVC) as part of the Wholesale Markets Review whilst EU proposals will recalibrate or make technical changes.   

In UK policy, we can expect tax reductions and deregulatory initiatives from the government in 2023 and beyond in an attempt to boost international competitiveness and stimulate financially-led GDP growth at a time of economic decline. As outlined in Jeremy Hunt’s autumn statement, this will include a plan to repeal EU red tape and replace it with rules tailor-made for the UK. However, it is important for firms to remember that even deregulation will require internal changes and adaptations. It won’t simply be a matter of switching off on certain compliance matters.

James Baugh, head of European market structure, Cowen Execution Services: We should hopefully get clarity in the early part of the year on where the European Council, Parliament and Commission stand on key issues regarding proposed dark and Systematic Internaliser thresholds and the Consolidated Tape. However, it’s unlikely we’ll see any agreement reached until mid-year or later.

This will depend on whether a compromise can be reached between those looking to compete with the UK versus those considering more inward-looking policies. Regardless, changes are not likely to kick in until 2024. Separately, the FCA will hopefully provide some clarity on several of its proposals, including the UK’s version of the CT. In the interim, the EU and UK will have to contend with a number of operation hurdles in 2023, including the end of the SEC’s No-action letter on “hard dollar payments” for research, which kicks in mid-year and readying for the introduction of T+1 settlement in the US which is currently scheduled for Q1 2024.

Liquidity trends will likely continue on their current trajectory as alternatives challenge the incumbent exchanges for market share and the primary close remains under competitive pressures. Retail will also likely continue to be a topic of discussion into 2023, including whether the EU will impose an outright ban for Payment For Order Flow. And finally, I hope ESG continues to be part of the discussion regarding the improvement of trading workflows and the wider execution business throughout next year.

Hayley McDowell, EU equity electronic sales trader / EU market structure consultant, RBC Capital Markets: Next year will be a critical one for regulation in European equity markets. Approaching two years after the UK formally left the EU, the bloc is still contemplating the future of regulatory alignment with the UK. Despite recent market earthquakes, the UK remains a vital market in Europe and any divergence presents a major challenge to participants from across the spectrum. Next year, the MiFID review will come into sharp focus – as the EU looks to shore up aspects of the regulation while maintaining its competitiveness not just with the UK, but globally.

We can also expect a debate around what an effective consolidated tape looks like – there is a huge opportunity to grow secondary markets – but the success of the tape will depend on the proposals put forward by the EU. Market participants will be keeping a close eyes on the regulatory debate in Europe and whether it will bolster market structure or fall short.