A more coordinated effort is needed to share surveillance data in Europe because liquidity fragmentation has made market abuse across trading venues harder to spot, according to market participants.
MiFID already obliges brokers to report executed transactions to the relevant regulator on a T+1 basis for abuse monitoring purposes. But this only allows regulators to track executed trades, not all orders sent to the market. There is currently no system for monitoring order-level information across venues, which would reveal order-related manipulative practices, such as layering, where traders send multiple orders priced closely to the current best bid and offer to create the false impression of liquidity in a stock.
Before the advent of multiple pan-European execution venues, national exchanges had a complete picture of both order-level and transaction-level information for on-order-book transactions, but the increasing amount of market share traded on multilateral trading facilities (MTFs) has fractured the picture.
While European Commission’s Market Abuse Directive, introduced in 2005, is aimed at tackling manipulation and inspired trading across the EU, it was not designed to cope with the multi-venue environment ushered in by MiFID two years later.
“It would be beneficial for the whole market if we could cooperate with the surveillance functions of other exchanges and MTFs that trade our shares,” Annika von Haartman head of Nordic surveillance at exchange group Nasdaq OMX, told theTRADEnews.com. “But while MiFID opened up markets or competition, it didn’t address how surveillance should be conducted in a fragmented world.”
Haartman contends that trading venues are unlikely to collaborate without some impetus from regulators. “We need to have a European regulatory framework to enable us to cooperate and exchange confidential information with MTFs,” she said.
Market abuse has risen up the financial markets agenda of market participants in recent months, with the UK’s Financial Services Authority (FSA) issuing £10.96 million in market abuse fines already this financial year. Earlier this month, the FSA fined broker and market maker Winterflood and two of its traders a total of £4.25 million for market abuse after they lost their case in the Court of Appeal. In March, a consortium of consultants that advise exchanges on surveillance claimed that liquidity fragmentation had increased the scope for market abuse.
“This problem was already quite evident a year ago. I’m surprised it has taken so long for the discussions to become this vocal in Europe,” said Haartman.
Monitoring order-level information across venues could pile further pressure on securities regulators, some of which are already feeling the strain of policing MiFID. One proposed solution – creating an intermediary authority such as the Investment Industry Regulatory Organization of Canada – is regarded as too cumbersome. “Conceptually, it’s an interesting idea for the UK or even across Europe, but it is almost certain to add cost,” said Nick Bayley, head of regulation at the London Stock Exchange. “It would be easier for UK platforms to collaborate under FSA oversight and create a framework and mechanisms for sharing regulatory information. That might be worth looking at as a first step.”
Denzil Jenkins, director of regulation at Chi-X Europe, acknowledged the value of a pan-European surveillance system and greater cooperation among regulators, but warned, “The more you centralise, the further you get from the coal face.”
Surveillance challenges have been noted at the European level. On 13 April, the Committee of European Securities Regulators (CESR) proposed making the collection by regulators of client IDs and meaningful identifiers for all counterparties mandatory across member states to improve surveillance. CESR noted that all authorities that currently collect client IDs place great value on the input they provide for surveillance.
The proposal was contained in three consultation papers issued by CESR on 13 April, which will feed into this year’s review of MiFID by the European Commission. Market participants have until 31 May to submit their responses.
“We would support a common system for client identification in transaction reports, as proposed by CESR, which would allow regulators much greater ability to spot where, for example, insider trading is taking place,” said Chi-X Europe’s Jenkins. “We would also support the proposal to extend transaction reporting to the small number of local own-account dealing firms which are members of exchanges, as long as this is done in a cost effective manner.”
However, while many contend that fragmentation makes abuse more difficult to spot, and despite the number of market abuse cases settled by the FSA this year, Jenkins does not believe market abuse has increased in today’s multi-venue environment.
He plays down the amount of fragmentation to date, pointing out that most of the on-order-book volume in UK stocks, for example, is now traded on either Chi-X Europe or the London Stock Exchange. The two venues combined accounted for 81.8% of trading in FTSE 100 stocks in March, according to figures from data vendor Thomson Reuters.
Furthermore, Jenkins argues that MTFs tend to focus on more liquid stocks, in which it is more difficult to influence the price and thus manipulate the market, and that MTFs lack mechanisms such as auctions and index expiries, which he contends are open to abuse.
“While there are now more venues, there have also been a great deal of improvements in surveillance,” he added.