14 February 2011

New report on “The Myths and Realities of Equity Trading in Europe”

The report  looks at High Frequency Trading, OTC trading and dark pools and clearing. It also looks to dispel a number of myths and explains why, in the context of this evolution, there is less reason for knee jerk reaction and more time needed for a considered response to certain developments of the market.

Niki Beattie, Managing Director of Market Structure Partners, wrote the report because she is concerned that there are a number of popular myths and misconceptions fuelling the debate about how the European market should develop. This is particularly pertinent now because the MiFID review is underway and there are a number of factions within the industry who would like to perpetuate these myths in order to maintain the status quo and protect their position. She says: “We need to move on from such basic prejudices as thinking that order driven markets are better than dealer markets. The reality is that a growing market needs a diverse set of tools that work well in different circumstances. Order driven markets and dealer markets are very complementary to each other and, given the right regulatory framework, the existence of both does not need to harm price formation or transparency.”

The report covers the history of high frequency trading and explains that it is not the new phenomenon that people think. Beattie explains: “The term ‘high frequency’ is simply a relative term on a spectrum of innovation that began over 150 years ago. Even ideas such as co-location and measuring roundtrip latency existed in the 1850s. The basic paradigm behind this trading has not changed; only the technology that supports it has moved on.” The report states that if institutional and retail participants are not prepared to trade patiently in the market and wait for similar counterparties to themselves to present the other side of the trade, then liquidity provision is a pre-requisite for the market and providing steady liquidity to the wider market is what high frequency firms do best.

The report concludes by saying that the opening up of the European market has created a market which is no longer being defined by restrictive geographical market places that serve a local need, but a market place that is defined by customers who have different goals and requirements. It makes clear that there are many nuances to a growing market and that customer segmentation, new technology and a diverse set of trading solutions should not pose a threat. 

However, Beattie is emphatic that this does not mean a lack of transparency should be tolerated and that improved surveillance at the regulatory level is required, particularly on a post trade basis. She makes clear “We need to stop being swayed by alarmist rhetoric in the market and start focusing on the fundamental issues, such as the ability to fully reconstruct the market in a post trade environment. This urgently needs to be fixed, not because it is nice to have for the market but because it is an imperative for the regulators.”    

She explains that the markets are becoming inextricably linked and information sharing across multiple trading platforms is key to circumventing new strategies for manipulation. “This can only be achieved if the regulators act for the benefit of the combined European market rather than defending their own national interests. The market has reached a point where the level of surveillance that used to be expected of a domestic trading platform now needs to be elevated to a higher level. The ability to reconstruct the market activity across multiple platforms is critical, as demonstrated by the so called “Flash Crash” in the US last week. We only have to see how hard the CFTC and the SEC are working to jointly reconstruct the market across multiple platforms, and in this multiple case instruments, to know that if we tried to coordinate the same across all 27 EU regulators in just one instrument at this moment in time, we’d be in trouble. If you can’t work out what happened then it is very hard to punish, if appropriate, the perpetrators and prevent others from doing it again.”

© Market Structure Partners