24 April 2003

ISD Workshop: Debate on Internalisation – final report

Prospects for Europe to move to a single infrastructure
During the debate it became clear that there are considerable differences between existing practices in the 15 EU member states. There was broad consensus that it would be difficult for Europe to move to a single infrastructure in a decade or less. There would need to be a degree of flexibility to pre-empt a ‘big-bang’ that might not achieve the twin objectives of efficiency and confidence in the markets to encourage European citizens to save more. An efficient arbitrage of different price venues is expected to keep discrepancies between different markets and execution venues both brief and very small. With a customer contract for “best execution policy”, there was general agreement that retail customers should still be well served - in a competitive market. But consensus was lacking for the proposition that such a policy would obviate the need for mandatory pre-trade transparency.

SummaryThere is general consensus on the main aims of the ISD. Internalisation occurs in one form or another in almost all 15 member states. The current debate in Europe is on the optimum combination and proportion of the key elements needed to ensure both adequate investor protection and fair business incentives for the investment firms.

The UK example of a functioning “internalised” market for private investors was illuminating. It was generally agreed that each market had its particular idiosyncrasies and that it would not be necessary or desirable to prescribe a uniform system for all EU member states.

A major challenge will be to ensure a system that allows internalisation without draining liquidity from the major “reference” markets. However, it seemed inconceivable that serious price discrepancies could be anything more than brief.

Best execution was a central issue of the debate. “Pre-trade transparency” raises enormous practical problems. “Best execution” cannot mean just the trade price but a “best execution policy” that includes consideration of all the trading costs as well as settlement.

Key conclusion of the session was that the service contract between a retail investor and his/her broker could easily include a commitment to check a specified number of price venues. Competition amongst brokers should ensure that a reasonable number of venues were checked – and regulation might specify a minimum.

With a customer contract for “best execution policy”, there was general agreement that retail customers should still be well served - in a competitive market.

Contents
Background and participation Summary and Conclusions The UK example of a functioning “internalised” market for private investors Key conclusions derived from UK experience Implications for EU markets The fragmentation argument Best execution

Figures
Retail Service Provider: the UK system

© Graham Bishop