Where should regulators be focusing their attention to boost volumes in Europe?
The levels of trading volumes in European equities are influenced by a complex interplay of various factors like market fragmentation, economic conditions, monetary policy, investor behaviour and market volatility among other things. Market volatility was low across European stock indices in Q1 2024, compared to the same period last year, partly explains lower volumes across European cash and derivatives equity markets. A couple of other important factors which could help increase volumes in Europe would be to encourage the involvement of retail investors in the EU equity markets and, also the growth of small cap businesses, reducing complexity and costs for listing. However, regulators are not the only ones that could quickly help address these complex structural issues in Europe.
What is the role of regulators in addressing fragmentation in Europe – if any?
Market fragmentation has increased over recent years and led to the dispersion of trading activity across primary exchanges, lit and dark multilateral trading facilities (MTFs), banks’ systematic internalisers (SIs) and electronic liquidity providers’ (ELP SIs). The EU regulators have an important role to play to help all equity market participants get a clearer picture of post-trade data across all these execution venues, including to help show consistent flagging of trades and addressable liquidity for all investors in the EU equity markets.
Are central limit order books still fit for purpose?
Central limit order books (CLOBs) across primary exchanges remain a significant part of the trading ecosystem for European equities. CLOBs are still fit for purpose because they facilitate the price formation process in European equity markets for the benefit of all market participants. However, trading equities in CLOBs bring its own challenges, such as the risk of information leakage for the institutional traders who work large-size orders. Depending on portfolio managers’ instructions, orders’ size, liquidity levels and market conditions, deciding where and how to implement investment ideas efficiently has never been more important for institutional traders than in the current market environment.
If not, what is the alternative?
Institutional traders need to have a high level of flexibility and agility for large tickets to navigate the high fragmentation of liquidity in the EU equity markets. Buy-side traders typically use broker-driven smart order routers to access diverse execution venues like CLOBs, dark pools and systematic internalisers’ quotes during continuous market hours. They can also use a high-touch approach to trading blocks in different ways gain access to large pools of liquidity during the closing auction. All these execution venues and trading techniques are necessary and complementary for equity investors, and their relative importance can vary over time, depending again on portfolio managers’ instructions, orders’ size, liquidity levels and market conditions. The evolution towards agility and flexibility has clearly been supported by the new generation of order and execution management systems (OEMS). Real-time transaction cost analysis (TCA) within the OEMS allows buy-side traders to notice anything that might be going wrong during a trade in their system and discuss the execution process with their brokers.
Could a consolidated tape offer up a suitable alternative tool to CLOBs (CT)?
A like-for-like comparison between a consolidated tape for European equities and a CLOB is not really possible. A CT for European equities will likely give access to both consolidated pre- and post-trade data, and a CLOB only refers to pre-trade data. At this stage, there is also little clarity about the pre-trade format that the CT for European equities will eventually take: will it be a CLOB with five levels of order book data or simply the European best bid and offer (EBBO)? Whatever form an EU consolidated tape would take for European equities, it’s important to keep in mind that the CT should primarily be a viable commercial proposition for all stakeholders, and it should also not be too costly for investors.