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WORLD EXCHANGE CONGRESS
23 MARCH 2011
PRIORITIES FOR ENSURING THE STABILITY AND EFFICIENCY
OF FINANCIAL MARKETS
Ladies and Gentlemen,
Good morning and thank you for attending this session. Each year this Congress gives
the exchange industry a chance to meet again to share some pleasant moments and
discuss the developments and changes that continue shaping the sector.
I hope you are making the most of this professional event and also hope that you have
taken this opportunity to visit this great city of Madrid and enjoy its beauty, its people
and its invaluable cultural offering.
Please allow me some remarks concerning what I believe are some of the priorities for
ensuring the stability and efficiency of our markets.
1) Transparency
This is behind any and all of the issues you can discuss here during these days. The
difficulty is how to ensure that transparency. It is my opinion, as market practitioner and
observer of the markets, that proper transparency or any due increase in transparency
will come only as a result of enforced regulation.
Besides, transparency can appear in many forms and one that I clearly favour is to
work on the convergence of understandable financial reporting at a global level.
2) More transparency
When talking about transparency we should think about all assets and markets.
Especially I point out to bond markets. I am certain that one of the most important
improvements that could increase the credibility of those markets would be to enforce
necessary disclosure and transparency rules, in particular when they deal, in one way
or another, with retail investors. This is clearly a pending issue and MiFiD II, should
confront this serious problem. Bond markets in this respect should imitate the more
transparent equity markets.
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3) Correction of actual fragmentation of the cash equity markets
Fragmentation is not competition.
Fragmentation is the unintended negative consequence of ill designed competition
regulation and its logical use by market forces, when other compensatory regulatory
measures have not worked.
The fragmentation of the order flows into an excessive number of platforms is
damaging the size and importance of markets, without offering anything of social or
economic value in return. The risk that markets may lose liquidity and become less
attractive as a key source of financing is a very serious problem.
And it is bad for the public interest. The result of unleveled playing fields and
discrimination in cash equity markets produces insidious effects: one is that false
competition appears and distorts price formation mechanisms. Anything that can affect
the credibility of the prices of the most important assets in our economies has to be
corrected.
The disputes and the arguments about fair pricing of assets sounds like a bad joke
when the process to produce undisputable prices in our regulated equity markets is put
at risk by artificial fragmentation structures.
One of last year’s events that has most revived the debate about trading models has
been the flash crash on 6 May. This incident led to an in-depth investigation by the two
main regulators in the US, the SEC and the CFTC. In their joint report about the
causes of the flash-crash, the two bodies concluded that market fragmentation was a
contributing factor to this phenomenon and magnified the impact of the crash. The
report portrayed a market so fragmented and fragile that a single large trade could
send stocks into a sudden spiral.
More recently, the Joint CFTC-SEC Advisory Committee on Emerging Regulatory
Issues sent a letter last February to both regulatory bodies. In it they addressed the
market events surrounding the flash-crash and made recommendations related to
market structure and liquidity issues that might have contributed to the volatility
experienced on that day.
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In their report they state that in the present environment, where high frequency and
algorithmic trading predominate, liquidity problems are an inherent difficultly that must
be addressed. Indeed, even in the absence of extraordinary market events, limit order
books can quickly empty and prices can crash simply due to the speed and numbers of
orders flowing into the market and due to the ability to instantly cancel orders. The
report goes on to affirm that liquidity in a high-speed world is not a given: market
design and market structure must ensure that liquidity provision arises continuously in
a highly fragmented, highly interconnected trading environment, such as the market
today.
Liquidity of the markets is as valuable to society in general as to the financial markets.
The Committee warns that markets are fragmented and inter-connected, and this
should get the attention of the regulators.
Here in Europe, the same situation persists following the passing of MiFID, in
November 2007.
While the Directive introduced changes intending to increase
competition and reduce transaction costs, they have provoked market structure fragility
due to the fragmentation of markets it has brought about. A close look at the flashcrash is a good reminder of the serious risks that fragmentation poses to the orderly
functioning of markets and the financial system, as a whole.
The value of the regulated exchanges as the only trusted venues for price discovery
has been evidenced, once again, just recently. The suspension of trading a few days
ago on Borsa Italiana and the London Stock Exchange was not followed by a migration
of liquidity and trading to other trading venues. Market participants placed their trust in
a regulated market and its price discovery mechanism, not on any of the many
multilateral trading facilities that have sprung up under MiFID. What is key here is that
MTFs themselves or their participants trust stock exchanges for price discovery and in
fact use the prices set at regulated markets as their reference prices.
4) Fragmentation is introducing serious risk for the financing provided through
exchanges
Another insidious effect is showing now: some cash equity markets are losing a
relevant portion of the activity they used to have. That can take place in favor of
institutions which provide no financing capability.
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These elements work in a negative direction: If exchanges lose significant market
share in an uneven battle, they might be drawn into what I would call as relative
irrelevance. If they lose relevance they are less attractive to companies looking for
equity financing. Then their possibilities to provide financing are seen as doubtful by
the potential issuers. So their role as financial intermediaries diminishes.
But the trading venues which are taking their volumes do not provide financing.
Is there any public interest in analyzing this process?
5) Proper treatment of issuers
Issuers have been forgotten in MiFiD.
The decision to offer its shares on a specific market represents a milestone for any
company. Nonetheless, under prevailing legislation, it is extremely unfair that a
company’s shares be traded on a market that it has not chosen, under trading
regulations with which it is not familiar, and subject to unwanted potential risks.
One possible recommendation to avoid such undesirable consequences could be to
require other systems that issuers have not voluntary selected, to obtain explicit
authorization from issuers before they can trade in their shares
6) To enlarge the universe of regulated trading
The big, big challenge to really help in the direction of stability and efficiency of
financial markets is very clear: Let’s have more regulated trading and less unregulated
trading. That requires the will and the power to install the proper regulation.
In Europe MiFiD was meant, in my opinion, to open new avenues (systemic
internalisers, etc.) to attract and engulf bilateral, unregulated, over the counter trading
up to a logical volume. We know that, however, the result now is that unregulated
trading has increased and apparently it is on the rising. No need to say any more about
how this is the big challenge, the big quantitative and qualitative challenge, to reach
more stable, efficient, and transparent markets.
Thank you very much for your attention.
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