Fragmented Liquidity in Pan-European Securities Hinders Transparency, Best Execution

With fierce competition breaking out in pan-European securities trading among alternative trading systems and traditional exchanges, liquidity in the top 500 stocks has become increasingly fragmented across the various electronic execution venues. Amid the fragmentation, multilateral trading facilities -- particularly Chi-X -- have captured significant market share, but buy-side firms have been left to grapple with the ever more complex market structure.

While the European Union's Markets in Financial Instruments Directive (MiFID), implemented Nov. 1, 2007, paved the way for multilateral trading facilities, or MTFs, to compete with the incumbent exchanges, the alternative venues are not interconnected, and their price and volume data is dispersed (and in some cases hidden in dark pools or not required to be reported for several days), so the buy side is struggling to see the entire European marketplace. The fact that Europe -- unlike the United States -- lacks a consolidated tape to track the bids and offers on all of the MTFs and exchanges exacerbates the challenge for buy-side traders.

"At the moment, the [European] market is in chaos and everybody is going back to the usual [exchanges] because at least they have the feeling that they know what the price is," relates Mick Holman, adviser to the global chief investment officer at Axa Rosenberg Investment Management in London. "What we have here is simply fragmentation between the main markets and the venues created by MiFID."

"The major portion of the off-exchange volume is traded on Chi-X, while a decent amount is on Turquoise, BATS Europe, and with little bits going on in Equiduct Trading and Nasdaq OMX Europe," according to Anthony Whalley, investment director and head of dealing and derivatives at Scottish Widows Investment Partnership (SWIP) in Edinburgh.

Market Data Knowledge Gap

"While the MTFs have taken between 10 and 14 percent of the [pan-European] market, they have led to less knowledge on the trading desk as to where the real price and the real market are," asserts Axa Rosenberg's Holman. Further, the MTFs are mainly concentrated in the top index stocks, but most buy-side participants are interested in depth-of-market names, right down to the small-cap stocks, he notes.

Compounding this absence of market insight, there is a lack of consistency on post-trade data. MiFID removed the requirement to report all trades to the domestic exchange, so the MTFs -- numbering 10 and growing -- have different rules for disclosure of price and trade data, and trade reporting now is scattered among multiple printing facilities, such as Markit BOAT, a consortium of nine leading investment banks launched in response to MiFID in September 2006. Some MTFs even report their trades on their own Web sites.

"In order to have a tape that everyone trusts and everybody believes in and that reports in the same way and in the same fashion, you have to have levels of consistency and standards," says Miranda Mizen, principal at TABB Group. "You don't have that in Europe. Coupled with that, you have a choice of where you print, so that means you don't have the post-trade view of the market that we used to have."

Adds Axa Rosenberg's Holman, there is a "price reference waiver and size waiver [as part of MiFID] where the MTFs don't have to show what they've done as long as they are within the price -- or bid/offer spread -- or the normal market size." In addition there are rules in place for block trades that permit the reporting of trades up to five days after the deal. As a result, buy-side traders can't even confirm the total volume in a stock, he adds. "You could miss an awful lot of data."

Adding to the complexity of Europe's market structure -- not to mention the dearth of available market data -- is a wave of dark liquidity pools, which of course do not publish their prices. What's more, the "lit" MTFs -- including Chi-X, BATS and Turquoise -- now offer dark order types for hidden liquidity.

"[With] all the dark pools, you've got to go into each one to see if there is a match and wait," says Axa Rosenberg's Holman, explaining that the dark pools try to cross internally before sending the order to an external marketplace. "That leads to a worry that you will miss the best price [elsewhere]."

The lack of transparency created by the fragmented market and incomplete market data has emerged as a common theme among buy-side traders, notes Rob Maher, head of European sales at Credit Suisse Advanced Execution Services (AES) in London. "They used to be able to look at the primary exchange and know what was going on in the individual stock," he says. "In this new environment it can be challenging to know where and how a stock is trading," says Maher.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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