By Alfredo Baraldi
Introduction
The European equity trading landscape has undergone a radical transformation, evolving from a system dominated by national exchanges to a highly fragmented ecosystem. This evolution, accelerated by the MiFID I and II directives, has created a battleground among market participants, with the buy-side and sell-side on opposing fronts regarding the optimal market structure. The debate centers on billions of euros in trading costs, the efficiency of price formation, and ultimately, the competitiveness of Europe’s capital markets.
The Current Landscape of Fragmentation
Today, the European equity market features dozens of authorized trading venues. This proliferation includes:
- Incumbent Exchanges: Historic platforms like Euronext, Deutsche Börse, and the London Stock Exchange retain prominent positions, but their overall market share has declined.
- Multilateral Trading Facilities (MTFs): Venues such as CBOE Europe (which has integrated Chi-X and BATS) and Turquoise have captured significant volume by offering lower fees and innovative technology.
- Dark Pools: Allow for the trading of large blocks without pre-trade price impact, though regulated by a double volume cap.
- Systematic Internalisers (SIs): Large investment banks like UBS and Goldman Sachs execute a significant portion of client orders internally.
According to the latest data from the European Securities and Markets Authority (ESMA), no single venue controls a majority of the volume for the most liquid stocks, a stark contrast to more consolidated markets like the U.S.
The Buy-Side’s Position: The Pursuit of Efficiency
The buy-side (asset managers, pension funds, hedge funds) largely views fragmentation as a positive development. Their arguments, often articulated by associations like the European Fund and Asset Management Association (EFAMA), focus on:
- Cost Reduction: Competition has driven down trading fees dramatically.
- Improved Best Execution: A multiplicity of venues, scanned by Smart Order Routing (SOR) algorithms, offers more opportunities to find the best price.
- Technological Innovation: Competition has spurred innovation in order types, matching algorithms, and pre-trade analytics.
- Market Impact Management: Dark pools allow for the execution of large orders while minimizing price impact.
However, they acknowledge challenges related to technological complexity and the dispersion of liquidity, especially for less-liquid stocks.
The Sell-Side’s Position: The Quest for Stability
The sell-side (investment banks, brokers), represented by bodies like the Association for Financial Markets in Europe (AFME), faces a different set of challenges:
- Exponential Technology Costs: Maintaining connectivity, risk management, and compliance across dozens of venues incurs enormous costs.
- Liquidity Dilution: “Apparent liquidity” (the sum of all books) is often greater than “real liquidity” due to phantom orders replicated across multiple platforms, making it difficult to execute large blocks.
- Margin Compression: Intense competition has eroded market-making margins, threatening the profitability of providing continuous liquidity.
The Impact on Liquidity and the Consequences of MiFID II
Empirical studies show mixed results on fragmentation’s impact. While spreads have tightened for the most liquid stocks, market depth for small-cap stocks appears to have deteriorated. MiFID II, with its double volume cap, had the unintended effect of shifting more volume to Systematic Internalisers, increasing a less transparent form of fragmentation rather than reducing it.
Macroeconomic Implications and Future Outlook
In the context of the Capital Markets Union (CMU), a European Commission initiative to create a single market for capital, fragmentation raises strategic questions. An inefficient market can hinder optimal capital allocation and Europe’s global competitiveness.
One of the most discussed solutions is the creation of a European consolidated tape, a single data feed aggregating price information from all venues. While theoretically beneficial, the project faces immense technical, commercial, and governance challenges, with heated debate among industry stakeholders, as highlighted in ESMA consultations.
Conclusion: Towards a Sustainable Equilibrium
The conflict between the buy-side and sell-side over market fragmentation reflects fundamental tensions between competition, efficiency, and stability. The future is unlikely to be a return to national monopolies nor a further uncontrolled fragmentation. Instead, the most probable path is toward a more stable equilibrium that preserves competition, improves coordination through solutions like the consolidated tape, and enhances transparency. For market participants, this requires continuous technological investment and active engagement in the regulatory dialogue to shape a more efficient and resilient European equity market for all.
Bibliography / References
- AFME (Association for Financial Markets in Europe): https://www.afme.eu/
- CBOE Europe: https://www.cboe.com/europe/
- Deutsche Börse: https://www.deutsche-boerse.com/dbg-en/
- EFAMA (European Fund and Asset Management Association): https://www.efama.org/
- ESMA (European Securities and Markets Authority): https://www.esma.europa.eu/
- ESMA – MiFID II and MiFIR: https://www.esma.europa.eu/policy-rules/mifid-ii-and-mifir
- Euronext: https://www.euronext.com/en
- European Commission – Capital Markets Union: https://finance.ec.europa.eu/capital-markets-union/capital-markets-union-2020-action-plan_en
- Goldman Sachs – Markets: https://www.goldmansachs.com/what-we-do/markets/index.html
- UBS – Investment Bank: https://www.ubs.com/global/en/investment-bank.html