19.III.2.2 Amount of concentration

A main element of a market structure is whether trading is concentrated or fragmented. A concentrated market refers to centralised trading of a financial instrument on one (or a few) venues. The opposite is true with fragmentation, which refers to the situation where trading in a financial instrument splits across multiple venues. Fragmentation can arise due to inter-exchange (RMs) or alternative order-execution competition (e.g. MTFs and/or SIs). The market-shaping philosophy has traditionally preferred concentrated forms of trading, based on arguments such as improved investor protection, price formation and liquidity. Advocates of the market-shaping philosophy highlight the risks of trading outside centralised markets, such as reduced client protection and price formation. By contrast, the market-led philosophy has traditionally emphasized the importance of a competitive market, stating this results in reduced trading costs, while supporting innovation, and investor choice.

As noted, both the market-shaping and market-led philosophy favour a high degree of equity pre- and post-trade transparency. What distinguishes the perspectives on transparency, however, is that the market-shaping philosophy emphasizes EU regulation (top-down) to ensure that (a) sufficient equity pre- and post-trade data is published, (b) consolidated (e.g. through a CTP), and (c) available in terms of ‘reasonable’ equity pre- and post-trade data prices. The market-shaping perspective agreed on a competitive market setting under MiFID I, but only if properly compensated through equity pre- and post-trade transparency rules, not only for RMs and MTFs, but also outside such venues (e.g. SIs and for so-called client limit orders).1 The market-led perspective disagreed (bottom-up), which ultimately resulted in a complex MiFID I compromise.

The debate between the market-led and market-shaping philosophy continued under MiFID II. The final outcome of the debate is a more market-shaping equity transparency regime. Although still competitive in nature, MiFID II emphasizes: (i) concentration of trading (share trading-obligation), (ii) high quality and reliable consolidated equity data (in particular post-trade: APAs and CTPs), and (iii) ‘reasonable’ data prices. The market-shaping elements are in place to address fragmented liquidity, which implies data quality, consolidation, and pricing risks. This is because equity pre- and post-trade data needs to be published, consolidated and bought from multiple, instead of one or a few, venues. A competitive market setting can reduce fees (both for trading and market data services) and enhance investor choice and innovation. However, experience from the ISD to MiFID II shows that the market-led philosophy can also result in new transparency issues due to a fragmented market setting. The result has been increased EU equity pre- and post-trade transparency regulation from the ISD to MiFID II.