19.V Lessons learned

The development from the ISD to MiFID II learns that EU equity pre- and post-trade transparency regulation has become such a broad area of EU regulation that a narrow definition no longer fits. The current EU situation is characterised by a highly fragmented equity market and technological innovation. The result is higher demand for equity pre- and post-trade data in order to obtain a consolidated overview of trading. A broad definition of EU equity pre- and post-trade transparency regulation suits best with this situation. A broad definition of EU equity pre- and post-trade transparency regulation includes all EU requirements for equity pre- and post-trade transparency, with the term ‘transparency’ being a genus that includes several species, such as mandatory disclosure, publication and consolidation arrangements, and the price of equity pre- and post-trade data. At the same time, a broad definition is not perfect. A main disadvantage is unclarity. Although better suited for the current EU situation, a broad definition of EU equity pre- and post-trade transparency regulation makes it hard to assess where the definition – and in effect EU equity pre- and post-trade transparency regulation – ends.

The timeframe of the ISD to MiFID II also learns that three factors have driven the increase of EU equity pre- and post-trade transparency regulation. The three factors are: market philosophies, market structures, and technological innovation. Concerning market philosophies, from the ISD to MiFID II a trend is observable in which the EU uses a more market-shaping (not: market-led) strategy. This means emphasis on EU regulation (not: market forces) in order to ensure sufficient price formation and liquidity, as well as a level playing field. Brexit can have major implications here, since the UK has traditionally been a strong opponent of the market-shaping philosophy. In terms of market structures, it becomes clear that elements, such as the degree of fragmentation and preferences of market participants, have resulted in more EU equity pre- and post-trade transparency regulation. EU equity pre- and post-trade transparency regulation is a means to ‘glue together’ equity pre- and post-trade data in a fragmented market and can also enhance the level playing field between different trading venues (e.g. RMs/MTFs and SIs). The result is an increase of EU equity pre- and post-trade transparency regulation. The same is true for technological innovation. Technological innovation has the paradoxical effect of dispersing liquidity (fragmentation), while at the same time ‘gluing’ the fragmented market together through algorithmic trading. The effects of technological innovation are directly linked to the increase of EU equity pre- and post-trade transparency regulation from the ISD to MiFID II. With each regulatory regime, the EU has responded to new trends in trading made possible by technological innovation. Examples include new EU equity pre- and post-trade transparency regulation that requires faster equity pre- and post-trade data publication and ‘reasonable’ prices for equity pre- and post-trade data due to the growing data demand following technological innovation (e.g. algorithmic trading).

So what lessons can be learned from the consequences of increased EU equity pre- and post-trade transparency regulation? In my view, this question can only be answered from a holistic perspective. One lesson learned from the ISD to MiFID II is that many shortcomings of EU equity pre- and post-trade transparency regulation are related to the EU equity market structure. A solution could be to change the EU equity market structure as follows: (1) only allow equity trading on one or a few RMs and MTFs (i.e. mandatory concentration), (2) ensure strict RM and MTF equity pre-trade and post-trade transparency rules, and (3) prohibit RMs and MTFs to maximise profits. The result would be pooled liquidity (consolidated) and a high degree of equity pre- and post-trade transparency. Current shortcomings of MiFID II, in particular the lack of post-trade data quality outside RMs and MTFs (APAs) and the related lack of a consolidated tape (and consolidated quote), as well as the perceived absence of a level playing field between RMs/MTFs and SIs, would be solved. In addition, a concentrated market setting would no longer require market participants, NCAs and ESMA to engage in complex and operational data systems, including reporting across and collecting data from a wide range of venues in order to ensure the ESMA databases function in practice. In a concentrated market setting, the demand for equity pre- and post-trade data would probably drop, because data users would no longer be required to purchase equity pre- and post-trade data from multiple venues in order to obtain a trading overview. Hence, data costs can be reduced in a concentrated market setting. Because the interests of RMs and MTFs are not necessarily aligned with data users’ interests, the ability of RMs and MTFs to maximise profits would have to be reduced. The aim here is to diminish the market power of RMs and MTFs and to enable data users to obtain equity pre- and post-trade data at a ‘reasonable’ price.

While useful to solve many EU equity pre- and post-trade transparency problems, history from the ISD to MiFID II tells us that the foregoing solution has many shortcomings. This solution reminds somewhat of the ISD situation in which competition in the area of trading and data services was limited and there was only scarce investor choice and innovation. In fact, main innovations of the EU equity market (e.g. the shift from open outcry to electronic trading) resulted from the UK market in which trading platforms could compete before and under the ISD. The UK equity market under the ISD was also characterised by much more investor choice (e.g. internalisation) compared to the more concentrated market setting of France and Italy. In other words, a concentrated market setting has benefits, but it can also reduce the evolutionary spirit of the EU equity markets. Besides, limiting RMs and MTFs to maximise profits from data sales/licensing can harm innovation and investments in ensuring the published equity pre- and post-trade data is of high quality. A concentrated market setting also does not solve the difficult questions of how to deal with third countries in the current globalised trading setting. ESMA intends to ensure MiFID II has no extraterritorial effects, but it is highly contentious what an ‘EU situation’ is (e.g. how to deal with ‘dual-listed’ shares). Hence, concentrated trading does not solve all EU equity pre- and post-trade transparency regulation issues.

It is important to remember what benefits MiFID I brought for the EU equity market compared to the ISD. MiFID I opened up competition and gave freedom to market participants, including RMs, MTFs, and investment firms operating on and outside such venues. It is true that the competitive setting of MiFID I and MiFID II resulted in a fragmented market setting and high demand for equity pre- and post-trade data. This implies that a competitive market setting should be compensated by means of EU equity pre- and post-trade transparency regulation and, looking at the current shortcomings of MiFID II, probably even more in the future. These observations suggest that the best way forward might be somewhere in the middle. It could mean that more concentration of equity trading is necessary, but not to the same extent as under the ISD. In the end, this is an economic assessment and ultimately a political decision. My modest view, as a legal academic, is that EU equity pre- and post-trade transparency regulation is a means to achieve an end, namely to accomplish an integrated European capital market. Many problems of EU equity pre- and post-trade transparency regulation can be solved through a concentrated market setting, strict equity pre- and post-trade transparency rules for RMs and MTFs, and inability of RMs and MTFs to maximise profits. However, a holistic point of view is necessary to answer the question what is best overall, not just what is best for EU equity pre- and post-trade transparency regulation. This research intends to contribute in obtaining such a holistic perspective. This research intends to contribute by providing the what, why, and consequences of one element of the bigger EU equity market puzzle, namely the pieces of EU equity pre- and post-trade transparency regulation.