19.III.3.3 New trading techniques

Technological innovation resulted in new trading techniques. Early examples of such innovation include remote access, efficient order management and reference price systems (ISD), as followed by the newer development of algorithmic trading (MiFID I and MiFID II). Remote access permitted market participants to view equity pre- and post-trade data of distant liquidity in real-time. Technological innovation permitted better order management (e.g. efficient use of stop orders and iceberg orders) and reference prices (e.g. trade at the mid-point, instead of ‘crossing the spread’), with in particular the reference prices being controversial in terms of price formation (dark liquidity). The growth of algorithmic trading under MiFID I and MiFID II enables to take better trading decisions and also to ‘glue together’ fragmented markets through smart-order routers (SORs). A consequence of algorithmic trading is a growing demand for equity pre- and post-trade data (in conjunction with the growth in demand due to the rise of new venues resulting in fragmented markets) and accordingly more EU emphasis in the form of EU regulation on data consolidation and equity pre- and post-trade data prices.

Another relevant new trading technique is high frequency trading. High frequency trading, being a subset of algorithmic trading, is controversial. On the one hand, high frequency trading can support price formation (through fast trading) and liquidity. On the other hand, high frequency trading has resulted in increased dark liquidity and use of frequent batch auctions (traders trying to avoid/reduce (speed advantages of) high frequency traders) and the pre-trade data displayed is not always executable (ghost liquidity). The increase of dark trading due to high frequency trading resulted in stricter EU equity pre-trade transparency rules under MiFID II. Potentially new equity pre-trade transparency rules for frequent batch auctions are part of the ESMA MiFID II Review.

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 responds 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.