18.III.2.3.2.2 Where a financial instrument is traded (trading location)

Price formation also depends on where a financial instrument is traded. The price formation dynamics as to the trading location of financial instruments is open for debate, although some consensus exists when it comes to RMs and MTFs. Exchanges (i.e. RMs) have traditionally had large pools of liquidity and so are generally considered to contribute to effective price formation through the large amount of trading activity that exchanges (RMs) facilitate.1 This perspective is also apparent in the EU, since RMs have from the ISD to MiFID II been required to publish a high level of pre- and post-trade transparency (whether under national law or EU regulation).2 The same is true for MTFs. MTFs represent the same organised trading functionality as RMs.3 In addition, although MTFs are characterised with lower trading activity compared to RMs, MTFs have continually gained market share.4 From a price formation perspective, it is therefore understandable that EU equity transparency rules have applied to MTFs.5

Where the shoe pinches is trading activity outside RMs and MTFs. There is evidence that lower trading activity is still relevant for price formation.6 Within the EU this observation has raised complex debates, in particular concerning the merits of equity pre-trade versus post-trade trade transparency. The two main MiFID I controversies were (1) the SI regime and (2) the client limit order display-rule.7 The market-led supporters argued that equity post-trade transparency rules for investment firms operating outside RMs and MTFs would be sufficient and more meaningful in terms of price formation (i.e. data on actual, instead of potential trades). By contrast, the market-shaping supporters argued that pre-trade data, both of SI activity and client limit orders for shares outside RMs and MTFs, would be valuable for price formation.8 The final MiFID I regime was a compromise, which resulted in lighter SI and client limit order display requirements under MiFID I compared to RMs and MTFs (which is still apparent in the MiFID II regime). Another example of controversy under MiFID I concerned equity pre-trade transparency rules outside RMs and MTFs for so-called broker crossing networks (BCNs). BCNs were subject to MiFID I post-trade transparency rules, but fell outside the scope of the MiFID I pre-trade transparency regime (except for the client limit order display-rule). Besides level playing field and organisational requirements, price formation was an important – although controversial – argument in reducing BCNs under MiFID II.9 In short, the EU opinion is that – in order to support price formation – equity post-trade transparency is also crucial outside RMs and MTFs.10 There is no such EU consensus when it comes to pre-trade transparency outside RMs and MTFs.