The Covid-19 crisis has shown that European market infrastructure is resilient. During the early months of the pandemic, in particular, we saw high levels of volatility in nearly all asset classes. By and large, European markets have coped well, indicating that the world designed as part of the recast of the Markets in Financial Instruments Directive (MiFID II) is a robust one.
Regulated markets have played a big part in that. We have seen that in times of high uncertainty, more trading volume goes to regulated markets as investors seek a safe, transparent, and robust trading venue where core price formation takes place and where there is liquidity.
There is another lesson to be learned from the crisis though; we cannot build a company on debt alone. Those companies with high debt levels and little equity have suffered the most. To restore resilience, building or rebuilding equity buffers will be key for the long-term success of European companies.
While one could conclude that the EU’s market infrastructure has weathered the storm, unfortunately not all is perfect with European markets. The past years have shown that our market structure has some shortcomings. The upcoming review of MiFIR in late 2021 and, as a second step, the review of MiFID II in early 2022 will be an opportunity to remedy some of the problems that have become apparent with the implementation of the MiFID II framework. Arguably, the experiences of recent years and in particular during the height of the Covid crisis must inform the upcoming review.
A fair assessment of the implementation of the MiFID II framework will conclude that we did not manage to accomplish all the objectives we had envisioned. The objective of MiFID II was to turn on the light in financial markets and by doing so increase overall market transparency and efficiency. Unfortunately, this goal has at best been only partially achieved.
There are some trends that in fact run contrary to the MiFID II objectives. One of these is the growth in off-exchange trading and the growing number of Systematic Internalisers (SIs) that do not contribute to the price formation process at all. As a result – and contrary to the intention of MiFID II – the share of price-forming lit trading activity has decreased, to the detriment of issuers and investors alike. The European Securities Markets Authority has produced convincing data to prove this point.
Therefore, we need to think hard about which elements of the current market structure we need to retain and how we can increase or decrease the relative attractiveness of the venues in order to achieve the outcome we had initially hoped for; namely more transparent and more efficient markets.
One possible avenue would be to restrict SI equity trading to above the large-in-scale (LIS) threshold. Such a move would incentivise lit trading and ensure the quality and robustness of price formation, in line with the initial objective of MiFID II. In this simplified market structure, the large-in-scale threshold would be used as the main tool to delineate lit and dark trading. That would also mean that there is little need for a double volume cap mechanism that does not work particularly well anyway.
So, it would come with the added value of making the whole waiver regime a little easier to comprehend. Streamlining the waiver regime should be another objective of the upcoming review. After all, there is little need for any other than the large-in-scale waiver.
The consolidated tape question
One issue that will certainly be the focus of hot debate is the question of a consolidated tape, which is seen by some of its advocates as the silver bullet to fix all that is wrong with European markets. This assessment might prove to be a little too optimistic, though. After all, the original MiFID II/MiFIR framework already included the notion of consolidated tape to be delivered by the market.
Arguably, this has not come to fruition yet, and the review should carefully consider the reasons why this has not yet been an enticing proposition for the private sector. The idea of a consolidated tape is arguably to get the full picture of what is going on in European financial markets. This would imply that all types of venues have to contribute. If that were truly achieved, a consolidated tape would be a useful supervisory tool. It would probably also be a good instrument for checking best execution and could at some point also be of value to the buy-side.
For a consolidated tape to be truly useful though, there is one essential precondition: data quality. After all, a consolidated tape will only be as good as the worst data that is fed into it. Right now, the data quality coming from venues other than regulated markets is often poor.
Feeding shoddy data into a consolidated tape is arguably a somewhat pointless exercise. So the first – and perhaps most important – step would be getting data quality for all venues up to a certain standard. Once we have achieved that, we can talk about what a sensible consolidation of that data might look like and what a reasonable pricing model would be.
While the long-term goal should be an ambitious one, the starting point should probably be more modest. A tape of record for equities that gives the full picture to both regulators and market participants at the market closing could be a sensible first step for further development.
The upcoming review of the MiFID II framework will be an enormous regulatory project. Even though not all aspects of MiFID II have been a roaring success, the general objectives should be maintained. If that is the case, there is a good chance that the review can complete the process of making European markets more transparent, efficient and resilient, a project that was started more than a decade ago.