Global reform efforts introduced since the 2008 crisis have largely focused on increasing the safety and soundness of financial markets, and significant progress has been made. As reforms have been implemented, concerns about market fragmentation and its impact on market liquidity have arisen. Market structure reforms and International Standards Bodies (ISBs) can play an important role in helping to mitigate some of these issues.
In today's global financial markets, market fragmentation is caused by the formation of separate liquidity reserves, evidenced by shallower trading pools for specific asset classes. This is partly due to regulatory differences across jurisdictions leading market participants to base trading decisions on complying with or avoiding rules and mandates, rather than solely on the liquidity profile of, or expertise in, a given marketplace. In addition to increasing operational complexity and expense for market participants, in times of crisis, these trapped 'resource' pools could intensify the negative impact of a systemic event and weaken financial market resilience. Differences in the content and technical details of financial reforms contribute to this fragmentation, and while there has been progress in regulatory harmonisation, concerns remain that these differences will continue to exacerbate regulatory and therefore, market fragmentation.
ISBs are in a unique position to coordinate global regulatory efforts to address the issues. Solutions which should be considered include the continued implementation of substituted compliance frameworks which can best ensure that jurisdictions can allow market participants to compete on an equal playing field, and that progress on achieving the G20 commitments is not impeded.
Second, going forward, market fragmentation could be mitigated by formalising ISBs’ involvement in the policymaking process at a jurisdictional level, as well as providing greater notice and opportunity for input in the development of global standards. ISBs have played a critical role in the promulgation of international standards to help realise the goals of the G20, and while these reform efforts have been successful in many ways, their implementation was described in a recent FSB report as incomplete and inconsistent, due to a lack of global coordination. To address this, ISBs should be encouraged to provide formal and transparent feedback to regulators during their rulemaking process, in addition to the current practice of assessing adherence to them after regulators implement standards. If ISBs provided written responses to proposed regulatory standards intended for international adoption, regulators could benefit from such input before finalising a regulation, hence increasing the likelihood of its harmonised implementation.
Third, harmonising reporting requirements both at a domestic level - at least in the US - and globally can help mitigate the impact of data fragmentation. The need for uniform data on the derivatives market was recognised at the G20 Pittsburgh summit in 2009 as a way to help regulators assess market trends, market abuse, and risk globally. From a global perspective, uneven implementation of derivatives reporting requirements has hampered the usefulness of the data regulators collect, resulting in challenges to achieving the original policy goals.
Policymakers have the power to minimise the negative consequences of market fragmentation. ISBs are well-positioned to promote deeper trust among supervisors to apply common standards fully and consistently. Global parity must be achieved through agreement on policy objectives and outcomes, and perhaps on the means to those outcomes where necessary, to protect the integrity of markets and the formation of liquidity globally.