Personal message from FESE Director General on the MiFIR review proposal

Decision-makers across Europe are right now assessing proposed changes to the Markets in Financial Instruments Regulation. Having been part of the stock exchange industry for over 30 years, and as Director General of FESE, Rainer Riess here shares his thoughts. At this moment, the voice of exchanges needs to be heard and their value to society and the real economy needs to be recognised.

Let there be light

If I could only take away one image from my career, it would be the colourful bright lights of the stock prices, lit up in green and red on the big screens.

Those bright lights have really caught the attention of policymakers and market participants in recent years, with exchanges being challenged on a much-needed service integral to the proper functioning of open transparent markets: market data. Intensified discussion of a pan-European Consolidated Tape has further sparked debate on market data matters.

To understand market data, we need to take a step back and recognise that it is an essential part of a much bigger picture – market structure.

Market data doesn’t just appear from thin air – it is the outcome of a price formation process. But for this you need transparency, which is fading: based on ESMA figures, the share of trading on Regulated Markets fell between 2018 and 2020, while over the counter (OTC) trading approximately doubled. Put simply, without transparent trading activity, data would not exist.

The integrity of price formation is precious to all market participants, especially investors and listed companies: it creates the reference price for everyone to trade and value companies. Delivering reliable reference prices requires continuous investment and a dedication to quality – which exchanges provide.

“Financial stability, fairness and integrity are at risk when price formation becomes the exception, not the rule”

Assessing Europe’s market structure today, only exchanges and multi-lateral trading venues contribute to these reference prices. Data from Systematic Internalisers (SIs) and OTC lags in terms of transparency, quality, timeliness and consistency. SIs utilise exchange data as the basis for very lucrative business models which enable them to take flows away from the very place where they go to get their data.

Unfortunately, the European Commission’s MiFIR Review proposal seems not to change this for the better: financial stability, fairness and integrity are at risk when price formation becomes the exception, not the rule.

Why is market structure so important?

Over my career, I have witnessed a significant change in how equity trading takes place. While the 2008 introduction of MiFID I opened up competition in equity trading, it also had the unintended consequence of encouraging dark trading.

Ten years later, MiFID II introduced new rules to ensure that the majority of trading was carried out in a fair, transparent and competitive environment. The key to MiFID II was to limit the amount of dark trading and promote trading on transparent platforms.

Good news? Not really: the results are disappointing with Europe even lagging further behind the US or Asia in terms of transparency. According to ESMA, almost 60% of the total turnover in shares is not subject to pre-trade transparency.

Slowly but surely, we are seeing European equity markets shift back to a dealer market structure where opaque and bilateral trading prevail to the detriment of investors and financial stability. This development has largely benefitted a handful of non-EU banks which together control a substantial share of equity flows to Europe’s major markets. Frankly, we saw during the last financial crisis how easy it can be to exploit opacity to manipulate prices in one’s favour.

What is the link to market data?

Reliable market data will only ever exist with high-quality price formation on lit markets. Exchanges are only in a position to provide this service if the issues surrounding market structure are addressed. Preserving price formation means we need to limit dark trading to where it is needed: the execution of large trades, where market impact could be detrimental to investors.

“Reliable market data will only ever exist with high-quality price formation on lit markets”

Some (mostly SI operators) argue exchanges are merely fighting for transparency in order to overcharge on market data. Let me set the record straight. Exchanges have made considerable investments in streamlining their compliance and IT systems to provide the best quality market data for the benefit of all market participants. At the same time, their revenues on market data have remained essentially flat over the past half decade or more. And yes, simplifying market data policies across exchanges and assessing areas that could ultimately be harmonised for all trading venues across Europe should be a key objective. But while exchanges account for just 10% of the total spending on market data, where is the contribution of the other parts of the industry towards more transparency and less complexity?

Transparency and Price Formation Matter

In and of itself, the creation of a Consolidated Tape will not address deficiencies in market structure, or the disparities in market data quality. Worse, as currently conceived, the proposal places the costs of the tape almost entirely on exchanges to the benefit of less transparent operators in the industry.  If enhanced transparency is indeed the goal – which is what we need for a Capital Markets Union that truly works for the people – the Tape needs to offer a complete picture of the marketplace, by showing all transactions with a reasonable delay, and not to enable more internalisation.

“The absence of a transparent market structure poses a real threat to the price formation function which exchanges provide”

The absence of a transparent market structure poses a real threat to the price formation function which exchanges provide. Without trading dynamics clearly supporting transparency, markets will become prone to manipulation, investors will be disadvantaged, and, ultimately financial stability will be endangered.

For the sake of Europe’s market structure, the colourful bright lights of stock prices need to prevail.