Alternative Trading Venues Research Articles

Regulated Markets, Alternative Trading Venues & Systematic Internalisers in Europe

The purpose of this paper is to explain the similarities and differences between regulated markets (RMs), alternative trading venues (i.e. multilateral trading facilities / MTFs and organised trading facilities / OTFs), and systematic internalisers (SIs) in Europe. The structure of the paper is as follows. Paragraph II provides an overview of the main terms and definitions. Subsequently, the authors discuss the MiFID II scope in relation to RMs, alternative trading venues, and SIs (paragraph III). This is followed by a treatment of the organisational requirements for RMs, alternative trading venues, and SIs (paragraph IV). Then, the MiFID II pre- and post-trade transparency rules are discussed, both for equity (paragraph V) and nonequity (paragraph VI). The authors end with some concluding observations (paragraph VII).

Fragmentation and Market Quality: The Case of European Markets

This paper questions whether the proliferation of alternative trading venues in Western Europe after MiFID implementation in 2007 affected market quality. By means of a difference-in-differences analysis, we evaluate changes in market quality of stocks that initiated trading in Multilateral Trading Facilities (MTF) in relation to matched samples. Our analysis provides evidence that the overall liquidity (measured by transaction costs and price impact) and trading activity increased in the short term with trade initiation in MTF. Notably, we show that fragmentation did not cause lower price precision or informativeness, but some tests suggest that fragmentation correlates positively with volatility. The results of this study are stronger for stocks with greater propensity for MTF trade initiation, i.e. stocks with greater size and liquidity prior to that event. Interestingly, the impact on liquidity and trading activity varied across stock exchanges and timing of MTF trade initiation. As for long run effects, our results suggest an improvement of overall liquidity and a neutral effect on the trading activity of traditional exchanges.

The Role of Pre-Opening Mechanisms in Fragmented Markets

To facilitate price discovery, Euronext Paris has always relied on a transparent pre-opening phase and on a call auction to open continuous markets. Fast trading, competition from alternative trading venues and the poor volume at the open (2%) however question the role of these non-trading sessions. Using a unique dataset of stocks cross-traded on Euronext Paris, BATS and Chi-X, we explore the behavior of traders during the preopen based on their speed and nature of orders (proprietary, agency or market-making). We show that slow brokers submit orders very early, and most of them are executed within the day. In contrast, fast prop traders or dedicated liquidity providers only participate in the last half-hour. Interestingly the pre-opening activity of slow brokers is strongly related to the price discovery process across trading venues. Finally, we show that although tentative clearing prices of the preopen contain information, they are followed by a reversal in the following 15 minutes across the different platforms, reflecting price pressure and liquidity issues around the open.

The Real Effects of NASDAQ Delistings

It is claimed that exchange listing of its stock benefits a firm by improving its stock liquidity and access to capital, thereby affecting real decisions and consequent outcome variables. Testing this claim empirically encounters obvious and formidable endogeneity problems. This paper empirically examines the causal effect of involuntary delisting from a stock exchange on stock liquidity, access to capital, corporate investment and profitability. Focusing on firms in violation of NASDAQ continued listing rules between 2000 and 2009, I compare firms that eventually delisted and moved trading of their stock to OTC markets with those that regained compliance and remained on NASDAQ. Market volatility during the delisting grace period is used as an instrumental variable (IV) for the delisting outcome. My findings suggest the following: First, delisting causes stocks to experience reduced daily trading volume, but only if the stock was actively traded prior to delisting; for thinly-traded stocks, there is no effect. Second, surprisingly, the number of investors, institutional ownership or analyst coverage are not affected by delisting. Third, delisting leads to less future equity issuance only if a stock was actively traded prior to delisting. Fourth, delisting has no statistically significant effect on a firm's long-term investments. Fifth, delisting improves long-term gross margin for firms which were thinly-traded prior to delisting. Sixth, delisting does not have statistically significant effect on firm value. Overall, my findings indicate that delisting from a stock exchange is not as costly as commonly believed. This implies that the OTC markets may provide small firms that have limited trading volume with a low-cost, effective market for their stock. My conclusions support the recent policy initiations to provide the alternative listing and trading venues for small public companies.

The Anatomy of the CDS Market

Using novel position and trading data for single-name corporate credit default swaps (CDSs), we provide evidence that CDS markets emerge as alternative trading venues that serve a standardization and liquidity role. CDS positions and trading volume are larger for firms with bonds that are fragmented into many separate issues and have heterogeneous contractual terms. Whereas hedging motives are associated with trading volume in the bond and CDS markets, speculative trading concentrates in the CDS. Cross-market arbitrage links the CDS and bond market via the basis trade, impressing the negative CDS-bond basis and reducing price impact in the bond market.

Price discovery and convergence in fragmented securities markets

Purpose– The purpose of this paper is to study price discovery and price convergence in securities trading within a fragmented market environment where stocks are traded on multiple venues. The results provide novel empirical insights questioning the generalizability of the current literature and aim to expand the understanding of price determination in a fragmented market microstructure.Design/methodology/approach– This paper provides an empirical data analysis based on an event study methodology. The authors applied Thomson Reuters Tick History data covering German blue chip stocks listed on multiple venues in 2009 and 2013. Different time aggregations up to one second are applied to provide an in-depth analysis.Findings– The paper empirically discovers a persistent price leader-follower relationship not only during intraday auctions but also in subsequent continuous trading. The authors found that trading on alternative venues instantly dries out in case the dominant market switches to a call auction. In these situations, alternative markets await and adopt the official price signal of the dominant market although prices on alternative venues still indicate a certain extent of price discovery. This phenomenon remains persistent at different levels of market fragmentation, indicating that alternative trading venues fully accept the price leadership role of the dominant market, no matter their own market share.Originality/value– This paper provides an innovative empirical setup to analyze price co-movement and convergence based on high-frequent data. Further, the results provide novel and robust insights into the price determination process in fragmented markets that clarify the role of price follower and price leader.

The determinants of alternative trading venue market share: Global evidence from the introduction of Chi-X

In this paper, we examine market share drivers of a prominent alternative trading venue (Chi-X) in an international context. We find that Chi-X׳s market share is negatively related to trading fees and latency, while positively related to liquidity relative to primary exchanges. Venue market share is negatively related to order-to-trade ratio and positively related to average trade size, suggesting traders’ preference to interact with natural and accessible liquidity. Furthermore, trading tends to concentrate on the primary exchange during market stress, while tick constraint stocks tend to trade more on Chi-X to avoid queuing at the touch on the primary exchange.

The EU and Market Abuse

The European Union recently revised its rules to fight insider dealing and market manipulation, the so-called Market Abuse Regulation (MAR) and Criminal Sanctions for Market Abuse Directive (CSMAD). The new rules are meant to improve legal certainty for market participants, extend the regulatory coverage to alternative trading venues and over-thecounter (OTC) transactions, address potential fraud in spot and derivatives markets for commodities, and enable more effective enforcement and tougher sanctions. With the 2014 Global Market Sentiment Survey (in which members rated market fraud as the most serious ethical issue facing global markets) as a backdrop, CFA Institute participated in the consultations leading to market-abuse reform, arguing in favour of transparency, effective enforcement, and dissuasive sanctions. We also highlighted the importance of uniform rules and supervisory and judicial cooperation across borders to improve market integrity. In particular, two important aspects of the new rules deserve attention: the prevention of market abuse when providing investment recommendations and engaging in market soundings. These provisions will be a novel development in most jurisdictions and will have a material impact on everyday professional practice. Recommending that another person engage in insider dealing is well established as market abuse. Under the new rules, any inducement or persuasion also will amount to abuse. In other words, if you possess inside information in the legitimate exercise of your profession, you may not give any indication to deal (or not to deal) in the instruments concerned—even if you do not disclose the existence of inside information to the recipient or if you hold other powerful arguments to support your advice. As for the recipient, following the recommendation would amount to insider dealing if the recipient knew or should have known the recommendation was based on inside information. In cases of serious violations committed with intent, both parties could face prison, which was not previously the case in all European countries. In addition, EU member states may extend the possibility of prison sentences to persons who commit abuse without intent and do so out of negligence (the “should have known” bit). In all instances, administrative fines may apply.

Network Features of European Trading Venues

Consider a stock which is simultaneously traded on two or more venues, either because its company is cross-listed or because regulation allows multi-trading. We set the idea that these venues are 'indirectly' connected and represent a network. If the 'importance' of a venue is traditionally measured by its isolated-centrality (e.g. trading volumes observed inside it), we introduce a network measure, the degree-centrality, which includes trading activity due to its connections with other stock markets. Using trading volume data of nearly 22,000 equities we study the dynamic of market centrality among the various European trading venues between 2005 and 2009. European Regulated Stock Exchanges (SEs) and Alternative Trading Venues (ATVs), introduced in Europe in 2007, are the nodes/vertexes of our network. We observe that the birth of European ATVs (Multi-lateral Trading Facilities, Systematic Internalisers and the OTC market) eroded the isolated-centrality of certain European SEs (particularly London), but not for all. In contrast, degree-centrality significantly increased for the majority of the 48 SEs analyzed, in favor of multi-markets coexistence. Moreover, European ATVs did not act as substitute to the secondary market for cross-listed shares. Paradoxically, our results show that for medium size European SEs, cross-listing trading activity Granger-causes multi-trading on European ATVs.

The January effect, does options trading matter?

This study examines the effect of options trading on the January effect in the period 1996–2009. The options market offers investors an alternative trading venue that circumvents several trading limitations in the equity market and hence enables a higher level of arbitrage activities. In a cross-sectional setting, we find that optioned stocks exhibit significantly lower risk-adjusted returns in January than non-optioned stocks. This effect is not attributed to firm size, illiquidity, or transaction costs. We also find that the January effect is not only smaller but also considerably more short-lived for optioned stocks than for non-optioned stocks. In a firm-specific setting, January risk-adjusted returns are found to be significantly lower in the post-options-listing period than in the pre-options-listing period. These findings support the proposition that options trading enhances information-based trading activities and hence improves the informational efficiency of the equity market. JEL classifications: G10, G11, G12, G14

The Anatomy of the CDS Market

Using novel position and trading data for single-name corporate credit default swaps (CDSs), we provide evidence that CDS markets emerge as “alternative trading venues” that serve a standardization and liquidity role. CDS positions and trading volume are larger for firms with bonds that are fragmented into many separate issues and have heterogeneous contractual terms. Whereas hedging motives are associated with trading volume in the bond and CDS markets, speculative trading concentrates in the CDS. Cross-market arbitrage links the CDS and bond market via the basis trade, compressing the negative CDS-bond basis and reducing price impact in the bond market.

Leveraging a shared infrastructure to trade across asset classes, regions and strategies

This paper examines the key trends shaping the global securities trading industry, including increased automation, changing market structure and regulatory initiatives to promote market transparency and stability. In particular, it examines market structure changes taking hold in Asia that are beginning to mirror similar developments in the USA and Europe, where advancements in exchange technologies, the proliferation of alternative trading venues, waves of exchange mergers, increased uptake of high-frequency trading strategies, and the availability of advanced trading solutions from third-party vendors have all contributed to a new market landscape. In addition, the paper highlights the opportunities faced by firms looking to capitalise on this changing market landscape by expanding their trading operations in Asia, and examines the key requirements for developing technology infrastructures to support Asian trading operations, while scrutinising the case for partnering with specialist technology and data providers versus building proprietary systems. Finally, it outlines the key characteristics that service providers must possess to support firms expanding their Asian trading operations in the most profitable way possible.

Development Considerations for a Chinese National Securities Market

This is a contribution to a conference volume for the 2010 National University of Singapore Symposium on ―Law and Development in China - The Legal Dimension of China’s Development Model.‖ The paper aims to shed some light on the way forward for the Chinese securities markets. It examines the desirability of financial markets for broader economic development, and presents the national market system implemented by the US and the norms in the EU’s MiFID that promote competition among and integration of securities markets and alternative trading venues. The paper assesses the current state of the Chinese securities markets, where according to law trading is concentrated on traditional exchanges, against the backdrop of the rapidly evolving (disintegrating) US and EU markets. Clearly, China will be able to learn much from the experiences of the US and EU, but the route that China will take for further evolution of its national market for securities can at this point be neither predicted nor projected. * The author is grateful to Thomson Sweet & Maxwell for permission to use this material, which appears as parts of Chapter 1 and 6 of the text, The Law and Operation of the Hong Kong Securities and Futures Exchanges (forthcoming from Thomson Sweet & Maxwell 2012).

Where Has All the Trading Gone? A Network Approach to European Stock Exchanges and Alternative Trading Venue

This paper investigates the network features of European trading venues by analyzing the behavior of simultaneously quoted stock. Equity trading venues include both regulated Stock Exchanges (SEs) and Alternative Trading Venues (ATVs) and these represent the nodes of our network. The connections among these nodes are determined by choices of investors to exploit various venues in which a stock may be traded. Using trading volume data of nearly 22,000 equities we use social network analysis to measure prestige and connectivity between the various trading venues between 2005 and 2009. We find that the evolution of ATVs (including multi-lateral trading venues BATS, Chi-X and Turquoise, as well as various Systematic Internalisers) eroded the relative prestige of the largest established European SEs (particularly London). Prestige concentration also declined after MIFID although smaller SEs did not appear to suffer any major losses (in prestige). The introduction of multi-trading venues does not appear to have adversely influenced connectivity in terms of reducing the number (or volume) of cross-listed relationships although the introduction of ATVs has had a big impact in increasing connectivity overall and decreasing trades concentration.

The January Effect, Does Options Trading Matter?

This study examines the effect of options trading on the January effect in the period 1996-2009. The options market offers investors an alternative trading venue that circumvents several trading limitations in the equity market and hence enables a higher level of arbitrage activities. In a cross-sectional setting, we find that optioned stocks exhibit significantly lower risk-adjusted returns in January than non-optioned stocks. This effect is not attributed to firm size, illiquidity, or transaction costs. We also find that the January effect is not only smaller but also considerably more short-lived for optioned stocks than for non-optioned stocks. In a firm-specific setting, January risk-adjusted returns are found to be significantly lower in the post-options-listing period than in the pre-options-listing period. These findings support the proposition that options trading enhances information-based trading activities and hence improves the informational efficiency of the equity market.

Derivatives pricing and liquidity dominance in alternative trading venues

This study examines the quality of derivatives pricing in the market in which liquidity is dominated by an alternative market. We use US interest rate futures from the side-by-side open outcry and electronic markets, in which electronic markets dominate liquidity. We find that the bid-ask spreads in illiquid open outcry markets have increased substantially since electronic markets became a major part of the market liquidity. Accordingly, the implicit trading costs in open outcry markets have significantly increased. We also show that the volatility of bid-ask spreads in illiquid open outcry markets has increased, which is consistent with a decrease in the depth of the market. In addition, we find that the fast rate of price discovery in electronic markets instabilizes the bid-ask spread in open outcry market. Our results are particularly important for practitioners in that the performance of their portfolio and risk managements critically depends on which market dominates liquidity.

Regulated Technology Diffusion: The SEC and the Impact of 'Penny Pricing' in Electronic Options Trading

The Securities Exchange Commission (SEC) implemented the first phase of a 'penny pricing' pilot in the exchange-traded equity options market in February 2007. The initial phase of this trial required the six United States options exchanges to reduce the minimum bid-offer spread from five or ten cents to a penny for the options corresponding to thirteen underlying equity securities. The catalyst for this pricing change was the improved electronic capabilities of the exchanges. Over the course of the preceding decade, the exchanges invested in the development of electronic trading systems that allowed for more efficient quoting and trading of options securities. The SEC's mandated pricing change effectively redistributes the gains of innovation from the exchanges' market makers to individual investors. his paper analyses the market impact of the Penny Pilot and highlights the SEC's central role in shaping the options market's innovations and competitive environment. Beyond a reduction in bid-offer spreads, the pricing pilot has stimulated a variety of changes in trading dynamics and market structure. These repercussions include thinner markets, changes in market maker fee structures, the introduction of alternative trading venues, and incentives for the exchanges to prioritize further technological innovation.

A brighter future with lower transactions costs?

AbstractRecently, the OMX Nordic Exchange reduced the exchange fee for trading the OMXS 30 index futures with more than 22%. The reduction in exchange fees provides this study with a unique opportunity to investigate the effects of a change in fixed transaction costs on futures market liquidity, trading activity, volatility, futures pricing efficiency, and the futures exchange's revenues. The results show a ceteris paribus increase in futures trading volume with 19%, a 27% decrease in futures bid–ask spread, and a 27% increase in volatility, as a result of the futures exchange fee reduction, whereas the pricing efficiency of the futures contract and the exchange's revenues are unaffected by the change in transaction costs. The exchange fee reduction has improved futures market liquidity at the cost of higher volatility. Moreover, the attractiveness and competitiveness of the futures exchange has increased relative alternative trading venues, without a loss of revenues in the process. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:775–796, 2009

The new trading environment post-MiFID: One year later

Since the introduction of the Markets in Financial Instruments Directive (MiFID), the European equity trading landscape has seen major market-structure change. An increasing number of new multilateral trading facilities (MTFs) and so-called 'dark pools' are entering the arena, challenging the traditional European exchanges by promising faster execution at lower costs. As these alternative trading venues generate growing interest among brokers, banks and fund managers, this increased competition could lead to a rapid movement of trading stocks, away from Europe's traditional stock exchanges, leading to greater fragmentation of liquidity. The main questions to be answered are: what are the future challenges and opportunities in the new European trading area? Will the success of alternative liquidity pool trading, as is seen in the USA, be followed in Europe? And can the experience in the USA be used as a template to predict the likely impact of MiFID and other triggers on future European equity trading?

Market Dominance and Barriers to Competition in Financial Trading Venues

This paper examines market dominance and barriers to competition in financial trading venues. The interaction between competition and economic growth is a well established fact in the literature and recent years have witnessed a strong and ferocious promotion of competition in a large spectrum of markets. The financial trading industry is no exception. As of 1 November 2007, the Market in Financial Instruments Directive (MiFID) aims to increase competition and to foster client protection in the European financial market. Among other provisions, it abolishes the concentration rule and challenges the market power of existing trading venues. The directive introduces venue competition in order to achieve better execution and ultimately lower trading costs. I argue that, although positive, the impact on the degree of actual competition may be limited due to two barriers to competition: i) direct network effects together with increasing returns to scale and ii) post-trading constraints since venues typically bundle trading and post-trading services. In particular, the paper proposes to empirically address the following questions: i) evaluate the actual degree of competition between alternative trading venues, ii) measure the impact of network effects on competition, and finally iii) assess the barriers to competition induced by post-trading constraints. The results imply that financial intermediaries tend to value liquidity more than total fees when deciding to which venue to route a given order for execution - implying that being the incumbent venue translates into a competitive advantage. Furthermore, eliminating the mentioned barriers to competition seems to be associated with a significant decrease (of a similar magnitude) in the asymmetry of the industry.