By Mark Schaedel Founder and Principal, Vondelpark Capital
Since MiFID introduced competition to our equity markets in 2007, the resulting fragmentation of liquidity had a significant impact on the efficiency of sourcing liquidity. Whilst competition resulted in lower explicit costs (spreads), the implicit costs of accessing liquidity and data from a broad spectrum of competing markets have offset the gains. Costs aside, the visibility of liquidity in the market has been impaired to the point that investors are flying blind – ask 5 different people how much turnover traded in Air France KLM today and you will get 5 different answers.
Soon after MiFID was implemented, when these issues were first observed in equity markets, the immediate conclusion was the need for a consolidated tape which would logically provide a single source of information about market liquidity. A closer look, however, reveals a more complex challenge resulting from the quality of this information. Aside from aggregating the fragmented sources of trading venue data, the data provided by APAs for OTC trading has proven to be wildly inaccurate thereby undermining any attempts to assemble a clear picture of market liquidity. Unfortunately, these problems have little to do with how data is consolidated and reveal the actual challenge of how data is collected by APAs who are not empowered nor motivated to address these issues.
A similar challenge applies to trading venue data which inherently lacks any standards for how liquidity is represented and can therefore be difficult to accurately aggregate. While efforts have been developed to translate native representations of liquidity into a harmonized standard, they must be enshrined into Regulatory Technical Standards (RTS) to ensure adoption which means that the inputs to a consolidated tape must be defined and mandated. In fact, the fatal flaw of the consolidated tape debate has been the assumption that trading venue data would be sourced from the existing, commercially available data products rather than a defined input protocol, as in the case of the US and Canadian tapes. This flawed assumption has led to a series of failures and created the primary distraction from progress in the industry’s collaboration with policymakers on the consolidated tape – data costs. Despite the fact that TV data products were never designed (nor priced) for use in consolidated tapes, these shortcomings have been cited as the primary obstacle to establishing an official tape and the reason why the existing consolidated data products are deemed to be of insufficient quality and prohibitively expensive. Exacerbating this problem is the tendency for data vendors to optimise costs by selecting only a subset of TVs for inclusion in their consolidated tapes, thereby leading to further inconsistency and an incomplete representation of the true liquidity picture.
So where do we go from here? Until we understand the problem that the consolidated tape solution solves, we are likely to be disappointed with the outcome – or perhaps more likely to continue the series of failures. After almost 15 years, it may be that the challenge of establishing a consolidated tape has nothing to do with the consolidation of data at all! Perhaps, in our haste to break down the monopolies of trading, we overlooked how transparency would be maintained in a fragmented market structure. It may be that the industry has already adapted and developed all the infrastructure it needs to provide a complete liquidity picture, yet policymaking has failed to keep pace by prescribing rules and specifications which make use of it. This might be attributed to lacking or inefficient collaboration between policymakers and the industry. Or perhaps by design, the industry is influenced mostly by those who enjoy the benefits of the informational advantage and avoidance of investor accountability.
The US established their consolidated tape system through an act of congress in 1975. Now 50 years later, the SEC and industry are exploring alternatives that better suits the needs of the current market structure. Here in Europe, the recommendations are to establish an almost identical framework to the US under a single consolidated tape provider. Presumably, the requirements needed to build this monolithic tape would at some stage, reach a conclusion that the data sources be made fit for purpose. Whatever the case, it seems ironic to respond to the inadvertent effect of competition in trading by creating a monopoly for data.
Our MiFID journey by now, should have taught us that the road to hell is paved with well-intentioned rules like double volume caps and RCB provisions which have proven to be rigid, ineffective and collectively introduce unnecessary complexity. The reality is that the industry evolves and survives by lobbying for regulatory policy to be designed in such a way that it can be circumvented. Only where there is an alignment of commercial interests, does policy usually achieve its objective and still, that is achieved through compromise. By some measures, this constitutes a successful collaboration and partnership but, rarely do the needs of investors get properly represented or prioritized due to a lack coordination, representation and coherent voice.