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The unintended consequences of MiFID

The news that BATS is opening in London can only be bad news for the London Stock Exchange as the post MiFID new order begins to bite. However, with the number of new trading venues already hitting the market, is there going to be enough business to go round to keep every venue afloat?

We are entering a period of strife in the securities markets with a global economic downturn of an unknown size, causing investors to shift their assets to safer options. We have all seen the natural return to investment in the "Gold" haven enjoying resurgence, which is often a clear indicator of investor unease. The European market is obviously going through a major restructuring but is creating a strange conundrum of business opportunities, at a time when normally retrenchment would be the order of the day. This is of course caused by the political intrusion in business, which can disrupt the norm and create an artificial situation.

In this climate the establishment of new business enterprises has to be loaded with risk and fraught with danger. It would be interesting to have sight of the business plans of all these new venues and the anticipated timescale to get a return for their investors. If current market conditions persist for a few years, I hope the investors have very deep pockets!

There must be huge doubt that all these post MiFID trading venues will last as they will struggle for volume and offer minimal liquidity. The traditional Stock Exchanges are sure to fight hard to maintain their position and this strong competition will examine the strength, resolve and pockets of all the new trading venues. 

Much is made of the speed of execution, with BATS bringing the millisecond as the new benchmark in Europe (I am sure this will be challenged by other venues in the near future) but will speed prove to be a winning feature for the new world markets?

I often marvel why speed is considered mightier than the ability to decide wisely. It could be argued that the speed of modern markets is one of the biggest causes of volatility, where with electronic orders flashing out to market, triggered by a programmed equation, the market can be left behind, as it needs time to analyse its position. This is one reason why we get huge falls on one day only to recover the following morning. I am not sure the real investors are gaining from this type of volatility. The traders will of course enjoy the challenge of short selling and gambling the banks/investors capital, but is this the type of market we need?

The HBOS share manipulation story of a few weeks back is just an example of what happens when you get mass market selling triggered not by normal market conditions based on analysed facts, but by traders joining the bandwagon to collectively deflate a price. This is not planned but a reactive opportunistic approach to trading. I would argue it's not illegal but just taking the opportunity created by speed of execution front running analysis. BATS looks like adding a few speed notches to the market making it a far riskier place.

It could be that the best type of market for the investor is a single market where all transactions are reported and all prices viewed by all investors at the same time. But this is not what is being created in Europe. We are fragmenting the stock markets by using electronic trading venues where speed is the main factor rather than analysis. The strange thing is that this is being created at the same time as Europe is building a single financial market! This scenario looks like one of the unintended consequences coming out of what was thought a simple political objective.

It's hardly worth moaning about the change. But it's certainly worth understanding that we are heading towards a securities market, which is completely fragmented but tied together with high speed electronic execution systems. Where hardly any analysis is included but where huge volatility in prices is triggered and investors are given a rollercoaster ride that requires a strong heart and iron nerves.      

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Gary Wright

Gary Wright

Analyst

BISS Research

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19 Sep 2007

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London

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This post is from a series of posts in the group:

MiFID

A place to discuss MiFID


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