The International Organisation of Securities Commissions (IOSCO) has published a consultation report on ‘Regulatory Issues Raised by Changes in Market Structure’, which refers to the new requirements coming in now that mean financial market participants must use central counterparty (CCP) clearinghouses for over-the-counter (OTC) derivatives trades and provide more transparency. The report identifies possible outstanding issues surrounding this move, and others like it such as the move towards a standardised legal entity identifier (LEI), and details the risks posed by existing or developing market structures under this post-crash ‘new normal’ environment. The ISOCO report also provides recommendations to address these potential risks.
At its summit meeting in 2010, the Group of Twenty (G20) finance ministers and central bank governors asked IOSCO to “develop recommendations to promote markets´ integrity and efficiency to mitigate the risks posed to the financial system by the latest technological developments.” The consultation report forms part of IOSCO´s response to that request.
In the ‘Regulatory Issues Raised by Changes in Market Structure’ report, IOSCO seeks to gather evidence and views for developing recommendations that promote market liquidity and efficiency, price transparency, and investors’ execution quality in a fragmented environment. The report proposes possible policy options and regulatory tools to cope with the potential drawbacks arising from market fragmentation. Issues such as the need for a consolidated tape in Europe, high frequency trading (HFT) and the impact of the Basel III capital adequacy regime also fall under its scope.
The IOSCO report concludes that securities regulators bear the responsibility for striking an appropriate balance between a market structure that promotes competition among markets, and one that minimises the potentially adverse effects of fragmentation on market integrity and efficiency, price formation, and best execution of investor orders.
Accordingly, it says, an appropriately balanced market structure must provide for strong investor protection, foster fair and efficient capital markets and confidence in those markets, and enable businesses to raise capital for the benefit of the overall economy.
The report takes into account the previous analyses and recommendations by IOSCO in other related areas. Specific reference is made to the IOSCO 2011 report ‘Principles for Dark Liquidity’ and the 2011 report on ‘Regulatory Issues Raised by the Impact of Technological Changes on Market Integrity and Efficiency’, as well as to the recently-published consultation report on ‘Technological Challenges to Effective Market Surveillance Issues and Regulatory Tools’.
It also updates the 2001 IOSCO report on ‘Transparency and Market Fragmentation’, to the extent that it provides an overview of the current state of market fragmentation and regulatory steps taken since 2001 in various members’ jurisdictions, covering the need for standardised LEIs and the like.
The analysis carried out for the report included the following fact finding exercise:
• A mapping of the various types of trading spaces in different jurisdictions.
• An overview of the regulations and rules that apply to the various types of trading spaces and ultimately the factors that fostered the establishment of multiple trading spaces for the same product.
• An analysis on how liquidity has been dispersed among these different trading spaces in equities and Exchange Trade Funds (ETFs).
• A dialogue with the industry, including consultation with the relevant IOSCO committees.
The report makes recommendations to monitor the impact of fragmentation on the following areas:
• Market integrity and efficiency.
• Trade information.
• Order handling rules and best execution.
• Access to liquidity.
• Market efficiency and resilience
The closing date for comments to this consultation is 10 May 2013.