Stock and Derivatives Exchanges in the European Union: An Analytical Framework

Regulated markets (or stock exchanges, in the traditional terminology) are fascinating and complex machines. They provide a diverse range of services, such as listing and trading services, to various entities, including issuers, investors, or data reporting service providers. While their fascination makes regulated markets an interesting subject to research, their complexity sometimes makes them challenging to study and teach. In our chapter on Stock and Derivatives Exchanges in the European Union, we try to address this difficulty by framing the EU regulation of regulated markets into a coherent structure, which we then use to analyse some of the highlights of regulated markets’ functioning across the three primary services they provide—listing, trading and data vending—as well as their ownership structure. We believe this exercise can be of help to students and those who would like to have an overarching understanding of trading venue regulation.

In line with the existing financial literature, our chapter puts the multi-faceted and complex European regulation of trading venues within a framework based on the theories of networks and network effects in platform economics, which permit to account for both exchanges’ externalities and the external influence to which they are subject. According to this framework, exchanges shall be analysed in light of their role as central nodes of a more complex network comprising financial platforms and platform users. In this context, exchanges act as transactional platforms, whereas issuers, banks and investment firms act as platform users.

While the network approach allows to rely on a coherent framework, our chapter also points out certain variations which may occur within that framework. In particular, user groups are not homogeneous, and whether their interests converge may depend on the changing context. For instance, the size of listed companies or traders relative to their companions may lead to different preferences, as does their specific business strategy. Our chapter analyses the critical functions of regulated markets in light of this approach.

With respect to listing services, we observe that the declining trend of new IPOs on European exchanges can result in several possible mutations of exchanges’ physiology, the type of platform they embody and the way they are, thus, regulated. Among them, some exchanges’ business models might evolve further to reduce the weight of listing on the total revenues and focus more on trading fees. In this regard, concerns that exchanges could increase their income from trading activities by relaxing their listing standards (so as to increase their trading volumes) may—and in some instances already have—trigger regulatory action, causing an enhancement of supervisory authorities’ control on listing decisions.

Network externalities also explain some of the most significant market and regulatory trends affecting trading services. As to regulatory strategies, for instance, the chapter frames trading obligations mandated by MiFIR as a strategy to foster the development of positive externalities by regulated markets—just like a Pigouvian subsidy would do.

The dynamics of network externalities can easily be noticed by looking at the regulation of algorithmic and high-frequency trading (‘HFT’), which the chapter addresses as a case study to highlight the complex effects that regulatory and self-regulatory measures can have on different users. In particular, HFT shows how different levels of granularity in the identification of user groups, along the lines sketched out above, account for different strategies policymakers and regulated markets may adopt—for instance, traders do not have homogeneous preferences as regards fee structures, trading rules, market microstructure and other crucial variables. Regulatory strategies that the chapter analyses from this perspective include those concerning order cancellation, rules of conduct for HFT traders and trading venues, capital requirements, tick size and circuit breakers. And while HFT heavily influences exchanges and their regulation, it is also affected—and favoured—by exchanges themselves, through the offering of co-location services, which in turn caused the adoption of additional requirements specific to the provision of such services.

Differences between types of platforms and their user groups can also account for the different regulatory backdrops for pre- and post-trade information. Indeed, equity, debt and derivative markets have generally different microstructures, whereby equity markets are more often sufficiently liquid to sustain an order-driven system, while debt and derivatives markets resort more often to quote-driven matching systems. This results in different regimes for the provision of pre- and post-trade market data, such as more considerable recourse to request-for-quotes (and their related waivers) in certain debt and derivatives exchanges.

Ultimately, the regulated markets’ primary sources of revenues—listing and trading fees as well as data vending—interact with each other and determine the network effects across the different sides of the trading platform. All in all, regulatory and business strategies reflect and shape these interactions. Indeed, listing rules define what financial instruments will be traded (and hence the scope of trading services) and, vice-versa, more liquid secondary markets make listing more attractive to issuers. At the same time, while market data is determined by the trades taking place on the exchange, the exchange’s liquidity and trade volumes are typically impacted by the availability of market data. From a regulatory standpoint, this relation is acknowledged by regulators in the determination of the prices market operators can charge when selling their data. 

Finally, our chapter describes how platform economics can also be used to study exchanges’ ownership structure and constituency requirements, including the risks of adverse selection and conflicts of interest in the old mutualistic and new for-profit models. These market failures are eventually addressed by the governance requirements imposed by MiFID II upon market operators, as well as the requirements current or prospective constituencies must meet under the same directive, which ultimately contributes to shaping the individual exchanges’ structure and operations as well as the competitiveness of EU exchanges and—thus—the whole financial network.

Matteo Gargantini is Assistant Professor of Business Law at the University of Genova.

Michele Siri is Professor of Business Law at the University of Genova.