Background

<span/>As a critical part of the global economy, capital markets have evolved into an information-driven ecosystem where value is created and transferred through the exchange of data which collectively supports investor transparency. Prices are no longer considered to be exhaust resulting from a transaction between two parties, but the fuel which is vital to efficient market operation from asset and fund valuation to benchmarks, risk, clearing and settlement.

Within the broader transparency regime, the term market transparency refers to the general availability of market data (prices, quotes, orders, etc.) to market participants. Despite its critical role to the functioning of markets, determining the sufficiency of market transparency can be subjective and requires both context and balance. While an adequate level of transparency is required for markets to operate at a reasonable level of efficiency, excessive transparency can discourage market participation from institutions being less willing to commit capital and unable to efficiently manage risk. The market transparency equilibrium varies by type of market and instruments traded, but, at a minimum, there needs to be enough market transparency for investors to identify the liquidity which was accessible at any given time in the market as a means holding their agents accountable for their best execution obligations.

In the context of European equity markets, competition between markets has resulted in lower explicit trading costs (spreads) while the implicit costs of accessing liquidity and market data from a broader spectrum of sources has offset some of the cost savings. While the cost of data has dominated the transparency debate and efforts made to reduce costs through disaggregation, the deeper data quality issues have not received sufficient attention or priority. ESMA's Consultation, along with the European Commission's tender for a study on the creation of a consolidated tape, provides the opportunity to surface these issues and gain the understanding necessary to address them.

Consolidated tape?

While it has long been concluded that a consolidated tape is an important part of the answer to address these challenges, it has proven to be an elusive development. A lack of clear definition or objectives from policymakers for a consolidated tape has undermined the intentions of the regulatory framework designed to support it. The transparency provisions in MiFIR included measures designed to improve access to, and reduce the costs of, the existing market data offerings from trading venues (TVs) and approved publication arrangements (APAs) - ignoring the fact that these data offerings were not designed nor priced for use in consolidated form. Due to an inherent lack of standards and inadequate OTC trade reporting rules, the data provided by TVs and APAs is of insufficient quality. Each TV and APA source operates a different model and represents the activity differently preventing users of consolidated data from accurately distinguishing the collective, accessible liquidity across the underlying markets. While progress has been made in the development of the MMT data standard [1] which classifies post-trade data from TVs and APAs into accessible and non-accessible categories, adoption of the standard has been voluntary and not consistently applied. Some progress has also been made in the accuracy of OTC trade reporting. However, due to inadequate trade reporting rules and requirements, APAs have similar problems to CTPs where the quality of the source data is poor with off-market trades are often reported inaccurately and, in many cases, multiple times or not at all.

Although TVs, APAs and Systemic Internalisers (SIs) are all supervised entities, there are no specific rules for how they each make data available. Establishing a supervised CTP function for the consolidation of this data will not address the problem, nor should any firm be expected to opt to become one. The commercial prospects of becoming a supervised entity responsible acquiring data from more than 150 sources and making it available in consolidated form at a "reasonable cost" and free of all cost under a delayed embargo has not appealed to any data provider. Data providers have instead elected to continue to make consolidated data available on their own terms, deciding for themselves which trading venues to include and how to consolidate and publish the data - resulting in inconsistent information. Asking five different people how many shares were traded in Royal Dutch Shell today is likely to result in five different answers.

The US and some other jurisdictions have addressed this issue and may provide a useful reference for what a consolidated tape model could look like. However, it is important to recognise that European markets are fundamentally different from the US and both markets have evolved considerably since the time these models were established. In the US, the Consolidated Tapes were mandated by an act of Congress in 1975 and built into the National Market System and the rules that govern it. While the US consolidated tapes are each operated by an exclusive processor, the current technology infrastructure required is broadly and commercially available. Data is provided through myriad sources and services applications designed specifically for the diverse needs of each user. In the EU, leveraging existing infrastructure would avoid switching costs for users in addition to the cost of redundant infrastructure with high availability requirements.

Although the speed at which markets now operate have rendered the use of Consolidated Tape data obsolete for trading, they continue to play a critical role as the official record for US market activity. Their use is enshrined in rules requiring the display [2] of Consolidated Tape data to investors at point of sale and support the trade-through rule which requires investors orders to be routed to the market with the best price. CTPs could help eliminate the need for convergence to a consolidation standard. However, this would introduce significant infrastructure cost and switching costs for users. Instead, we would encourage policymakers to seek opportunities to promote competition and innovation where ever possible. The prospect of a consolidated tape, if designed properly, presents the opportunity to address the transparency challenges, which are critical to investors, while enabling competition and positive commercial incentives to sustain transparency and encourage innovation.

Contribution to the US Consolidated Tapes is mandated for US exchanges and participation in the Consolidated Tape Association (CTA), which oversees the operation of the Consolidated Tape System and Consolidated Quote System, is available exclusively to exchange participants. Participants are compensated in the form of revenues allocated from the use of Consolidated Tape which is managed by the appointed tape administrator. Tape revenue allocations play an important role in the competitive dynamics of US markets by supporting the rebates exchanges pay for orderflow. These rebates have become a necessity to attract orders making it hard for Alternative Trading Venues (ATVs) [3] to compete without the benefit of tape revenues. These competitive dynamics have constrained innovation and driven ATVs to become authorised as exchanges or consolidate with exchange groups in order to compete. US exchanges have now consolidated into groups each operating multiple markets which provide differentiation through various features and pricing models.

Another consideration in referencing the US Consolidated Tape model is the revenue allocation model itself. This is embedded in Regulation NMS and has been amended from time to time to discourage certain problematic market practices (such as washed sales and tape shredding [4]). The natural consequences of allocating revenue based on market share is to incentivise extraneous data to be contributed. Due to a lack of an MMT-like data standard in the US, this extraneous data creates noise which can cannot be easily distinguished from accessible liquidity. The ability for data representing accessible liquidity and other types of valuable market activity (e.g. price formation) to be distinguished from data with less information value presents the opportunity to both enhance transparency and to create positive incentives through consolidated tape revenue allocations.

Enhancing market transparency, therefore, requires different types of trading activity to be distinguished from one another. Data standards which enable investors to identify accessible liquidity and price formation can also be leveraged to enable competition between tape contributors. Allocating revenues derived from the sale of consolidated tape data to users based on the relative information value associated with each contribution, presents a unique and exciting opportunity to provide positive commercial incentives which encourage healthy market behaviours.

European markets require a fresh approach and we should learn from the US experience rather than follow it. The "clean slate" provided to us allows for a modern transparency solution. ESMA's advice to the European Commission presents the opportunity to establish effective and sustainable market transparency for investors by imposing rules which ensure an accurate and consistent record of market activity can be made broadly available through a framework which encourages competition and innovation.

In our response, we have focused on how a consolidated tape could be established efficiently based on post-trade equity data that would be used as an accurate and consistent record of market activity. While the tape of record should be available in real-time, by definition, it provides a historical record due to the latency introduced by the consolidation process and the fact that the data is post-trade. We believe that progress could be made on this project relatively quickly if the framework we advocate here was adopted by policymakers. There has been discussion of whether CTPs should be including pre-trade data and/or be extended out to other asset classes. We believe that consideration of how wider sets of data could be consolidated would be useful. For example, a consolidated tape in bonds would be extremely useful and we would encourage policymakers to consider how transparency can be improved in fixed income markets. However, such work should be considered as separate projects as the issues and solutions are quite different. Work on a post trade equity consolidated tape should not dependent or held back due to work on other factors.

Recomendations

We recommend that ESMA's advice to the European Commission focuses on reviewing the existing level 1 rules and establishing clear objectives which focus on enhancing market transparency for investors by adopting rules which address the availability and quality of data available to consolidated data providers. Before a consolidated tape can be delivered, there must be rules adopted which require the contribution of post-trade data from all TVs and APAs in an accurate and timely manner in accordance with defined specifications. Rules must also be adopted to ensure that OTC trade reporting is conducted accurately and consistently with proper oversight.

Further to these recommendations, we advise that:

• Scope focusses initially on a real-time, post-trade consolidated tape for equities as a reliable, consistent record of market activity and as a means of addressing the effects of fragmentation resulting from the competition introduced under MiFID;
• Establish a technical working group to define specifications for the contribution of data and the definition of the consolidated tape which ensures accuracy and 100 percent coverage of European market activity and the necessary consistency across competing CTPs;
• An advisory group be established to determine the commercial structure for the consolidated tape including the fees for the redistribution and use of consolidated tape data;
• CTPs provide consolidated tape data on a cost-plus-margin basis, and can offer complementary, value-added services available on separate commercial terms;
• Define and enforce clear, comprehensive OTC trade reporting requirements to ensure the accurate, comprehensive and timely reporting of OTC data by APAs and OTC market participants;
• All contributors to the consolidated tape should be compensated through a revenue allocation managed by an appointed administrator and overseen by ESMA; and
• An advisory group be established to determine the weightings for revenue allocations in order to recognise the value of contributions to accessible liquidity and other types of information which enhance transparency such as trades which are price forming.

We propose not to respond on most of the commercial aspects of the consultation. While we recognise the commercial challenges, we believe that the provision of a consolidated tape on the model outlined here presents the opportunity to address or avoid many of these challenges. We, therefore, urge policymakers to seek opportunities to enable competition in the provision of data as a means of addressing the transparency challenges as a priority and to continue to promote competition in European markets at all levels.

[1] The Market Model Typology (MMT) standard is managed by FIX Protocol. Reference http://www.fixtrading.com/mmt

[2] Regulation NMS Rule 603c

[3] Known in the US as Electronic Communication Networks or "ECNs"

[4] Trades conducted solely for the economic purpose of tape revenue. There were also amendments made for pre-trade to address "flickering quotes" by weighting allocations partly on the basis of the duration of time at which participants contributed to the NBBO.

Posted 12 September 2019 by David Cook, Executive Director, Regulatory Affairs

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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.