Analysis of market data from a day when a partial outage prevented liquidity providers from accessing a major pan-European exchange has revealed that their absence materially decreased volumes and increased the cost of trading, according to a paper published today by FIA European Principal Traders Association.
The paper, which relates to an outage on the pan-European market in May 2023, points out that simulating such a scenario would have been impossible, making the event a “unique, natural experiment showing the fundamental importance of liquidity providers in European secondary markets.”
FIA EPTA used historic market data from that day to compare standard market quality metrics across both the impacted and unimpacted stocks on the market in question, as well as on Europe’s largest Multilateral Trading Facility (MTF).
Specifically, when liquidity providers could no longer trade on the exchange, the following impact on liquidity could be observed:
- The spread at the Best Bid and Offer of the exchange’s order book was on average 1.059 bps (or almost 14%) wider than the 30-day moving average, representing a material increase in the cost of trading on this exchange.
- Volumes decreased significantly, with the available liquidity at the Best Bid and Offer (BBO) shrinking to less than two-thirds of the historical norm on the exchange.
In practical terms, an investor executing a €5,000 (typical average trade size) order paid a spread 1.68 bps wider than the 30-day average (a 20% increase). For a €10,000 order, the spread was over 3 bps wider (a 35% increase), representing a significantly higher cost of trading for investors.
“The temporary absence of liquidity providers on this market highlights the role these firms play in maintaining healthy, liquid, stable markets. The findings underscore the need for European policymakers to appropriately tailor the regulatory framework to ensure a broad mix of investors and investment firm types, including liquidity providers, are incentivised to participate in secondary markets,” said FIA EPTA Secretary General Piebe Teeboom.
“Features of such an environment should include appropriately tailored and proportionate capital requirements for firms providing liquidity to end-investors, and robust transparency regimes across financial instruments to support competition and healthy price formation,” added Lara Shevchenko, Senior Policy Advisor – Market Structure at FIA EPTA.
Source: FIA EPTA
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