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WFE Focus February 2011
Fragmentation? No thanks
Peter Clifford
Deputy Secretary General,

The triple disasters that struck Japan this month continue to generate an intense reaction of sympathy and support from people all over the world as they watch the unbelievable scenes unfolding. Japan is considered one of the leading nations both in its care for building codes in earthquake areas and for its concern in nuclear energy. If these misfortunes could happen there, they could occur anywhere. No matter how well technology is used, and no matter what safeguards are in place, their risks are never eliminated.

Long before those events unfolded, the topic of fragmentation had been chosen for this issue of Focus with the cover printed that borrows the old slogan from the anti-nuclear movement : ‘atomic energy, no thanks’. Like the anti-nuclear movement, fragmentation is being resisted by various groups in the markets who are nervous of about new technology.

Fragmentation means different things to different people. Institutional investors consider that fragmentation makes it harder to find liquidity. Regulators are concerned that fragmentation makes it harder to conduct effective market surveillance against market manipulation and abuse. Listed companies fear seeing their shares trade at prices that do not reflect the value of their companies due to technical reasons about order routing that are hard to explain. Strangely for an industry obsessed with performance and efficiency, the costs or economies directly attributable to fragmentation are still obscure and there is no consensus on a figure. However, researchers and academics are beginning to fill this gap.

This month Focus has assembled three recent reports. The excerpt from the joint SEC-CFTC report on the flash crash looks at two prominent features of the way trading takes place in the fragmented US market : internalization of orders by intermediaries that control or purchase order flow, and high frequency trading . This interesting report could increase the intensity of debate about these activities and whether regulatory action is needed. (For the record, only part two of that report is printed here; part one deals more with trading pauses and volatility.) Focus also includes some fresh research on internalization and high frequency traders that have been cited widely in discussions with regulators and market operators.

Daniel Weaver’s paper looks at costs that can be attributed to internalization. In most markets where fragmentation occurs, internalization is large contributor to trading that is hidden from the regulated market.

The Jonathan Brogaard study looks at the impact of high frequency trading (HFT). Again, it provides some hard data on various aspects of this important component to trading on and off exchanges. For example, it challenges the assumption that exchanges are profiting from the rise of HFT with the analysis of the maker/ taker model.

If you would have an opinion on any of the reports or issues raised, please join the World Federation of Exchanges group on LinkedIn and let us know what you think.


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