60 Seconds with…Thierry Foucault, HEC, Paris

 

1. As an independent observer, what are your thoughts on the Plato Partnership project and their aims more generally?

Financial markets are experiencing tremendous changes in the way trading is done, such as the rise of algorithmic and high frequency trading, new rules regarding best execution, the growth of dark pools, the centralization of trading in derivatives markets, the advent of big data etc. These changes raise new challenges for the industry. Coordinated efforts between the buy side and the sell side, such as the Plato partnership, to respond to these challenges are very important. The Plato partnership project is an opportunity to assess collectively, from different angles, what works and what does not in current market structures and find ways to improve the functioning of financial markets. Ultimately, this should benefit end-users by reducing execution costs.

There is a lot of on-going academic work on these issues, in particular by researchers working in the field of market microstructure. Changes in market structures (e.g., changes in market transparency) and their effects on liquidity, volatility etc. are systematically and continuously assessed and analyzed by academics in this area. This line of research has considerably enriched knowledge about securities market design and informed regulators and industry participants for their decisions. The Plato Partnership’s Market Innovator (MI3) is a very good opportunity for academics to share their insights on market structures with Plato members, get feedback from the members on their research and collaborate with them on better ways to organize trading in financial markets.

 

2. How did you first hear about Plato Partnership’s Market Innovator (MI3) and what were your motivations for getting involved?

I think I first heard about the partnership through conversations with some members of the partnership. I like sharing views and confronting my ideas with people in the industry as this is a good way to get new research insights and cross-check the validity of research findings. I am also a member of the CEPR, which organized the inaugural Plato Partnership MI3 academic conference, Evolving Market Structure in Europe and Beyond, in conjunction with Imperial College London in June 2017. I was therefore informed by CEPR about this event and decided to submit one of my research paper to the conference as I thought it was a good opportunity to get feedback from participants and to learn more about the Plato Partnership.

3. What role do you think academia can play in the development of global market structure?

I see at least two ways in which academics can contribute to the development of market structures and the Plato partnership’s Market innovator (MI3).

First, they have developed a set of tools to predict and assess effects of changes in market structures. Applying these tools, they can therefore contribute to independent assessments of changes these changes. Let me take an example. There are debates about the transparency of trading in corporate bond markets in Europe and in the U.S. In 2002, the U.S. bond markets became more transparent with the implementation of a post trade price reporting system called TRACE (the Trade Reporting and Compliance Engine). This new system raised questions by industry participants and regulators about whether or not it would contribute to make bond markets more liquid. Several academic studies have carefully analyzed the effects of TRACE implementation on trading costs in bond markets, reaching the conclusion that in general these costs declined after the implementation of TRACE. This is a very good example of how independent academic assessment of changes in market structure can shed light on debates regarding the best way to organize markets. Moreover, lessons of such studies have broader implications (e.g. one can get insights from studies about post trade transparency for the potential effect of a consolidated market tape in Europe).

Second, academics can help to bring in innovations in market design. For instance, there are debates about whether trading is too fast in electronic markets. One problem in particular is that limit orders have become increasingly exposed to the risk of being picked off by very fast traders when news arrives. This evolution raises an interesting question about market design: how to change the current market structure to alleviate this problem while not destroying potential benefits of fast trading? Economic analysis can be very useful here to find innovative ways to address this type of issues. For instance, academics can compare, both in theory and empirically, the relative merits of speed bumps or batch auctions, two solutions that have been recently proposed to the previous problem.

Let me take another example. There are debates about the role of make and take fees in electronic markets and the SEC is now considering running a pilot experiment to assess the effects of these fees. These debates are very complex because make and take fees often interact with other dimensions of the market structure (e.g., rules regarding how orders should be routed, rules regarding best execution etc.). A basic question is to identify under which minimal conditions maker/taker fees could play a useful role, for instance, by enhancing liquidity. Once these conditions are identified, it is easier to identify other distortions that might prevent make/take fees from efficiently playing their role. I have recently worked with various colleagues on this question. We showed that the price grid used by trading platforms is very important. That is, in the presence of price discreteness, make and take fees can enhance liquidity. Our papers on this topic use economic theory and abstract from many relevant factors in the real world. Yet I think they can be useful (I hope) to guide the debates on these fees in more complex environments.