3rd CEPR-Imperial-Plato Market Innovator (MI3) Conference 2019
Do We Need Electronic Stock Dealers?
Fatemeh Aramian (Stockholm University)
Lars Nordén (Stockholm University)
Lars Nordén is Professor (Chair) of Finance at Stockholm Business School. He holds a PhD in Economics from Lund University. Professor Nordén’s research agenda is focused on securities trading, liquidity, and financial market structure.
About the paper
This paper explores the practices and costs associated around stock transactions with electronic dealers. It outlines the role of stock dealers as investment firms that trade from their own inventories by initialising trades off exchange, and analyses the their use by traders and how much the service costs.
In line with the broader theme of SIs across the conference, the paper makes specific reference to SI dealers, tracking their increased use via the Fidessa Fragmentation Index. The paper goes on to trace the use of exchanges against SIs, via exchange figures, the CBOE Trade Reporting Service and Refinitiv Tick History (RTH).
The research is focused around three main questions: What determines a trader selecting and independent dealer (like an SI) against an exchange; how much does sourcing liquidity from an independent dealer cost; and who needs independent dealers (informed or uninformed traders) within the European equity market.
The paper finds that MiFID II has spurred on the rise of SIs significantly, with their market share of European stocks rising from 2% to 20%. Trades undertaken via SIs have higher average effective spreads, realised spreads and a lower overall average price impact.
The key conclusions drawn are that traders use dealers when trade size is large, tick size is binding in the exchange limit order books or the exchange order book depth and spread are high. It also finds that uninformed traders are more likely to trade through dealers, and that dealers are more costly than exchanges.
The paper breaks down the key features of SIs and Exchanges. SIs have pre-trade transparency only up to standard market size, are exempt from the MiFID II tick size regime, are non-anonymous and offer flexibility in post trade transparency. Exchanges require pre-trade transparency for all order sizes, must follow the MiFID II tick size regime, anonymous trading and all trades are immediately reported.
It also suggests that there needs to be significantly more research into competition between SIs and exchanges is this post-MiFID II period as it will provide a strong indication of outcomes of the regulation while providing insights into future regulatory decisions. For dealers and exchanges, further research would provide them with better insights into trading structures, allowing more informed decisions around competition between each other. For traders, it would help enable better execution quality for participants across both dealers and exchanges.
Images: Muhammad Ashraf ©2019