FEDERATION OF EURO-ASIAN STOCK EXCHANGES
ANNUAL REPORT APRIL 2011
NASDAQ OMX
Market fragmentation poses serious
challenges to the surveillance function.
Lorne Chambers
Head of Sales and Account Management for
SMARTS at NASDAQ OMX
The challenges of cross-market
surveillance
Market fragmentation poses serious
challenges to the surveillance function.
A major concern is that the effectiveness of
a single market’s surveillance efforts is
reduced if it doesn’t incorporate trading
data from all venues into its surveillance
system.The natural consequence is that
effective surveillance becomes more costly
and there is a doubling of efforts across
venues. In more markets, we’re seeing a
single entity, such as a regulator, taking on
the responsibility for consolidated market
surveillance.
Ideally, the price, volume and time of trades
from all venues should be consolidated
and made available to all participants. In the
U.S., equity trades must be reported to a
consolidated tape within a specified period
of time. Trading venues populate their
surveillance system with National Best Bid
and Offer changes and prices from other
venues, providing a view of trade-to-trade
price changes across venues, but even that is
not foolproof.
While the current U.S. consolidated tape
enhances transparency, it only identifies the
trade's price, volume and time. It doesn't
identify the broker that did it and whether it
was done as a proprietary trade or on behalf
of a client. As a consequence, you can’t link
related trades across markets.
Surveillance challenges of market
fragmentation
• Unusual Price Changes: In fragmented
markets, price changes need to be
considered at the consolidated level. The
solution employed in the U.S. is for every
trading venue to populate their surveillance
system with the national best bid and offer
change as well as prices from other venues.
This allows an accurate view of trade-to-trade
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Real-time data provided by data aggregators
is also used to benchmark executions and
make comparisons for surveillance purposes.
However, some market participants find these
products too expensive.
Meanwhile, Europe is one step behind
the U.S. The regulators have established a
pan-European trade reporting system, but
the data is unreliable because the member
states do not follow the same protocols and
standards, and it is an end-of-day system,
not real time.
Better cooperation is needed. Surveillance
departments at exchanges and other
trading venues need to be able to share
sensitive information in a secure manner.
The shared information would only be used
for surveillance purposes, not for commercial
purposes. Given the complexity of this
operation, it will make sense for some trading
venues to outsource it to an entity that has
the expertise and advanced technology to
handle it.
In the meantime, this environment has
made it easier for certain types of market
manipulation to go undetected (see
accompanying box).
price changes across venues, but does not
identify the broker behind a more gradual
price increase in a particular security when a
broker’s trades are spread across venues.
This can only be effectively accomplished by
an entity with a complete market picture, such
as a regulator, since exchanges are unlikely to
allow their competitors to view which brokers
are most active on their markets.
Operational issues can also undermine multi-
market surveillance efforts. Market operators
often respond to high volatility in a single
security by calling a trading halt in that stock
and issuing a price query to the listed
company. This enables market participants to
assimilate newly disclosed information and
allows price discovery to occur through a call
auction. Sometimes, alternative markets
ignore the halt and continue trading, allowing
participants with unfair access to information
to trade before the primary market re-opens.
Conclusion
It is clear that market fragmentation has
reduced the effectiveness of traditional single
market surveillance. Each market can adapt
and import a consolidated view of trading,
identify unusual activity in their data and
compare this to the consolidated data,
but this approach is incomplete. Canada
and Australia have adopted complete
solutions where a single regulator has a fully
consolidated, broker identified, order book of
every security trading under its jurisdiction.
Self-regulated organizations in the U.S. have
strong surveillance capabilities but still require
consolidated data. European markets
recognize the need for consolidated data but
face the added complexity of cross-border
cooperation. Fragmentation is not yet a major
issue in Asia and South America, but we
expect it to be in the future.
• Unusual Volume Changes: Monitoring
security volumes to identify potential disclosure
issues is more difficult in fragmented markets.
An increase in volume on one venue may
be offset by a decrease on another. Only
aggregate volume changes matter, so either
the venues must import other venues’ trades
or a single entity needs to monitor the
consolidated volumes for the venues.