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Posted by on in Market Integrity
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Like life, liberty and the pursuit of happiness, many assume that the integrity of securities markets is a self-evidently good thing. IOSCO defines market integrity as "the extent to which a market operates in a manner that is, and is perceived to be, fair and orderly and where effective rules are in place and enforced by regulators so that confidence and participation in the market is fostered."

Others, perhaps more cynical, or more realistic, would say that today's market self-evidently lack integrity. If they did not, the European Commission could not have arrived at an estimate of €13.3 Bn of the cost to investors of abuse of equity markets in the EU alone, for instance. Deliberate market abuse is a major factor impairing market integrity - and is rightly proscribed (though how effectively these proscriptions are enforced is questionnable). However, technical factors, and unexpected systemic behaviour can also impair market integrity. We are not aware of any sensible estimates of the costs due to such factors, but the 2010 Flash Crash offers evidence of their serious consequences.

In this context the current debate over the effects of HFT on market integrity misses the point: the effort and emotion invested in this debate indicates, in IOSCO's terms, that there is a widespread perception - justified or not - that HFT may cause markets to be unfair or disorderly, and hence confidence and participation in the markets is damaged. Without wanting to join this debate we would observe that, if perception is reality, and market integrity depends on perception - as well as objective fact - then HFT has a perception problem, and so do markets that support it.

But while such debates rage, and regulators and legislators get their act together to define and enforce appropriate rules, the world continues to spin, and society needs investors to continue to invest through securities markets. We cannot and need not wait for some perfect system to emerge, even if we could all agree what that system should look like.

Better Execution

So, we have to deal with the world as it is. That means we should not delude ourselves that it is somehow different, or that the consequences are trivial, just-the-way-things-are, or someone else's problem. The cost to investors of neglecting market integrity as a best execution criterion is enormous, as the EC's estimate shows. Conversely, taking market integrity into account when deciding when, where and how to trade creates a substantial opportunity for better execution.

That means when a decision on when, where and how to trade is made, the integrity of the markets - or apparent lack of integrity - should be taken into account alongside "price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order."[1] Buy-side investors should insist on it; sell-side firms should offer it as part of their order execution policy; execution venues should publish data including it[2].


[1] MiFID Article 21, on best execution: a firm must take all reasonable steps to obtain the best possible result for the investor.

[2] The MiFID II proposals will require venues to publish data on execution quality.



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