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Gulliver, John & Scott, Hal S., International Review of Equity Market Structure Regulation: Phase III: Best Practices for Regulating Equity Market Structure (2021).

Abstract: The research staff of the Program on International Financial Systems (“PIFS”) has conducted a three-phase comparative analysis of international equity market structure regulation in the five major global equity trading markets. The five markets include the People’s Republic of China (including both the Mainland market and the Hong Kong Special Administrative Region), the European Union, Japan and the United States, which collectively represent 90% of global equity trading market volume. This report represents the third phase of our international equity market structure review. In Phase I, we reviewed the regulation of equity market structure in each of the five major jurisdictions. The purpose of this phase was to inform the public and policymakers as to key similarities and differences among the regulatory regimes. In Phase II, we set forth a quantitative analysis of equity trading in the five markets, including a summary of market characteristics, as well as an overview of the performance of each market for investors, measured primarily by institutional trading costs. The purpose of this phase was to assess the performance in each of the five major markets. We found that each of these markets performs well for institutional investors and demonstrates a positive five-year trend. We also noted certain cost differences among the markets. In Phase III, we will assess key similarities and differences between the regulatory structures outlined in Phase I and their impact on performance measures quantified in Phase II. Our goal is to provide policymakers with guidance as to best practices for regulating equity market structure. We list our policy recommendations at the end of the Executive Summary. The first part of Phase III describes the equity market regulations common across all five major markets, each of which contribute to their jurisdiction’s strong performance for investors. These regulations include (i) broker-dealer best execution obligations, (ii) regulation of trading venues, including exchange fees, (iii) public reporting requirements for executed trades, and (iv) volatility controls. We then review the performance of each of the five major markets, illustrating the relatively low transaction costs prevalent in each of the markets. In addition, we note the positive trend in each of the markets with respect to these performance measures. This part concludes by recommending that policymakers in other jurisdictions that lack these regulations implement the four core features of equity market regulation that are common across the five major trading markets. The second part of Phase III notes the differences in average transactions costs among the five major jurisdictions and then discusses key regulatory differences between the E.U. and U.S. markets and their counterparts in Mainland China, Hong Kong, and Japan, including: (i) market decentralization and competition among trading venues, (ii) dark trading as a complement to lit trading, and (iii) electronic, algorithmic and high frequency trading activity. Each of these discussions includes a literature review of empirical research on the link between the specific market characteristic and overall market performance. The E.U. and U.S. markets demonstrate that competition among trading venues, an appropriate balance of dark and lit trading and a framework that facilitates electronic, algorithmic and high frequency trading are key components of transparent, resilient and efficient equity markets. We therefore believe that policymakers should consider creating a regulatory framework to foster evolution of such trading activity. As demonstrated throughout PIFS’ series of reports on international equity market structure, regulations in place in the E.U. and U.S. can provide guidance as to the appropriate regulatory structure. Although certain emerging markets have low levels of liquidity and thus may not yet be sufficiently developed to fully benefit from an immediate transition to trading venue competition, dark trading (as a complement to lit trading) or electronic, algorithmic and high frequency trading, we believe that it is incumbent on policymakers in all jurisdictions to evaluate how their markets could benefit from a modernized regulatory framework that can enhance liquidity and investor outcomes.