# **Box 6:  Synopsis of regulatory framework for different methods of trade-execution**

**_<mark>New developments in EU financial trading:</mark>_**

<mark>The following technology-driven trends have transformed the financial trading landscape:</mark> <mark>1.</mark> <u><mark>inter-exchange competition:</mark></u> <mark>the era of utility-run stock exchanges, acting as a single uncontested national liquidity-point, is gone. Profit-driven exchanges are now competing directly for order flow and listings, seeking to expand activities through cross-border mergers or vertically integrating along the clearing and settlement chain;</mark> <mark>2.</mark> <u><mark>competition from alternative trading systems</mark></u> 38 <mark>: new entrants are providing alternative venues for own-account trading by institutional and professional investors. These systems are now the principal organized trading venues for bond trading. However, they account for only one percent of equity trading volumes in the EU (a much lower share of equity transactions than in U.S.);</mark><sup>39</sup> <mark>3.</mark> <u><mark>increased internal execution of client orders within investment firms: the concentration of</mark></u> <mark>brokerage in the hands of a diminishing number of investment firms and banks is creating a situation in which large volumes of client orders can be executed “in-house” – either by crossing one client order against another or executing against proprietary position of broker-dealers. A diminishing balance of retail investor orders that cannot be executed internally is routed to exchanges for execution. This practice is well established in jurisdictions which have not introduced a “concentration rule”: in these countries, available information suggests that many large institutions are currently internalizing between 15-30 percent of client order flow.</mark> Source: EC Commission November 2002 Therefore, the 2002 ISD Proposal seeks to establish a coherent and risk-sensitive framework for regulating the main types of order-execution arrangements currently active in the European financial marketplace. It aims to create a situation in which trading interests, regardless of the medium through which they are expressed or where they are located in the European Union, are able to interact with each other on a cross-border basis in real time, so that liquidity is fully responsive to price differentials.

Central to realization of these goals is a comprehensive set of rules requiring transparency of trading information. This regime encompasses all main categories of execution method for equities transactions – regulated markets, MTFs, and off-exchange execution by investment firms. These transparency obligations aim to allow the effective, real time, cross-border interaction of trading interests without which a single financial market cannot be said to exist. This regime will also permit competition and innovation in trade-execution, or services that include trade-execution, without jeopardizing efficient price-formation. It will do so in a manner that promotes the disclosure of as much trade information as is possible, taking account of the fact the same degree of transparency is not suitable for all business models. This transparency regime will be an important guarantor of the fairness and efficiency of EU financial markets, and

> 38 The term “alternative trading system” (ATS) has entered into common parlance as a catch-all term for a wide range of new trading support facilities whose shared characteristics are that they are not licensed as exchanges. Some respondents to the consultation have noted that this terminology is not suitable for a legal text and does not capture the specific functionality of the entities which it is proposed to authorize as a new core service.  In view of this, the term “alternative” has been replaced by “multilateral.”  The word “system” is replaced by “facility” to avoid confusion with a well-established bond-trading outfit.

> 39 J.P. Morgan, 2002.

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