Opposing sides

I attended the Danish Securities Dealers Association’s Market Place Seminar in Copenhagen last week and was treated to some lively and interesting discussions. The startling differences between the approaches of the European regulator to the trading environment, and the opinions of the trading community and how it operates to the benefit of the investment community, were clearly illustrated in the presentations given by European Parliament rapporteur Dr Swinburne and Kee-Meng Tan, MD of Knight.

Kay Swinburne stated her belief that market makers should be more tightly regulated and obliged to provide liquidity across the order book for all stocks, not just the most liquid. Kay also touched on the potential regulation of the practice of short-selling, possibly as a pre-trade declaration.

Kee-Meng told the audience that, in his opinion, the cost of stock borrowing for some of the more illiquid stocks already makes the role of the market maker commercially unviable. He stated that the lack of liquidity in second line stocks is the result of the lack of commercially-sensible stock borrowing facilities, leaving the usual liquidity providers unable to provide the services required by the market. My own interpretation of this is that further obligations will not increase liquidity, but will disenfranchise the liquidity providers further and push them away.

Kee-Meng then went on to defend the role of short-selling, presenting it as an essential tool for market makers, allowing them to bridge the gap between buyer and seller. Greater regulation of short-selling would result in wider spreads, a fact borne out when the effect of similar rules in the US are analysed. This is a cost that the investor will have to cover. He went on make it clear that, if the EU regulated the market to the point that the trading risks did not merit the investment by market makers like Knight, then they would not participate any more.

Sabre-rattling? Or is he about to pull back in Europe and focus on Asia to make sure Knight’s investment out there flourishes?

It will be interesting to see whether the role of the market maker in Europe has its lifeblood squeezed out of it, or if common sense prevails and acknowledges that the risk/reward model in which the market maker participates is valuable to the investor.

One Response to “Opposing sides”
  1. steve grob says:

    Interesting post, David – a good illustration of the difference in intellectual bandwidth between regulators and those actually involved in the market. You can’t expect, let alone compel market makers to operate at a loss.

    Probably the best approach to the problem is the limit up/down model adopted in derivatives where stocks cannot jump more than specified set limits each day. Whilst this means it does take longer for “wrong” prices to be worked out of the system is does prevent the wild swings that regulators are so worried about.

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