The impact on financial market liquidity of the markets in financial instruments directive (MiFID)

The Markets in Financial Instruments Directive (MiFID), which entered into force on 1 November 2007, implies the abolition of the concentration rule regarding equity transactions so far in force in France. This rule, which was applied to varying degrees across Europe, resulted in the vast majority of order flow being concentrated in regulated markets, and notably in Euronext Paris for shares listed on the French stock exchange. Over the coming years, order flow will become fragmented de facto as a result of being able to execute client orders on regulated markets as well as on multilateral trading facilities (MTFs), and by use of systematic internalisers (SIs), which act as counterparties for transactions in the same way as market makers on price-driven markets such as the London Stock Exchange (LSE) or Nasdaq. The competition between trading venues, which will be enhanced at the European level, has steadily been increasing since the 1970s. Since then, alternating series of regulations and technological progress have gradually weakened the monopolistic position of national regulated markets. The impact of this phenomenon has been a continuous fall in transaction costs, benefi ting investors and issuers of securities through a drop in the cost of capital. However, the fragmentation of order fl ow stemming from a proliferation of trading venues may raise concern about a reduction in market liquidity and a slowdown in the decline in transaction costs, which would run counter to the competitive effect between systems sought by the European regulatory authorities. Although the most conservative medium-term scenarios point to continued dominance by regulated markets, we estimate that in the case of France, a very signifi cant share of order fl ow may rapidly be executed on alternative trading systems. Here, we focus on the impact on “wholesale” transactions, i.e. transactions of at least EUR 50,000, which we attribute to institutional investors. In particular, we identify the portion of these trades currently executed outside the order book. According to our estimates, these transactions constitute roughly 10% of the traded volume on CAC 40 shares and that may be lost to the regulated market each year. This volume, which would more or less equally be distributed between SIs and MTFs operating crossing systems, only constitutes a fraction of the total volume of the wholesale market.