Fragmentation vs. Competition

Terry Flanagan

Increasing competition has brought about increased fragmentation, and vice versa.

As the markets prepare for a potential 14th equities exchange to enter the landscape, the issue of increasing fragmentation is once again at the forefront.

“The growth in the amount of exchanges is directly an outcome of exchanges trying to innovate,” Gary Katz, president and chief executive officer of the International Securities Exchange, said during a conference at Baruch College. “If an exchange wants to change their matching algorithm from first in-first out to a pro rata model, and offer that to customers, the only way for an exchange in the U.S. to do that is create another exchange. The SEC doesn’t allow an exchange to have two different rule sets for assets they trade, so you literally have to create another exchange. So you see a proliferation of exchanges, as a result of innovation. If you want to tweak your model, you need a new exchange.”

In addition to potentially creating the 14th equities exchange in the U.S., Miami International is also looking to introduce the 10th options exchange. Both platforms would be located in Miami and focus on Central and South American securities.

“With each new exchange, it has caused other participants to step up their game, and offer better technology, better pricing, more transparency and products,” said Katz. “Competition as measured based on the number of exchanges show that competition is alive and well, and the growth of trading volume is a result of that.”

But with the increasing fragmentation, there is the increasing danger of reaching a point where order flow is spread too thin.

“From a macro-economic point of view, there is enough capacity from the exchange and ATS business to satisfy orders many times over,” said Alfred Berkeley from Pipeline Trading Systems. “Competition is good, it increases innovation. But it is also important to recognize that the game continues to change.”

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