The future of European equity market structure

This report highlights that European equity markets are more liquid and are working better than the complex patchwork of exchanges and post-trade infrastructure along national lines would suggest. It argues that investors have benefited from increased competition and choice over the past decade, and warns that trying to ‘copy and paste’ the market structure in the US onto European markets or winding back the clock on reforms would be counterproductive.

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The starting point for this report is that deeper and more dynamic capital markets are a vital ingredient in supporting growth and competitiveness in Europe. Vibrant and competitive public equity markets are a vital part of effective capital markets and a valuable public good in themselves

At first glance, it may not look like European public equity markets are in a fit state to perform this important function. The structure of equity markets in Europe is a complex patchwork of exchanges and post-trade market infrastructure along national lines that looks parochial compared with the US. The US stock market is four times bigger by value, three times larger relative to GDP, and twice as liquid.

This fragmentation has combined with more competition in how and where equities are traded, raising concerns in some corners that European public equity markets have become less ‘public’ with a larger share of trading taking place away from traditional exchanges, away from trading venues, or in the form of equity swaps.

But the closer you look at European equity markets, the more it becomes clear that they are working better than you might think. Over the past few decades, they have become both more consolidated and more competitive, increasing choice and lowering costs for investors. The evolution of different types of trading in Europe has broadly mirrored that in other markets. The perception of a lack of liquidity in Europe - a hangover from the days when most trading was done on national stock exchanges - is perhaps a bigger problem than the reality. Market participants have adapted to the proliferation of trading venues by applying technology to replicate a much more seamless market at an operational level than the headline market structure would suggest.

This report, published in partnership with Goldman Sachs, focuses on three main issues and feeds into the debate around the EU consultation on market structure and the recent FCA discussion paper on equity markets:

• The complex patchwork and fragmentation of market infrastructure in Europe compared with the more streamlined model in the US;

• The shift in trading patterns between different types of trading mechanism that has been driven by regulatory reform and increased competition in equity markets;

• The balance between the short-term debate (how markets are operating today) and the longer term debate (how they might work in future if current trends continue).

Over the past decade, fragmentation has combined with more competition in how and where equities are traded, raising concerns in some corners that European public equity markets have become less ‘public’ and less attractive to issuers and investors.

We think these concerns are overplayed. Over the past few decades, European equity markets have become both more consolidated and more competitive, increasing choice, lowering costs, and improving outcomes for investors. The perception of a lack of liquidity in Europe - a hangover from the days when most trading was done on national stock exchanges - is perhaps a bigger problem than the reality. Market participants have adapted to the proliferation of trading mechanisms by applying technology to create a much more seamless market than the headline market structure would suggest.

This is a complex area, with many different market participants with different incentives and perspectives playing an important role. This report is an attempt to draw a blueprint in the interest of the wider market to help support the vital role that public equity markets can play in supporting growth, investment, and competitiveness.

1. A fragmented model: across 31 European countries there is a complex patchwork of 20 different exchange groups operating 35 different exchanges for listings and 42 exchanges for trading, feeding into 17 central counterparties for clearing and 28 central securities depositaries for settlement. In the US there are eight exchange groups operating two main exchanges for listing and 17 exchanges for trading, feeding into a single CCP and a single CSD.

2. A surprising consensus: despite this fragmentation there is a surprising degree of agreement across the industry - from exchanges and investment banks, to asset managers and trading firms - that European equity markets are working well, that competition has led to better outcomes for investors, and that European markets are more liquid than you might think.

3. The world has changed: the landscape of public equity markets has fundamentally changed in terms of where and how things are traded (and by whom). The share of trading on primary exchanges has declined to less than a third of all trading volumes, and alternative mechanisms such as systematic internalisers have grown. However, the overall balance between ‘on’ and ‘off’ venue trading has remained unchanged since 2019.

4. Perception vs reality: the increased competition in European markets and shift in trading patterns has brought many benefits (such as more choice, better outcomes, and a lower cost of trading) but has helped feed a perception of a lack of liquidity in European equity markets. This perception is more of a problem than the reality. If you only look at trading on primary exchanges it may look like liquidity is low, but investors can access more than twice as much liquidity as is available on primary exchanges by using other trading mechanisms such as MTFs, periodic auctions, and SIs.

5. Terms of reference: there is short-term debate and a longer-term debate. In the short-term, the increased competition that has been introduced into European equity markets over the past few decades has been a net positive. The shifts in trading patterns are not unique to Europe and (so far at least) have not undermined price formation. There is a more important debate to be had on the longer-term direction of travel: what would happen to liquidity and price formation if current trends continue, and - for example - if lit continuous trading went to zero and was replaced entirely by auctions, equity swaps trading or off order book trading?

6. Improving outcomes: the shifts in trading patterns have been a rational response by market participants to the shifting regulatory framework, economic incentives, and more sophisticated trading strategies. While trading on central limit order books plays an important role in the trading strategies of many investors, it is not suitable for all trading (particularly larger or less liquid trades). Other off order book trading mechanisms - such as systematic internalisers or OTC - provide a greater degree of flexibility for market participants that can better suit their needs and help them meet their best execution obligations.

7. An attractive model? The US model may look seductive to European policymakers. What if all the exchanges in Europe were connected to each other, competed with each other for trading, and had to pass on an order to another exchange if that exchange was posting a better price (known as the order protection rule or OPR)? But a market structure that has evolved over decades to suit the US market is not something you can copy and paste into the European market.

8. The main barriers: while European equity markets are fragmented along national lines and by the increased competition in trading mechanisms, the biggest barriers to more liquidity go well beyond market itself.  The main ‘upstream’ barriers include the fragmentation in national legal and regulatory frameworks, differences in implementation of the single European rulebook, and different tax regimes. The big ‘downstream’ barriers are the high level of fragmentation and low level of competition in post-trade market infrastructure (clearing and settlement).

9. Reforming market structure: there are a number of improvements that can be made to market structure in Europe but it is not a magic wand that will transform European capital markets. The launch of a consolidated tape in the EU and in the UK (probably in 2026 and 2027 respectively) will provide a more comprehensive and transparent view of liquidity across different mechanisms and it will be important to get this right before embarking on more structural reforms.

10. The bigger picture: the main priority within market structure should be introducing more competition in post-trade, such as requiring more interoperability in clearing and more open access to and competition between CSDs. Beyond that European policymakers need to convert their public commitment to reforming capital markets into concrete action, take difficult political decisions to boost demand through reforming pensions and retail investment, simplify the complex regulatory framework, and streamline supervision (potentially bringing trading venues and post-trade market infrastructure under a single supervisor). Above all, they need to inject more urgency into the debate.