The writer is the founder and managing director of New Financial, a capital markets think-tank
When the German Chancellor Friedrich Merz last week called for the creation of a single European stock exchange he highlighted the acute concern that European equity markets were falling further behind the US.
This debate focuses on two main issues: first, that the complex patchwork of exchanges and post-trade market infrastructure along national lines in Europe is fragmenting liquidity. And second, that this is exacerbated by the increased competition between traditional stock exchanges and other types of trading introduced by regulatory reforms over the past few decades, which some argue has gone too far.
However, an upcoming report by New Financial in partnership with Goldman Sachs argues that in both cases, these concerns are perhaps overplayed and that the perception of fragmentation and low liquidity is a bigger problem than reality.
At a headline level, European markets look 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 as European markets. The combined market value of the “Magnificent 7” tech stocks of over $21tn is more than the entire market value of European stock markets.
It is perhaps not surprising that dynamic European companies choose to move to the US market or not go public at all when Europe has more than 35 exchanges to choose from, feeding into 17 different central counterparties (CCPs) for clearing and 28 central securities depositaries (CSDs) for settlement. The US market looks like a model of simplicity in comparison, with — in effect — two exchanges for listings, one CCP, and one CSD.
This structural problem is compounded by the increase in competition in trading introduced by the EU’s Mifid I and Mifid II reforms. The share of trading that takes place on traditional national exchanges has fallen to less than a third in Europe (and scarcely a quarter in the UK). The proportion conducted in the form of “lit continuous trading” — widely seen as the most transparent form of trading — has fallen to just 28 per cent in Europe and 22 per cent in the UK.
Concern over the growing share of less transparent trading was echoed recently by former City minister John Glen, who argued that the decline in “lit” trading risked undermining liquidity and ultimately the attractiveness of UK equity markets. So far at least, it is hard to argue that this has been the case.
In terms of market structure, while Europe looks like a spaghetti junction compared with the US, EU equity markets are working better than you might think. The market has adapted to fragmentation and the consolidation between exchange groups, rise of cross-border trading venues such as Cboe, and increasingly sophisticated order-routing systems create a more seamless market than the headline structure would suggest.
And while the share of trading by traditional exchanges and via lit continuous trading has declined, the overall balance between trading on order books and trading away from them has remained constant in Europe (at 56 per cent versus 44 per cent) since 2019. This split is almost identical to the US market and suggests that more of the shift in trading patterns is within different types of lit trading rather than between lit and less public trading.
The increased competition in trading has provided investors with more flexibility as to where and how they trade, often with a lower market impact, less information leakage and lower overall costs. And while trading on lit venues plays an important role in the European equity market, it is not always suitable for all types of trading. Investors can access more than twice as much liquidity than is available on traditional stock exchanges by expanding the range of trading mechanisms that they use.
The reviews under way by EU authorities and the UK Financial Conduct Authority are a valuable opportunity to recalibrate the current framework and — more importantly — to think about what equity markets should look like in the longer term. But the real challenges facing UK and European equity markets are not so much their fragmentation along national lines or competition between different types of trading, but the lack of deep pools of long-term capital such as pension funds, the prevalence of a savings rather than an investment culture and the byzantine structure of regulation in different markets.
If Merz and other European leaders really want to close the gap with the US, trying to create a single European stock market or clamping down on competition in trading is not the place to start.
