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Regulatory-driven market fragmentation

‘Market fragmentation’ has been the key theme at both the Australian Securities and Investment Summit that followed the IOSCO Annual Meetings, and the Refinitiv Australian Regulatory Summit.

Last week, the International Organisations of Securities Commissions (IOSCO) released a paper looking at regulatory-driven market fragmentation. The report, Market Fragmentation and Cross-Border Regulation, follows up on the 2015 Task Force Cross-Border Regulation report, and addresses many of the remaining issues in cross-border regulation.

Much of the current work in that area looks to redress market fragmentation that may have been driven by post-global financial crisis reforms, and last week, the Financial Stability Board (FSB) also published their own paper, the FSB Report on Market Fragmentation. At the Refintiv event, ASIC Commissioner Cathie Amour told attendees that the FSB’s report was the result of two roundtable sessions on market fragmentation and cross-border regulatory experiences since 2015.

One of the IOSCO report’s key findings is that regulators have been aware of the risks of unintended market fragmentation. The result of that has been greater collaboration between members of the IOSCO.

According to the IOSCO report:

Deference between regulators through the use of cross-border regulatory tools, particularly those identified in the 2015 Report, has increased significantly. Bilateral arrangements in the form of Memoranda of Understanding (MoUs) are now a common tool used by regulators, particularly with respect to information exchanges. And regulators have developed novel processes to work multilaterally to the benefit of the markets they oversee.

Where deference may not be appropriate and might do more to perpetuate the issue of market fragmentation, IOSCO has positioned itself as forum to facilitate the exchange of information for its members about different jurisdictional approaches to cross-border regulation.

Interestingly, the report highlights that not all forms of market fragmentation are ‘bad’, and in fact poses some benefits when it is ‘tailored to fit the unique circumstances of domestic markets’:

Such benefits could include instances where regulatory developments may fragment markets in a way that also strengthens resilience, stability and investor protection or enhances competition to the benefit of the markets and consumers. For example, the enactment of the Markets in Financial Instruments Directive I (MIFID I) abolished the “concentration rule”, meaning that EU countries could no longer require investment firms to route orders only through national stock exchanges. This allowed for cross-border trading competition across the EU.

The report goes on to look at how to deal with over-the-counter trading, extra-territorial regulation like the General Data Protection Regulation (GDPR), and the Markets in Financial Instruments Directive (MiFID).

The report also addressed areas of future focus. BREXIT is an obvious area of concern in this space as it will not only effect European jurisdictions but will require each jurisdiction to look for their own IBOR benchmarks.

Emerging sectors is another area examined by the report, especially in the context of rapid financial innovation, its derivatives, and market infrastructure.

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