The case for market fragmentation in larger developed markets, such as the US, is well understood. Generally, as these markets have fragmented, trading costs have fallen but have also come with additional costs in data and complexity in order-routing. While the quality of the market has improved in the larger, highly liquid stocks, there is compelling evidence that fragmentation has been detrimental to the less liquid counters.

Given this, and the fact that emerging markets are less liquid than dominant global counterparts, there is no clear evidence yet to support the case for market fragmentation or its success, in emerging markets such as SA. ‘Larger global markets have a higher participation from retail clients, an increase in passive activity, separate dark pools or block venues, and [a] much more varied profile of client, whereas in South Africa, we have fairly limited characteristics that drive trading behaviour. Hence, looking towards advanced markets for the success of fragmentation, may be potentially misleading or an unsuitable benchmark to adopt for emerging markets,’ says Valdene Reddy, Head: Equity and Equity Derivatives at the JSE.

Without the technological tools that allow the brokerage industry to transact across different markets, market fragmentation in emerging markets has the ability to in fact erode quality. In many emerging markets, there is either one stock exchange or a single dominant player. By definition, the best quality of liquidity will be found at these dominant exchanges as this is where the greatest number of diversified buyers and sellers resides.

In SA’s case, this is at the JSE. ‘Exchange-market fragmentation is much more complex than simple supply versus demand principles in terms of driving down costs,’ says Reddy. ‘On the surface it may seem fragmentation is about multiple exchanges offering an order matching system at the lowest transaction fee. ‘However, it has much more to do with what this change does to the broader ecosystem of clients in terms of transparency, liquidity, required technology changes and the alignment in compliance and regulation.’ As with fragmentation, this is usually followed by a number of regulatory changes to ensure efficient and fair market practices are still intact.

While the local market has seen the introduction of a number of competitors to the exchange, ‘the JSE strongly supports the fact that these have presented an opportunity for our exchange to challenge itself to become a better and more agile trading environment, enhancing competitiveness in product, service and costs’, says Reddy. Measuring market quality considers many attributes, with cost playing a significant factor as a function of price, trading impact, spreads, liquidity and overall cost of trade as contributors to consider; not just fees alone. Other metrics also support strong quality such as the ease of trading, assurance of settlement, robustness of trading venue and, perhaps most importantly, the depth of the order book.

According to Reddy, the JSE has ‘delivered on its commitment to reduce fees, chiefly through the new equity-tiered billing model introduced in 2018. Not only has this led to a 12% decline in trading fees; it has improved market liquidity as well. It has presented a good opportunity for the JSE to be benchmarked against a similar service platform and [we] believe our clients are seeing the value in the services we offer’.

It has not stopped there. The exchange’s bond electronic trading platform project went live in July 2018, with the equity and foreign exchange derivatives markets migrating onto its MIT trading platform earlier this year. This ensures an improvement in latency (quicker trades), stability and increased flow to these markets.

By Hilton Tarrant
Image: Gallo/Getty images