Safeguarding market integrity: Getting the UK’s equities consolidated tape right

Reforms to the UK’s capital markets over the past five years have achieved an incredible amount, from simplifying the rules for stock market listings to reducing costs for firms trading bonds and derivatives. 

The goal behind these once-in-a-generation changes has been to answer critical questions for the country: how can the capital markets – a finely tuned engine of the economy - support the UK as the best possible place to start, grow, scale and sustain businesses? And how can we ensure that our markets deliver for UK investors, pensioners, policy holders and savers over the long term? 

This is fundamental to the nation’s growth and our shared prosperity.

However, many of the reforms delivered so far have focused on the rules for companies listing, not the rules for how shares in those companies are traded. Yet when it comes to it, ensuring that the UK remains one of the world’s most attractive, transparent and efficient places to trade shares – as it has been in its different guises for hundreds of years – should be the top priority. 

Unfortunately, the UK now sits near the bottom of international league tables for the proportion of trading that happens on so-called “lit” exchanges - open venues where transparent bids and offers are displayed in real time. That matters, because credible price formation is the foundation that every investor and every listed company relies on. 

This has happened in part because the FCA has made it easier than its regulatory peers in Europe or the US for trades of standard market size or less to move away from “lit” venues and into off-exchange mechanisms where there is far less price transparency for the market as a whole. The process has accelerated over the past decade as major banks and proprietary trading houses, in part through their trading platforms known as “Systematic Internalisers”, have come to dominate trading. 

Left unchecked, market structure will keep drifting in the direction it has for years because we have a classic prisoner’s dilemma, with each market participant relentlessly focused on optimising their own individual outcomes and lobbying regulators for maximum flexibility in how trading occurs (for example, by avoiding lit exchanges). However, when everyone does this, it undermines transparent price formation and weakens the overall health and competitiveness of UK capital markets - leaving everyone worse off in the long run.

As liquidity fragments across a growing web of off-book venues and bilateral mechanisms, trading becomes harder to navigate, and true “lit” liquidity becomes harder to see. That feeds directly into the IPO competitiveness debate: if global investors think London is less liquid than it really is, they will price that risk in - or take their capital elsewhere. In time, it can become a vicious cycle that steadily undermines the UK’s status as a highly liquid market, undermining a core national policy objective.

To address some of the complications – created in part by some of its previous actions – the FCA is now considering introducing a ‘pre-trade’ consolidated tape for UK equities: a single feed that aggregates buy and sell orders visible on “lit” exchanges so that prices and volumes can be referenced more easily across the market.

But a pre-trade tape – which provides data on bids, offers and volumes before any trade has taken place – only strengthens integrity and transparency if all market participants contribute to it. If participants are able to see prices on the tape, but do not themselves have to contribute to the tape’s data by sharing their own prices and volumes, there is a ‘free-rider’ problem: participants can benefit from the transparency the tape offers but are not obliged to contribute to that transparency.

It is a little like playing cards with someone who wants to see what everyone else is holding but keeps their own hand close to their chest. This is sometimes framed as an argument about protecting an incumbent; in reality, it is an argument about preventing a framework that lets some participants use transparency without contributing to it.

Among those who want a pre-trade tape but are reluctant about having to contribute to it are many of the Systematic Internalisers. They like the idea of being able to see what prices are available across all “lit” venues, but don’t want to have to say what prices they themselves would be prepared to offer or take. 

Yet if they don’t participate in the tape, it threatens the very purpose the FCA hopes the tape will serve – to bolster UK market transparency and liquidity. To be clear, the London Stock Exchange is not opposed to a pre-trade tape in principle. However, four critical tests must be passed first.

First, how do we ensure the tape captures enough activity to stay useful? Venues and mechanisms that claim to be price forming should be required to contribute to the tape. If firms can use it but never contribute their trading activity to it, it will inevitably become less useful over time. 

Enhancing market integrity is a core aim for the FCA so regulators will be aware of the potential risk of a pre-trade tape that does not have sufficient contributors. However, it is vital that these provisions are built into the terms of its ‘pre-trade’ tape tender, which is due to be published by the FCA in the coming weeks. Once the consolidated tape becomes operational, it will be too late to mitigate any unintended consequences, including the erosion of UK “lit” markets. That would risk causing real damage to market integrity at a critical and sensitive time.

Second, if market participants rely on the pre-trade tape for pricing, how do we ensure it is operationally resilient? “Lit” venues invest millions each year in resilience; a tape that is “cheap to deliver” is not automatically “safe enough to depend on”. It is essential that the FCA focus on resiliency and not just on the cheapest way to deliver the tape. This changes the economic viability of such a pre-trade tape, however.

Third, how do we ensure that the tape does not become a mechanism whereby the speed of the venues’ feeds and the speed of the tape can be arbitraged to the benefit of a few? There is no proposal from the FCA to mitigate this risk. It is not a minor issue. Indeed, Michael Lewis wrote a whole book about it ….

Fourth, the consolidated tape framework should include revenue-sharing arrangements that compensate the venues that actually create the reference price. Lit venues underpin price formation and invest heavily in surveillance and resilience; if the tape relies on that value, it should not simply extract it without proper safeguards or compensation, including a fair approach to contribution and meaningful revenue sharing.

These four key considerations have often been reflected in jurisdictions that have introduced a consolidated tape. While the US and Europe both have very different market structures to the UK, each has more protections for market integrity. The UK’s current approach would make it an outlier – and we should not seek to be an experiment in testing market integrity. Rather, at a time when there is the potential for markets to move to 24/5, regulatory priorities should lie in preparing for a smooth transition to the future state of our markets. 

We share the same goal: markets that are open, accessible, and transparent – where price formation is efficient and resilient. Public policy and regulation must recognise that there is a risk to market integrity, and ultimately to the national interest, if innovations like a pre-trade tape are not introduced within the right framework. It is also the case that introducing a damaging framework and assuming that any breakage to the system can be corrected afterwards may be playing fast and loose with market integrity. 

If the FCA is not prepared to proceed with caution and protect market integrity, it may be essential to ask the Government to step in instead. 

Public policy in this area should be determined by what is in the national interest, what enhances market integrity, and an awareness of what risks should not be taken. In LSEG’s view, a post-trade tape is the more prudent and pragmatic place to start. It would give an authoritative view of total daily market volume in each stock, so that UK liquidity is not understated and global investors can allocate with greater confidence. Better visibility supports better outcomes: for issuers, for investors, and for the competitiveness of London as a listing venue.