There Is No Silver Bullet for Market Structure

It doesn’t matter what country you are in, regulators always seem to be reworking rules to make their markets better. The problem is that, often, different market objectives (and their solutions) conflict with each other. 

Today we compare how three major markets have tackled market structure problems. What stands out is that there is no silver bullet for the perfect market structure. 

Different markets protect quote setters, retail and competition differently

Some aspects of markets are consistent regardless of market structure.

• Bids and offers are provided by buyers and sellers.
• Limit orders can help capture spreads, while market orders provide instant access to liquidity.
• Traders are competitive and always profit maximize (or cost minimize).
• Information is important to maximize profits and reduce costs.

However, how regulators solve for these same problems can be very different – even in some of the most sophisticated markets in the world, as Table 1 shows: 

Table 1: Comparing market structure solutions 

Tight spreads are good for investors and issuers

Most regulators seem to appreciate the value of public quotes. Competitive public bid and offer prices lower the spread (trading) costs, add certainty and liquidity to traders, and improve valuations and arbitrage. They can even protect investors trading off-exchange because of best-execution, and monitoring rules, like the U.S. rule 605.

Research suggests that it reduces company costs of capital, which in turn helps finance investments and grow the economy. These are all “good.”

To achieve tight spreads and deep liquidity in lit markets, it’s important that economics (and rules) support those providing competitive quotes. In short, that quote setters actually capture spread or are rewarded for their quotes in other ways.

How the three markets in question have solved for this is very different:

• Canada has order protection rule (OPR), ensuring lit quotes capture spreads before worse prices can trade, and trade-at, putting lit quotes at the top of the consolidated queue unless a dark order meets a minimum size. That ensures they capture spread “first.”
• The U.S. has OPR, ensuring lit quotes capture spreads before worse prices can be traded. The U.S. SIP formula also rewards quotes via revenue share, which are paid to exchanges and that, in turn, helps some exchanges pass on the economics of quote and liquidity provision via rebates and revenue sharing programs.
• Europe has rules that encourage limited bilateral pre-trade transparency. They also force all venues to trade on the same tick-regime, which also requires significant spread improvement to jump existing queues.

Interestingly, Canada switched to trade-at back in 2012. Shortly after, Comerton-Forde (2018) found that the trade-at prohibition reduced retail order segmentation as order flow migrated on-exchange, enhancing lit liquidity. Retail traders receive less price improvement, but their effective spread is unchanged. The authors hypothesized that retail brokers costs increased (exchange fees) while high-frequency traders’ profits increased (from spread capture) at the same time. They also noted in their conclusions that inverted venues gained market share, possibly absorbing the retail order flow migrating away from dark pools as those venues reproduce payment for order flow on exchange. 

Competition brings down prices and brings up innovation

One way that regulators like to control costs, or encourage market improvement, is to allow for competition. Typically, allowing for innovation requires relaxing fair access rules. 

This has typically increased fragmentation, as new venues seek to cater to specific customer group in ways that equal markets can’t. For example: 

• The U.S. has speed bump exchanges and very different rules for off-exchange venues that allow tiering and bundling in dark pools and even trading off-tick in bilateral trades.
• Europe has different rules for multilateral trading facilities, or MTFs (which are exchange-like, with quotes and fair access), and systematic internalizers (which trade bilaterally). They also have more trading in quasi-dark trading venues, such as periodic auctions, cap trading in dark pools, and allow broker preferencing on-exchange.
• Canada has allowed speed bump venues and broker preferencing on-exchange, too.

We show how fragmentation differs across each region in the chart below. The width of the bars shows the market share of each venue. Exchanges are blue, periodic auctions are gray, dark pools are black, and bilateral traders are green. We can see that:

• Fragmentation is far higher in the U.S. and Europe (the height is the count of venues).
• Bilateral trading is banned in Canada (no green), and much larger than dark pools in the U.S. (green area is larger than black area).

Chart 1: Fragmentation and complexity are highest in the U.S. and noticeably lower in Canada

Reducing fragmentation and complexity

The main side effect of adding competitors is the increase in fragmentation and complexity. 

Fragmentation has real costs. The market has more fixed costs. Brokers have additional connection costs. Investors have higher search costs, missed fills and signaling. 

Arguably, complexity benefits smarter, more sophisticated traders. Some research has also found that fragmentation makes latency arbitrage easier, especially in Europe, where distances (and order travel time) are so much larger.

Chart 2: Latency is much higher in Europe

Importantly, segmentation takes away some of the economics of setting NBBO, making it less than a “best” price.  While fragmentation adds distance between where quotes happen, delaying any quotes that a consolidated tape is trying to protect.

Despite that, consolidated tapes are a key way that most markets have tried to solve for fragmentation:

• Canada has a consolidated tape, with trade-at protection, but it excludes venues with less than 2.5% market share, dark pools and speed bump markets. They also ban off-exchange systematic internalizers. That focuses liquidity on lit and larger public venues – while allowing smaller venues to innovate.
• Europe has used dark pool volume caps (with questionable success), and requires all venues to trade on the same ticks, leveling the economics of trading.
• The U.S., to a large extent, relies on the SIP to “reconsolidate” its fragmented market. The SIP even tells slow traders where to route for the best prices, and when trades are happening in the dark. Ironically, SIP also adds to fragmentation via the revenues new exchanges earn just by matching existing quotes.

Interestingly, Canada removed full order protection status back in 2016. There are now 17 trading venues in Canada, of which only seven venues are protected. Foley, Liu, & Jarnecic (2022) studied the partial removal of OPR and observed “that the 2% trading threshold […] for order protection has halted the fragmentation of liquidity in Canada, with no new venues added since the thresholds introduction.”

Clearly, once regulators allow for innovation and segmentation, the concept of “best” prices is also changed. Ironically, the more differentiated liquidity a market creates, the less useful and relevant a public tape becomes.

Protecting investors

One of the key mandates for regulators is often to protect investors.

The most common way to do that is to require brokers to give all customers the best execution (“best-ex”) possible. How that works is different, too: 

• The U.S.: Not only are NBBO quotes “protected” from trade through rules during the day, but there is also a monthly report showing the price improvement (or not) for each marketplace (known as 605 reports).
• Canada: Rules requiring displayed quotes must be traded first, unless a hidden order provides meaningful price improvement - a full tick or mid-point if the spread is at a minimum, which protects investors from trades at worse prices.
• Europe: Has just approved a consolidated tape that could be used to assess trade prices against other prices in the market. However, in contrast to North America, MiFID best ex-rules are very subjective, and allow trade-throughs (trades at worse than BBO prices) if they can be justified. There is no plan currently to require brokers to measure or report their execution quality versus the upcoming EBBO. 

Interestingly, how traders pay for consolidated tape data differs, too.

• Europe seems to be heading toward very cheap data – although regulators have made it clear that, given it is delayed, it should have limited value for traders who send orders (that would, after all, be free riding).
• The U.S. consolidated tape pricing is set subject to SEC approval. It also carries only the data required to trade at the NBBO. Although, there were rules approved years ago to add depth and odd-lot data to the SIP, too (odd lot data scheduled to be included in May 2026).
• Canada also has a utility that compiles a consistent consolidated tape for all. Although the data costs the same as if you compiled a CBBO yourself, the Canadian regulator evaluates data prices based on market share.

Keep calm and carry on?

It’s amazing, really, how different these three modern markets can be. And yet we can see that there are benefits (and costs) to each approach. 

• The U.S. has a simple NBBO with a SIP that recognizes the economic benefits of NBBO data, but the most fragmentation and the most trades that use (but don’t contribute to) the NBBO.
• Canada has a complicated PBBO (with unprotected and speed-bumped quotes excluded) but more explicit rules (like trade-at) that reward lit quotes with spread capture.
• Europe has the most level tick regime but no way of quantifying the actual costs of brokers' routing decisions.

One thing seems clear – there is no silver bullet when it comes to market structure!