Market Dominance and Barriers to Competition in Financial Trading Venues

The Market in Financial Instruments Directive (MiFID) aims to increase competition and to foster client protection in the European …nancial market. Among other provisions, it abolishes the concentration rule and challenges the market power of existing trading venues. The directive introduces venue competition in order to achieve better execution and ultimately lower trading costs. In this paper I address the question of whether fostering competition between alternative trading venues alone may or not be able to impact actual competition in the market. I consider two reasons for why it may not: direct network e¤ects together with increasing returns to scale, and post-trading constraints. In particular, I (a) evaluate the actual degree of competition between trading venues, (b) measure the impact of network e¤ects on competition, and lastly (c) assess the barriers to competition induced by post-trading constraints. The results imply that …nancial intermediaries tend to value liquidity more (than total fees) when deciding where to route a given order for execution implying that being the incumbent venue translates into a competitive advantage. Furthermore, eliminating the mentioned barriers to competition seems to be asociated with a signi…cant decrease (of a similar magnitude) in the assymetry of the industry. JEL Classi…cation: C13, G10, L11, L84 Keywords: Market Dominance, Network E¤ects, Financial Trading, Demand, Barriers to Competition STICERD, London School of Economics, Houghton Street, London WC2A 2AE, UK. Tel: +44 20 7955 6690. Fax: +44 20 7955 6951. Email: [email protected]. http://personal.lse.ac.uk/ribeiror/. Thanks are due to Peter Davis and John Van Reenen for their guidance and continuous help as well as to Kevin Gouder, David Lawton and Carlos Santos for helpful comments and suggestions. I gratefully acknowledge …nancial support from the NET Institute (www.netinst.org) and the Kau¤man Foundation.