Latin American Capital Markets

496 KENROY DOWERS, RUBEN LEE, AND ANTONIO VIVESThere is frequently regulatory concern about the perceived problem of fragmentation.There are three main reasons, however; why concerns about fragmentationarising from the existence of multiple dealing systems are likely to be misplaced. 6First, the experience of competition between trading systems in the equity marketsof both Europe and the United States has been unequivocally positive. It has led tolower transaction costs, increased the efficiency and quality of trading systems, andaugmented liquidity. It has encouraged the use of better technology in trading and hasprovided an incentive for trading systems to enhance their product lines. Finally, it hasallowed different types of trading systems to come into existence to satisfy the needsof disparate types of traders.The second reason why fragmentation is unlikely to lead to adverse outcomesis that, notwithstanding the current proliferation of trading systems, there is apowerful reason why trading in any particular class of assets is likely to be concentratedon a single dealing mechanism or at most a small number of competing systems.Successful trading systems benefit from a positive network externality, in thatthe likelihood of a market participant receiving an execution of an order on a tradingsystem is higher if other participants also send their orders to the trading system.Order flow thus attracts further order flow, and only a few of the best competingtrading systems are therefore likely to survive.The third reason is that the private sector is likely to provide solutions tomost of the problems of fragmentation. In a market with multiple trading systems, akey regulatory question is whether some form of infrastructure linking the tradingsystems should be required. The two most important types of linkage are an orderroutingfacility and a vehicle to consolidate price and quote information. Both typesof mechanisms are likely to be provided by the private sector In Europe, for example,where competition between the London Stock Exchange and Virt-X for tradingthe same securities has occurred, various data vendors have combined the data feedsfrom the London Stock Exchange and Virt-X to provide a single screen on which allcompeting orders may be ranked against each otherMany different types of barriers to competition in securities markets may beestablished, which could harm market development. The taxation of transactions insecurities markets, for example, can impose significant disincentives on trading forboth local and foreign investors. Such taxation can take many forms, including repa-6 This and the next few paragraphs draw on Lee and Qin (2002).Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub