Market Dominance and Barriers To Competition in Financial Trading Venues

The Market in Financial Instruments Directive (MiFID) aims to increasecompetition and to foster client protection in the European financialmarket. Among other provisions, it abolishes the concentration rule andchallenges the market ower of existing trading venues. The directiveintroduces venue competition in order to achieve better execution andultimately lower trading costs. In this paper I address the question ofwhether fostering competition between alternative trading venues alonemay or not be able to impact actual competition in the market. Iconsider two reasons for why it may not: direct network effects togetherwith increasing returns to scale, and post-trading constraints. Inparticular, I (a) evaluate the actual degree of competition betweentrading venues, (b) measure the impact of network effects oncompetition, and lastly (c) assess the barriers to competition inducedto post-trading constraints. The results imply that financialintermediaries tend to value liquidity more (than total fees) whendeciding where to route a given order for execution - implying thatbeing the incumbent venue translates into a competitive advantage.Furthermore, eliminating the mentioned barriers to competition seems tobe associated with a significant decrease (of similar magnitude) in theasymetry of the industry.