European regulators should incentivize Liquidity Providers into secondary markets, says FIA

Rick Steves

Features of such an environment should include appropriately tailored and proportionate capital requirements for firms providing liquidity to end-investors, and robust transparency regimes across financial instruments to support competition and healthy price formation.”

A recent paper published by the FIA European Principal Traders Association has shed light on the crucial role of liquidity providers in maintaining efficient markets, as evidenced by a unique event in May 2023: the hacking of ION Markets.

During a partial outage that barred liquidity providers from the major pan-European exchange, significant impacts were observed: trading volumes plummeted, and the cost of trading surged. This incident served as an involuntary experiment, highlighting the indispensable function of liquidity providers in European financial markets.

Liquidity Providers need appropriately tailored and proportionate capital requirements

The paper meticulously compared market data from the day of the outage with historical averages, revealing a notable widening in the spread at the Best Bid and Offer (BBO) by approximately 1.059 basis points or almost 14%, significantly elevating trading costs. Additionally, liquidity at the BBO dwindled to less than two-thirds of the norm, with an investor placing a typical €5,000 order facing a spread 20% wider than the 30-day average, and for a €10,000 order, the spread widened by over 35%.

FIA EPTA Secretary General Piebe Teeboom said: “The temporary absence of liquidity providers on this market highlights the role these firms play in maintaining healthy, liquid, stable markets. The findings underscore the need for European policymakers to appropriately tailor the regulatory framework to ensure a broad mix of investors and investment firm types, including liquidity providers, are incentivised to participate in secondary markets.”

Lara Shevchenko, Senior Policy Advisor – Market Structure at FIA EPTA, commented: “Features of such an environment should include appropriately tailored and proportionate capital requirements for firms providing liquidity to end-investors, and robust transparency regimes across financial instruments to support competition and healthy price formation.”

FIA launched  Cyber Risk Taskforce after ION Markets hack

The ION Markets hack last year, attributed to the Russian-linked LockBit ransomware gang, significantly impacted financial institutions by forcing several European and U.S. banks to revert to manual processes for some derivative trades. This cybersecurity incident affected at least 42 of ION’s clients, highlighting the vulnerability of financial infrastructure to cyber threats.

In response, regulators and industry bodies swiftly took action to mitigate the impact and address cybersecurity concerns. The UK’s Financial Conduct Authority (FCA) engaged with affected firms and worked with counterparts to support the financial services firms impacted by the incident, despite ION not being directly regulated by the FCA. The US Treasury Department downplayed the systemic risk posed by the attack but acknowledged its impact on smaller and mid-size firms, emphasizing ongoing communication with key financial sector partners.

Following the attack, FIA announced the formation of a global Cyber Risk Taskforce to review the incident and develop recommendations to enhance market resilience. This taskforce aims to assess existing cyber protections, the effectiveness of the industry’s initial response, best practices for reconnection, and safeguards around third-party service providers, with the goal of releasing an initial report detailing these findings and recommendations.

The CFTC also acknowledged the incident’s impact on clearing members’ ability to provide timely and accurate data, resulting in delays in the submission of required regulatory reports. The CFTC worked with other regulators, market participants, and impacted parties to understand the issues and ensure the integrity of the derivatives markets was maintained.

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