Level 3 Insights - European and US trading landscapes: how they compare and contrast

First published on Tabb Forum, March 2022

Understanding the key differences in fragmentation, regulation and market microstructure between the US and European equities & ETFs markets improves decision making for global market participants. This is crucial for firms developing new products, providing execution services or conducting market-microstructure research.

In order to remain competitive, European and US Equity & ETF traders need to be aware how these differences can impact on execution analysis and best execution. We’ve used Level 3 data and analytics to help highlight these differences, so firms can get a more in-depth understanding of what is really going on at market level.

Regulatory regimes and tick sizes

To start off, there are some obvious differences between the US and European markets. The US is much larger than Europe, with high levels of lit trading versus other mechanisms. The European market on the other hand cannot simply be thought of as one regime, the separate entities of the UK and Switzerland need to be added in the mix.

The regulatory regimes on both sides of the Atlantic have had a profound impact on both liquidity and fragmentation. Reg NMS in the US and two iterations of MiFID in Europe have led to a proliferation of new trading venues and mechanisms which have created a very competitive, but also very fragmented, equities and ETF trading landscape. Add to this, the non-equivalence (UK and EU) and equivalence (UK and Switzerland) supervisory regimes.

In Europe, fragmentation and competition have also led to new trading mechanisms such as trade-at-last, block venues and conditional order types, as well as the rise of systematic internalisers which have gained significant market share. In the US, whilst dark pool trading exists, trading is dominated by a smaller number of lit venues, such as NASDAQ and NYSE. While these regulatory differences mean there are not necessarily the same types of trading mechanisms across the two, there is still a contention between what is traded on and off exchange.

Different tick size regimes between the two regions affects limit order book liquidity. Whereas the US has a static tick size regime, European MiFID II rules dictate a dynamic tick size policy, in which tick size is adjusted according to stock price. (We recently wrote a blog demonstrating how BMLL Level 3 Data provides better insight into how price change does not necessarily represent a change in liquidity, but rather that market makers are adjusting their positions to keep the same risk profile when the tick size changes, in order to get nearer to the touch.)

In the US, we see different effects between stocks which are more or less tick-constrained, in terms of spread, but also actual numbers of orders sitting around the order book. BMLL Level 3 Data can, therefore, provide information on queue dynamics which could alter the way a participant decides to execute their order, for example, by either breaking the order into child orders, or simply incrementing the price by one tick.

Examining market microstructure of big events

Analysis of BMLL Level 3 Data can also help participants better understand what impact the big events of 2021 had on market microstructure. We’ve used the following two examples:

  • GameStop Short Squeeze: The huge increase in the GameStop share price within a matter of days in January 2021 highlights the potential impact retail trading investors can have on market behaviour. By examining occurrences of insertion and cancellation rates on a minute-by-minute basis (found only in Level 3 data), we can see a classic liquidity U shape in terms of more activity around the start and end of the day, but with an order of magnitude more activity. This historical data is useful, therefore, in understanding and predicting future behaviours in these types of scenarios and puts the phenomenon of retail trading firmly in the spotlight.

  • Geo-political Tensions: To uncover the effect of the war in Ukraine on limit order book behaviour, an analysis of the year-to-date close price of Gazprom observes the impact that the Ukraine crisis has had on that Global Depository Receipt (GDR). We can also compare rising gas prices over the summer to the close price of Exxon in the same period. In contrast to Gazprom, Exxon prices have steadily risen since the start of the year.

Uncovering depth through Level 3 data

For traders to achieve best execution and maximise trading performance, it is essential for them to understand and account for the nuances between the US and European trading landscape, enabling execution desks to enhance order routing behaviour, capture optimal liquidity and achieve best execution. It is only by examining the true depth of the order book - which can only be achieved through analysis of Level 3 Data – that participants can truly understand market behaviour and maximise trading performance.

The themes of this article were covered in a recent BMLL Webinar on the “European and US Trading Landscapes: How they Compare and Contrast”. The webinar is available here.