Changes in market-making: impact of technology and regulation

Peng Zhao

Financial Stability Review, 2018, issue 22, 83-98

Abstract: Market makers perform an essential role in financial markets by facilitating price discovery and providing liquidity to buyers and sellers who would not naturally interact. In recent years, technological innovation and forward-looking regulatory reforms have shown their potential to improve market-making capabilities and yield a more competitive landscape, benefiting investors through better pricing and more sources of liquidity, all at a lower overall cost to the financial system. These enhancements yield a lower cost of capital for businesses and governments, and better returns for private and public savings programmes. Technological innovation has transformed markets, which have become more reliable, efficient, and cheaper to transact in. A new generation of market makers has emerged, using predictive analytics and modern risk management techniques to enhance price discovery and liquidity provision. However, in many parts of the fixed income, currency, and commodity (or FICC) markets, legacy structural barriers and frictions persist, impeding competition between new entrants and incumbent intermediaries. Certain forward-thinking regulatory reforms in the FICC markets - notably related to clearing and settlement, non-discriminatory access to trading venues, and real-time post-trade transparency - have begun to unlock greater competition, but the potential for further progress remains. Policy measures that promote fair, open, and transparent FICC markets will foster more competition and greater diversity in the market-making community, providing better pricing and liquidity to investors and contributing to resilience in times of stress.

Date: 2018
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