Regulatory reforms and developments in information and communication technology

have increased competition between different types of stock trading venues. The result
is fragmentation in two dimensions. First, we find extensive fragmentation of trading
between stock exchanges and off-exchange venues, such as alternative trading systems
(ATSs) and multilateral trading facilities (MTFs). Second, we also find an increased
fragmentation between dark (non-displayed) trading and lit (displayed) trading.
In 2015, two thirds of all stock trading in the United States took place on 11 different
exchanges and the remaining 33% on numerous off-exchange venues. Of all trading, 42%
was in the form of dark trading, of which about one-fifth was carried out on exchanges.
In the European countries, 

around 50% of all trading takes place on exchanges and the
rest on off-exchange venues. The amount of dark trading in Europe varies across
countries from 35% to 48% of all trading.
Off-exchange trading and dark trading have often been seen as a way for investors to
reduce the market impact that could occur if they place large orders on a stock exchange.
However, our analysis of trading data for the United States indicates that average order
sizes do not differ significantly between off-exchange venues and traditional exchanges.
Fragmentation does not seem to have affected the distribution of trading in large and
small company stocks. Moreover, the distribution of trading in large and small company
stocks is fairly similar in countries with fragmented trading venues and countries where
trading is concentrated. Since 2000, trading in the 10% largest companies has accounted
for 70-90% of all trading, both in the United States and Japan.
The main concerns with respect to increased off-exchange and dark trading are the
quality of the price discovery process, the fairness of markets, and the level playing field
among investors. Together with recent enforcement actions against some dark pools,
this has opened up a discussion about the rationale for existing differences in regulatory
regimes between trading venues that seem to serve similar functions.
Looking ahead, it is likely that regulatory initiatives in both Europe and the United States
will come to focus on regulatory convergence between exchanges and off-exchange venues.
It remains to be seen what the effects will be in terms of stock market fragmentation.
From a company’s perspective, there are two characteristics that make equity capital
different from other forms of capital that the company can use. First, providers of equity
capital (the shareholders) are not guaranteed any fixed interest rate or any given rate of return
on the money that they invest. Second,

 once the equity capital is provided to the company,
shareholders cannot withdraw their individual stakes. These characteristics mean that equity
capital is crucial to, and particularly well suited for, long-term corporate investments that have
an uncertain outcome, such as research, innovation and the development of new technologies.
Based on firm-level data, Chapter 2 also demonstrated that greater equity financing in
relation to debt is essential to promote the long-term focus that is needed for productivity
growth. It showed that a higher debt-to-capital ratio was negatively correlated with
productivity growth. A recent OECD report (Cournède et al., 2015) addressed the use of
equity at an aggregate level, highlighting the role of equity for overall economic growth.
The report noted that while an increase in outstanding bank credit was associated with a
reduction in long-term growth across OECD countries, further expansion of equity
financing was likely to promote economic growth.
There are a number of different sources of equity capital, including the founder’s
initial equity capital and the retained earnings that are re-invested in the company rather
than taken out in the form of dividends. Importantly, a company may also raise equity in
the capital market. And since 2000, companies around the world have used public stock
markets to raise a total of USD 11 trillion in equity.
During this period the stock exchange industry has experienced profound structural
changes. Most traditional stock exchanges have either been acquired by another entity or
become subsidiaries of an upstream parent company. The ultimate parent company of an
exchange may in turn be a public company with its shares listed and traded on one or more
of its own stock exchanges. As part of this transformation many of the national stock
exchanges today form part of an international group structure.

 At the same time, public equity markets have also been characterised by fragmentation
along two lines. First, there has been a fragmentation of trading between stock exchanges
(on-exchange trading) and other trading venues (off-exchange trading). Second, there has
been a fragmentation between lit (displayed) and dark (non-displayed) trading. Among the
driving forces behind these fragmentation trends are advancements in information and
communication technology, supported by regulatory reforms aiming to promote
competition between different trading venues.
This chapter describes the features and functioning of this new stock market
ecosystem. It also discusses how developments may have influenced access to equity
capital for smaller growth companies and concerns that have been raised with respect to
market fairness and a level playing field among equity investors.

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