The challenge for liquidity in small stock exchanges and trading portals : the case of the Belgian Stock Exchange

Abstract

The world-wide consolidation in the electronic trading industry has provided evidence that small exchanges and trading portals need to deliver more than sophisticated technology, streaming quotes and market data. In order to deliver value and survive, they need to provide liquidity. Noteworthy among the most recent industry challenges is the dismal performance of exchanges like the Belgian Stock Exchange that finally caved in to the inevitable merger with the London Stock Exchange. The Italian exchange took similar action and so did a number of other small exchanges in the European Union. This development has exacerbated the debate over the need for small stock exchanges and portals to exist unless they can provide both superior technology and liquidity. This paper proposes to examine the performance of the Belgian stock exchange and a select group of portals trading Belgian equities through the metric of liquidity access for fostering trade execution and capital flows. Illiquidity and the dislocation of a number of securities traded on the Belgian exchange are examined using transaction costs and the price impact of trading (as opposed to just asset prices) to explain such lack of liquidity.

Concurrently, the intervention of aggregators of liquidity pools and the rising influence of noise traders (hedge funds) are analyzed to provide a framework for understanding the mechanisms used to attract liquidity. This serves to determine whether portals may continue to attract large pools of liquidity. In closing, we suggest that capital assets are probably not mispriced in markets served by small exchanges, and thus arbitrage opportunities do not exist. Other factors related to timing, anticipation effects and outliers are more significant in determining whether liquidity providers initiate in those markets. The nature of the economies that these exchanges are designed to support is also a contributing factor to the dislocation and disintermediation of capital demand from local firms and truly large global organizations.