1. Exchange Trading Rules Douglas Cumming Schulich School of Business York University, Toronto, Canada Sofia Johan Tilburg Law and Economics Center (TILEC) Tilburg University, The Netherlands

2. Research Question Vague versus detailed rules Vague versus detailed rules Context: equity stock exchanges Context: equity stock exchanges Do detailed trading rules facilitate trading? Do detailed trading rules facilitate trading? Enhance investor confidence that the risk of manipulation has been mitigatedEnhance investor confidence that the risk of manipulation has been mitigated

3. Prior Work Aitken and Siow (2003 Hewlett-Packard Handbook of World Stock, Derivative & Commodity Exchanges) Aitken and Siow (2003 Hewlett-Packard Handbook of World Stock, Derivative & Commodity Exchanges) Rank markets based on efficient and integrityRank markets based on efficient and integrity La Porta et al. (2006 Journal of Finance) La Porta et al. (2006 Journal of Finance) Public enforcement of securities laws does little to help the development of stock marketsPublic enforcement of securities laws does little to help the development of stock markets Private enforcement and disclosure rules help stock marketsPrivate enforcement and disclosure rules help stock markets Cumming and Johan (2008 American Law and Economics Review) Cumming and Johan (2008 American Law and Economics Review) First look at international differences in surveillanceFirst look at international differences in surveillance Cross-market surveillance and information sharing helps development of stock marketsCross-market surveillance and information sharing helps development of stock markets

4. New Contributions First look at exchange trading rules across countries and time First look at exchange trading rules across countries and time Relate trading rules to trading velocity Relate trading rules to trading velocity Trading Rules Trading Rules Insider tradingInsider trading Market ManipulationMarket Manipulation Price Manipulation Price Manipulation Volume Manipulation Volume Manipulation Spoofing Spoofing False Dissemination False Dissemination Broker agency conductBroker agency conduct

5. What Are Business Trading Rules? Found on the stock exchange webpage Found on the stock exchange webpage Like a contract between all stock exchange trading participants Like a contract between all stock exchange trading participants Some exchanges have vague rules Some exchanges have vague rules (“thou shalt not manipulate the market”) Other exchanges precisely set out exactly what they mean by manipulation in the rules… Other exchanges precisely set out exactly what they mean by manipulation in the rules…

6. Insider Trading Rules Frontrunning Frontrunning Client Precedence Client Precedence Trading Ahead of Research Reports Trading Ahead of Research Reports Separations of Research and Trading Separations of Research and Trading Broker Ownership Limit Broker Ownership Limit Restrictions on Affiliation Restrictions on Affiliation Restrictions on Communications Restrictions on Communications Investment Company Securities Investment Company Securities Influencing or Rewarding Employees of Others Influencing or Rewarding Employees of Others Anti-Intimidation/ Coordination Anti-Intimidation/ Coordination

7. Market Manipulation Rules Price Manipulation Price Manipulation Volume Manipulation Volume Manipulation Spoofing Spoofing False Dissemination False Dissemination

8. Price Manipulation Marking the Open Marking the Open Marking the Close Marking the Close Misleading End of Month/Quarter/Year Trades Misleading End of Month/Quarter/Year Trades Intraday Ramping/ Gouging Intraday Ramping/ Gouging Market Setting Market Setting Pre-Arranged Trades Pre-Arranged Trades Domination and Control Domination and Control

9. Volume Manipulation Churning Churning Wash Trades Wash Trades

10. Spoofing Giving up Priority Giving up Priority Switch Switch Layering of Bids/Asks Layering of Bids/Asks

11. False Dissemination Dissemination of False and Misleading Information Dissemination of False and Misleading Information Parking or Warehousing Parking or Warehousing

12. Broker Agency Conduct Trade Through Trade Through Improper Execution Improper Execution Restrictions on Member Use of Exchange Name Restrictions on Member Use of Exchange Name Restrictions on Sales Materials and Telemarketing Restrictions on Sales Materials and Telemarketing Fair Dealing with Customers Fair Dealing with Customers

13. New Indices in this Paper Across Countries and Time Insider Trading Insider Trading Market Manipulation Market Manipulation Price ManipulationPrice Manipulation Volume ManipulationVolume Manipulation SpoofingSpoofing False DisseminationFalse Dissemination Broker Agency Conflict Broker Agency Conflict

14. Trading Velocity Accounts for market size… makes different exchanges comparable Accounts for market size… makes different exchanges comparable

15. Table 3. Descriptive Statistics This table presents descriptive statistics for the full sample of country-month observations in the data. The data span the months February 2006 - October 2008, and the exchanges listed in Table 2. MeanMedian Standard DeviationMinimumMaximum Number of Observations Velocity0.9510.7090.7510.0344.0931363 Insider Trading Index2.20222.0960101363 Market Manipulation Index5.26644.0360131363 Price Manipulation Index2.62722.268071363 Volume Manipulation Index0.69110.710021363 Spoofing Index1.24211.019031363 False Disclosure Index0.70710.583021363 Broker Agency Index0.83601.240051363 Investor Protection Index2.3442.3370.8260.6863.7751363 Log (1+MSCI)-0.0010.0090.057-0.3710.1381363 Log (GDP)9.50010.1641.3326.56511.3041363

16. Comparison Tests Difference in means and medians Difference in means and medians Panel A: All countries Panel A: All countries Panel B: Subset of Mifid Countries Panel B: Subset of Mifid Countries Panel C: Pre- versus Post-Mifid Panel C: Pre- versus Post-Mifid

17. Panel A. All Countries Insider Trading IndexMarket Manipulation IndexBroker Agency Index Investor Protection Index >1<=1>5<=5>0=0>2<=2 Number of Observations 883480537826526837891472 Mean1.070.741.170.810.920.970.990.88 Standard Deviation 0.840.490.750.720.820.700.810.61 Median0.810.600.930.530.680.740.780.63 Difference in Means 8.963***8.986***-1.0872.946*** Difference in Medians p <= 0.000*** p <= 0.171p <= 0.000***

18. Panel B. Subset of MiFID Countries Insider Trading Index Market Manipulation IndexBroker Agency Index Investor Protection Index >1<=1>5<=5>0=0>2<=2 Number of Observations3128420718987309198 Mean1.2271.0261.1861.1831.3661.1331.3411.028 Standard Deviation0.5620.5050.5960.5100.3160.5970.3330.678 Median1.3650.9571.3571.2061.3521.2921.3830.717 Difference in Means3.158***0.0624.835***5.826*** Difference in Mediansp <= 0.000***p <= 0.028 **p <= 0.067*p <= 0.000***

19. Panel C. Pre-MiFID versus Post-MiFID Non-MiFID CountriesMiFID Countries Post-MiFIDPre-MiFIDPost-MiFIDPre-MiFID Number of Observations358609144252 Mean0.8950.8321.2671.137 Standard Deviation0.8410.7720.5810.537 Median0.6790.5631.3731.276 Difference in Means1.1672.200*** Difference in Mediansp <= 0.019***p <= 0.025**

20. OLS Regressions Trading Velocity is a function of Trading Velocity is a function of Insider Trading IndexInsider Trading Index Market Manipulation IndexMarket Manipulation Index Broker Conflict IndexBroker Conflict Index LLSV (1998, 2006) IndicesLLSV (1998, 2006) Indices GDP per capita (annual lagged)GDP per capita (annual lagged) MSCI Index (monthly lagged)MSCI Index (monthly lagged) Robustness Robustness Country dummy variables & fixed effectsCountry dummy variables & fixed effects Difference-in-differencesDifference-in-differences Endogeneity considered laterEndogeneity considered later

21. Table 6 Model (1)Model (2)Model (3)Model (4)Model (5) Coeffici ent t-statistic Coeffici ent t- statistic Coeffici ent t- statistic Coefficie nt t- statistic Coefficie nt t-statistic Constant-1.588-1.850*0.054 23.938 *** 1.763 2.026* * 1.8362.150** Country Dummy Variables Yes NoYes Country Fixed Effects No YesNo AR(1) ModelYesNoYes After*Treat0.0524.018***0.121 3.038* ** Treat3.455 17.620** * 0.908 8.867* ** Insider Trading Index 0.037 4.005* ** 0.0171.866* Market Manipulation Index 0.0053.356*** Log (1+MSCI)-0.080 - 4.464*** -0.159-1.244-0.081 - 4.526* ** -0.025-1.352-0.083 - 4.624*** Number of Observations 1363 Adjusted R20.88 0.870.88

22. Model (6)Model (7)Model (8)Model (9)Model (10) Table 6 Coeffici ent t- statistic Coeffici ent t- statistic Coeffici ent t- statistic Coefficie nt t- statistic Coefficie nt t-statistic Constant1.847 2.174* * 1.858 2.203* * 1.852 2.155* * 1.8241.995**1.9582.058** Country Dummy Variables Yes Country Fixed Effects No AR(1) ModelYes Price Index0.008 3.490* ** Volume Index 0.036 2.059* * Spoofing Index 0.021 3.073* ** False Disclosure Index 0.052 2.811** * Broker Agency Index -0.019-0.413 Log (1+MSCI)-0.083 - 4.585* ** -0.087 - 4.855* ** -0.084 - 4.683* ** -0.084 - 4.663** * -0.088 - 4.862*** Number of Observations 1363 Adjusted R20.88

23. Model (11)Model (12)Model (13)Model (14)Model (15) Table 6 Coeffici ent t- statistic Coeffici ent t- statistic Coeffici ent t- statistic Coefficie nt t- statistic Coefficie ntt-statistic Constant -1.904 - 9.738** *-1.850 - 9.298** *-1.975 - 9.532** *-1.944-9.337***-1.987 - 10.299*** Country Dummy Variables No Country Fixed Effects No AR(1) Model Yes Insider Trading Index 0.177 19.856* **0.172 17.589* **0.143 10.468* **0.144 10.582** *0.16918.392*** Market Manipulation Index 0.0051.3300.0082.115**0.0071.889* Broker Agency Index 0.065 2.949** *0.0351.455 Investor Protection Index 0.0722.977***0.1837.720*** Efficiency of the Judiciary -0.099-9.536*** Log (1+MSCI) -0.040-0.733-0.029-0.522-0.032-0.594-0.039-0.724-0.047-0.907 Log (GDP) 0.261 20.362* **0.254 18.265* **0.266 18.404* **0.248 15.816** *0.30621.492*** Number of Observations1363 Adjusted R20.260.270.280.290.32

24. IV Estimates Rules  Velocity Rules  Velocity Velocity  Rules Velocity  Rules Use instruments very similar to that in La Porta et al. (2006): Use instruments very similar to that in La Porta et al. (2006): English Legal OriginEnglish Legal Origin RepudiationRepudiation Efficiency of the JudiciaryEfficiency of the Judiciary

25. First Stage IV EstimatesSecond Stage IV Estimates Table 7 (16) Market Manipulation Index (17) Insider Trading Index (18) Investor Protection Index (19) Velocity(20) Velocity Coeffici ent t- statistic Coeffici ent t- statistic Coeffici ent t- statistic Coeffici ent t- statisti c Coeffici ent t- statistic Constant-12.871 - 3.977** * -0.682-0.3501.510 2.207* * 0.5361.817*2.2761.667* Log GDP per Capita1.0111.3710.0120.041-0.021-0.221 English Legal Origin0.5810.5460.6100.9240.986 3.993* ** Repudiation Index1.395 2.617** * 0.0400.177-0.013-0.140 Efficiency of the Judiciary -0.173-0.5530.3191.850*0.0951.149-0.094 - 1.874* -0.079-1.522 Market Manipulation Index (fitted values for Models 19-22) 0.167 6.147* ** 0.246 3.210** * Log (1+MSCI)3.5220.430-1.274-0.160 Log (GDP)-0.236-1.311 Number of Observations 42 Adjusted R 2 0.450.080.41 0.31

26. Second Stage IV EstimatesOLS Estimates without Instruments Model (21)Model (22)Model (23)Model (24)Model (25) Coeffici ent t- statistic Coeffici ent t- statistic Coeffici ent t- statistic Coeffici ent t- statistic Coeffici ent t- statistic Constant2.1981.749*2.5991.797*-1.156-1.734*-1.572 - 1.968** -1.234-1.794* Efficiency of the Judiciary 0.0620.374-0.032-0.487-0.064-1.312-0.119 - 2.405** -0.086-1.770* Insider Trading Index (fitted values for Models 19-22) -0.351-0.8430.1431.865* Market Manipulation Index (fitted values for Models 19-22) 0.259 3.304** * 0.2473.373**0.0471.715*0.0140.4380.0501.812* Investor Protection Index (fitted values for Models 19-22) -0.210-0.8430.0980.608 Log (1+MSCI)0.1110.0130.1110.0138.3220.8678.3770.9357.0970.663 Log (GDP)-0.265-1.425-0.262-1.4210.2242.402**0.298 2.713** * 0.2272.420** Number of Observations 42 Adjusted R20.310.390.180.270.17

27. Summary of Key Result Exchange trading rules a very statistically significant and robust factor Exchange trading rules a very statistically significant and robust factor Insider Trading Rules greatest economic significance: Insider Trading Rules greatest economic significance: Each rule increases velocity by at least 3% depending on the specificationEach rule increases velocity by at least 3% depending on the specification Market Manipulation Rules also economically significant Market Manipulation Rules also economically significant Each rule increases velocity by at least 1% depending on the specificationEach rule increases velocity by at least 1% depending on the specification Economic significance is even greater with the IV estimates. Economic significance is even greater with the IV estimates. Example: Example: Euronext Paris (138.57%) versus Hong Kong (95.32%)Euronext Paris (138.57%) versus Hong Kong (95.32%) Actual difference: 43.25%Actual difference: 43.25% Predicted difference for Insider Trading Rules (simple regression): 31.2%Predicted difference for Insider Trading Rules (simple regression): 31.2% Predicted difference for Market Manipulation Rules (simple regression): 45.18%Predicted difference for Market Manipulation Rules (simple regression): 45.18%

29. Figure 1. Partial Regression Plot of Velocity and Insider Trading Rules Index. This figure presents a partial regression plot of velocity and the Insider Trading Rules Index. The independent variables include the investor protection index (La Porta et al., 2006), the Efficiency of the Judiciary (La Porta et al., 1998), the log of MSCI and the log of GDP per capita. The coefficient is equal to 0.152, (robust) t-statistic 2.437 and adjusted R 2 is 0.157.

31. Figure 2. Partial Regression Plot of Velocity and Market Manipulation Trading Rules Index. This figure presents a partial regression plot of velocity and the Market Manipulation Trading Rules Index. The independent variables include the investor protection I ndex (La Porta et al., 2006), the Efficiency of the Judiciary (La Porta et al., 1998), the log of MSCI and the log of GDP per capita. The coefficient is equal to 0.050, (robust) t-statistic 1.812 and adjusted R 2 is 0.039.

32. Conclusions Insider Trading and Market Manipulation Rules are an important element to encouraging investors to trade on stock exchanges Insider Trading and Market Manipulation Rules are an important element to encouraging investors to trade on stock exchanges Detailed rules facilitate trading Detailed rules facilitate trading Vague rules in countries with high risk of repudiation Vague rules in countries with high risk of repudiation Not easy to change business rules, but possible Not easy to change business rules, but possible Mifid rules are an important benefit to trading on European Exchanges Mifid rules are an important benefit to trading on European Exchanges