The European Securities and Markets Authority (ESMA) recently clarified its position on shared order book arrangements under the Markets in Crypto-Assets Regulation (MiCA), stating that any entity managing a shared order book must be authorized as a Crypto-Asset Service Provider (CASP) under MiCA. This interpretation effectively prohibits EU-authorized CASPs from sharing order books with unauthorized entities, even those operating outside the EU. While this stance aims to ensure regulatory oversight and consumer protection, it raises fundamental questions about whether such restrictions may paradoxically undermine MiCA's own best execution requirements.
ESMA's position targets integrated models where multiple crypto-asset platforms merge their individual order books into a single, unified system. Under Article 3(18) of MiCA, operating a trading platform involves "the management of one or more multilateral systems, which bring together or facilitate the bringing together of multiple third-party purchasing and selling interests in crypto-assets." ESMA views order book management as fundamental to this definition, meaning any entity involved in managing shared order books must hold CASP authorization.
This interpretation creates a clear regulatory boundary: EU CASPs cannot participate in shared order book arrangements with unauthorized entities, regardless of the potential benefits to liquidity aggregation and market efficiency. The rationale is straightforward from a regulatory perspective – ensuring all market participants operating within the EU framework are subject to appropriate oversight and consumer protection measures.
MiCA's Article 78 establishes comprehensive best execution obligations for CASPs executing orders on behalf of clients. These requirements mandate that service providers "take all necessary steps to obtain the best possible result for their clients taking into account factors of price, costs, speed, likelihood of execution and settlement, size, nature, conditions of custody of the crypto-assets or any other consideration relevant to the execution of the order."
Importantly, MiCA does not restrict best execution to EU-only venues. Article 78(5) allows execution outside trading platforms, including non-EU venues, provided proper client disclosure and consent procedures are followed. This suggests the regulation recognizes that optimal execution may sometimes require access to global liquidity pools beyond EU-regulated platforms.
The prohibition on shared order books creates a fundamental market structure challenge: liquidity fragmentation. In traditional financial markets, liquidity begets liquidity and deeper order books attract more market participants, which in turn creates even deeper liquidity pools. By preventing EU CASPs from accessing shared order books with global counterparts, ESMA's interpretation may inadvertently create smaller, isolated liquidity pools within the EU framework.
This fragmentation manifests in several technical and economic ways. Smaller order books typically exhibit wider bid-ask spreads, higher price volatility, and increased market impact for larger trades. When institutional investors place significant orders, fragmented markets are more likely to experience "walking the book" ergo, where orders execute at multiple price levels, increasing overall execution costs. Additionally, fragmented markets often suffer from less efficient price discovery, as multiple disconnected price formation mechanisms can lead to delayed convergence and persistent arbitrage opportunities.
The practical consequence of these dynamics may be that the best execution for many client orders increasingly points toward non-EU venues. Global crypto exchanges operating outside the EU framework can continue to aggregate liquidity from multiple sources, including through shared order book arrangements that remain prohibited for EU CASPs. These platforms often maintain significantly deeper liquidity pools, tighter spreads, and more efficient price discovery mechanisms.
Consider a scenario where a large institutional client seeks to execute a substantial crypto-asset transaction. An EU CASP, constrained by fragmented domestic liquidity, may struggle to achieve optimal pricing compared to what could be obtained on a major global exchange with integrated order book depth. Under MiCA's best execution requirements, the CASP would be obligated to consider executing on the non-EU venue, provided proper disclosure and consent procedures are followed.
The fragmentation issue extends beyond individual trade execution to the broader market maker ecosystem. Professional market makers require sufficient trading volume and liquidity to effectively manage inventory risk and provide competitive spreads. Fragmented order books may fall below the viable thresholds that make market making economically attractive, potentially leading to reduced competition among liquidity providers and wider spreads for end users.
Furthermore, this creates a competitive disadvantage for EU platforms in the global crypto market. While EU CASPs operate under structural liquidity constraints, their international competitors can leverage integrated global liquidity pools to offer superior execution quality. This dynamic may discourage both institutional and retail participants from using EU platforms, creating a negative feedback loop that further reduces domestic liquidity.
The restrictions on shared order books may also have broader implications for FinTech innovation within the EU. Limiting access to sophisticated liquidity aggregation mechanisms could reduce incentives for technological advancement in trading infrastructure and algorithmic trading strategies. Over time, this may contribute to the EU falling behind in infrastructural innovation, potentially affecting its competitiveness in the grand scheme of things.
From an investor protection perspective (one of MiCA's core objectives) the question becomes whether regulatory control justifies potentially higher execution costs and reduced market efficiency. While ensuring appropriate oversight of market participants is undoubtedly important, the unintended consequence may be that EU investors pay higher transaction costs and receive inferior execution quality compared to their global counterparts.
The tension between ESMA's shared order book restrictions and MiCA's best execution requirements highlights a fundamental challenge in financial regulation: balancing regulatory oversight with market efficiency. While MiCA may permit execution on non-EU venues under appropriate conditions, the structural advantages these venues may gain from unrestricted liquidity aggregation could systematically favor non-EU execution.
This dynamic raises questions about whether the current interpretation achieves MiCA's intended outcomes. If the best execution for EU clients increasingly points toward non-EU venues due to superior liquidity conditions, the practical effect may be to drive activity away from the regulated EU framework rather than strengthening it.
ESMA's restriction on shared order books reflects quasi-legitimate regulatory concerns about ensuring appropriate oversight of market participants operating within the EU framework. However, the practical implications of these restrictions may create a contradiction with MiCA's best execution requirements by fragmenting liquidity and potentially making non-EU venues systematically more attractive for optimal trade execution.
As the market continues to evolve, regulatory authorities may need to reconsider whether the current approach achieves the appropriate balance between oversight and market efficiency. The challenge lies in developing frameworks that maintain regulatory control while preserving the liquidity aggregation benefits that are essential for competitive and efficient markets. Until this balance is achieved, EU CASPs may find themselves in the paradoxical position of being required to look beyond EU-regulated venues to fulfill their best execution obligations to clients.
