Island Goes Dark: Transparency, Fragmentation, and Regulation

Responding to a September 2002 regulatory enforcement, the Islandelectronic communications network stopped displaying its limitorder book in the three most active exchange-traded funds (ETFs)where it was the dominant venue. Island’s share of tradingactivity and price discovery fell, fragmenting the market. ETFprices adjust more slowly when Island goes dark, and there issubstantial price discovery movement from ETFs to the futuresmarket. Trading costs increase on Island and decrease off Island,with higher trading costs overall. When Island later redisplaysits orders, market quality improves, with transparency and thereduction in fragmentation both playing important roles.