The Financial Services Authority (FSA) is considering tighter regulation of alternative trading systems and electronic communications networks (ECNs) to bring them into line with the way stock exchanges are regulated.

The FSA will today issue a discussion paper to stimulate debate on how the regulator should approach the governance of electronic trading. The move could lead to the ending of ECNs' status as authorised firms and require them to be regulated much more strictly. Matthew Elderfield, head of market supervision at the FSA, said: "If feedback from the paper suggests that we should have tighter regulation of ECNs, then we will look to align them more closely with existing regulated investment exchanges. That would mean tightening rules to ensure the networks are transparent, orderly and have technology of sufficient quality. There is a general issue concerning increased market reliance on the robustness and integrity of market systems and technology for services other than trade execution – such as order routeing and post-trade processing.' However, the FSA said it wants to address risks arising from the alternative trading systems without unnecessarily impending competition and innovation. "Competition is in itself a regulator. We do not want to drive competitors to traditional exchanges out of the market by stifling them with regulation.' Elderfield said that the main concern in the UK was the fragmentation of liquidity that arises from the increase in trading networks available. "Price formation is being directed away from the stock exchanges. That could hinder execution at best prices,' he said. Elderfield said that the FSA was open minded on regulation. "It will be best if we find a market solution – such as the use of information technology to link all fragmented sources of liquidity – rather than force regulation on what could be healthy competition.' He said that retail investors who trade online, and now account for 10% of trading activity on the London Stock Exchange, must also be provided for in the market. Elderfield is known to have asked for advice from the Securities and Exchange Commission in the US – where the use of ECNs is much wider – regarding their regulation. The paper is being released at the same time as the new source book setting out proposals for regulation of regulated investment exchanges. Elderfield suggests that the FSA has been mindful of non-traditional competition in the new source book.