Reimagining trading floors will be more valuable than simply reopening them

By Joshua Walsky, CTO, Broadway Technology

Dispersed trading floors are here to stay. While sell-side traders will eventually make it back to the trading floor, banks are accepting that they will need to maintain partially-remote trading floors for the foreseeable future. Though triggered by the COVID-19 pandemic, this is just another step along the path away from trading pits and towards electronic communication and automation. Trading pits gave way to electronic trading, physically separating traders from different firms from each other. This further progressed within the firm as trading floors grew larger and global, leveraging technology to allow trading and sales to sit farther apart – sometimes in different offices. Although the driving cause today is different, traders, sales, support and operations staff within the same firm are forced to physically separate. Technology is filling the space in between. 

In light of this, banks are taking an honest look at their own trading operations. Opportunities loom among the challenges. Those that shift towards digitized workflows, lean into partnerships and unlock the value of data will be ahead of their peers when physical trading floors open again. 

The renewed importance of outsourcing

Outsourced trading, be it outsourcing risk, outsourcing particular trading workflows, or outsourcing staff, will accelerate as teams continue to remain dispersed. 

Pre-pandemic, savvy banks had already begun evaluating which functions were best suited to remain in house or outside their organization. Furthermore, these banks created digital workflows leveraging technology to drive and mediate interactions between multiple parties inside and outside of the firm. When disruption hit, the attention turned towards ensuring continuity in their day-to-day functions. Now that the situation has relatively normalized, albeit to a “new norm,” banks are examining areas where they can hone their individual strengths and expand upon those digital workflows. 

Central to performance is technology that enables staff to stay connected and work together seamlessly, sitting at desks across the globe. Technology must mimic the complex workflows of trading in order to supplant the human, in-person interaction that is no longer possible. How can technology replace human coordination? It must be incredibly complex, flexible, and customizable. Trading workflows must shift with the constant tide of market changes.

A workflow that functions well today may be obsolete tomorrow. Human, in-person interaction adapts to this easily and almost subconsciously. Technology, however, needs to be structured and programmed. Banks will need to leverage others to manage the myriad of changing trading protocols, new products and internal processes. This is where outsourcing to trusted partners is a logical move. Adaptation at such a broad scale – as we saw in the early days of the pandemic – is taxing. Partners are well-equipped with the scalability that bank trading teams need to adapt on the fly, freeing up banks to focus on other areas where their IP can generate new business opportunities and support revenue growth, even in the midst of market disruption.

The changing nature of compliance 

Regulatory challenges are nothing new. What has changed in the ability to address them in a new working environment.

It’s well known by now that regulators have raised concerns over institutions’ capabilities to adequately monitor trader communications while they work remotely. Fortunately, the same process and approach of digitization of interaction provides the transparency and access that such monitoring requires. 

To adequately comply with regulatory monitoring requirements, voice and electronic communication workflows must be built on a foundation of structured and accessible data across various applications. 

The availability of this data opens new doors. Data transparency and accessibility plays not only an important role in a firm’s observance to internal and external compliance rules, but its overall productivity. When data is accessible, discoverable and logically structured across an organization it is now open to digitization of workflows of which will empower better remote connectivity, integration and regulatory awareness. 

Why workflows – and the data that support them – matter most

Physical distance between the trading desk, sales traders, compliance, operations, support and the customers themselves means increased complexity. To streamline all the information and processes splintered across numerous parties and locations, workflows must become increasingly digitized and well-defined. Those built on well-structured and universal data accessibility will prove strongest. 

Even the simplest of trading workflows will involve all or some combination of the parties above. These parties must seamlessly pass information back and forth, carefully accounting for human-human and human-computer interactions. In many cases, digital workflows and data transparency will entirely replace the physical interaction between teams – including client management and idea generation. 

The barrier towards modernizing trading workflows is identifying where data sits, its logical business purpose, its structure and its relation to other relevant data.  Data sitting across both new and legacy systems need to be surfaced and rationalized to create one clear picture of activity. Banks must leave no piece of their infrastructure unexamined. Unlocking the value hidden within legacy systems (instead of simply trying to replace them) by integrating their data into digitized workflows will be integral for success. 

Once more, this is where the right partner adds value. Banks are realizing that integrating legacy, third-party and in-house technology into one agile ecosystem is essential to their evolution – yet, doing this all themselves is beyond what their resources may allow. Technology partners have the capabilities to integrate and unlock various systems, without trying to usurp or diminish existing investments. Technology partners also build a natural expertise across a variety of technologies and uses. Additionally, banks may not have the time to tackle this all on their own, as the looming threat of further lockdowns and economic instability creates the possibility of further disruption. 

Continuing the momentum

To be sure, nearly every institution was able to make the shift towards a dispersed trading floor with relative ease. It was originally believed that the work-from-home scenario would be temporary; we are fast learning that this is no longer the case.

Looking nostalgically to restore the previous normalcy misses the opportunity at hand. Digitized and interconnected workflows, outsourcing and leveraging the power of data will reap significant benefits for trading teams well into the future. As banks consider how the post-pandemic trading floor will operate, the goal should not be how to get everyone back into the office – but how to connect them, workflows and data in a manner that enables them to thrive in a new market. This should be the new norm.

By Phil Mackintosh, Senior Economist, Nasdaq

ETFs have been one of the success stories of modern markets. Trading around $100 billion per day with a weighted average spread of just 1.7 cents or 2.1 basis points (bps) at the start of the year. Overall, ETFs track their net asset value (NAV) extremely well, allowing investors and traders cheap access to diversified baskets and thematic exposures.

Let’s dive deeper into the data on how ETFs trade for five fun facts on ETFs you might not know.

1. ETF turnover has declined

As the ETF industry matured it has seen some key developments:

1. More Active ETFs: With the creation of thematic, then smart beta, then active, and now the approval of active non-transparent (ANT) ETFs, the traditional gap between ETFs and classic mutual funds has closed.
2. Longer hold times: As that has happened, the holding times of the average investor has climbed and new ETF investors are more likely to use ETFs for long-term investing.

We can see this by looking at turnover (ETF trading per year/AUM, yellow line in Chart 1, and also in Chart 3 here).

Even though ETF trading and liquidity has significantly increased since 2004, the turnover has actually declined. ETFs remain much more of a trading vehicle than classic mutual funds—with turnover around 5x per year.

That shouldn’t be confused with the roughly 0.3x per year that mutual funds turn over the stocks in their portfolio, as most ETF portfolios likely trade less than their tickers too, especially index ETFs where portfolio turnover (before creations and redemptions) is typically under 0.1x per year.

It’s also interesting to see that despite the spike in ETF turnover during the credit crisis, the proportion that ETFs comprised of total market trading didn’t spike (blue line) as stock trading increased during the credit crisis.

Chart 1: Average daily ETF liquidity and turnover (AUM traded per year)

2. ETFs have tighter spreads than stocks

We’ve shown for company shares that liquidity is a major determinant of a stocks spread.

The same holds true for ETFs (Chart 2). But data shows that ETFs typically have even tighter spreads than stocks with the same liquidity.

Chart 2: ETF spreads are lower than stocks of comparable liquidity

There are good reasons for that. For a start, an ETF represents a portfolio of stocks with their own underlying liquidity and spreads. Often the liquidity of the portfolio is multiples of the liquidity of the ETF.

In fact studies have found that almost no ETF trades anywhere near as much as its underlying portfolio. That’s even true of the most liquid ETFs:

• The most liquid ETF (SPY) trades $22 billion per day, but holds stocks that trade closer to $170 billion per day.
• The next most liquid ETF, QQQ, actually trades less than AAPL or AMZN, two of its largest holdings.

3. Very few ETFs are priced over $100 per share

Of course, Chart 2 reminds us of the work we have done on the perfect stock price and the need for stock splits for corporates. There are now 228 S&P500 companies, or 45%, with prices over $100. Those “high priced” companies often trade with spreads multiple ticks wide and with odd lots providing the true BBO most of the time.

However, ETFs are different!

Data shows that only 8% of ETFs are priced over $100 per share. Importantly, the average liquidity of those ETFs is $403 million per day so most of those ETFs actually have the liquidity to support tight spreads and high prices. That can be seen by the small circles (spread in cents) in Chart 2.

In fact, around half of all ETFs are priced in the trading “sweet spot”, between $20 and $50 per share, where one tick represents 2 bps to 5bps. That is enough to attract quotes, but not so large as to deter trading.

That’s not surprising given one of the primary functions of ETF issuers is to minimize trading costs and provide liquidity; it seems ETF issuers already know on how important tradability is.

Chart 3: The majority of ETFs are around $25 per share, priced for tradability

4. Creations and redemptions are a small fraction of stock trading

Although ETFs are consistently 25% of market-wide value traded, it’s misleading to say ETFs cause stocks to trade anywhere near that much.

That’s partly because many ETFs actually track bonds or international stocks or commodities. But it’s also because ETFs have much tighter spreads than their underlying portfolio of stocks (Chart 2). In fact some studies have found that ETF prices are usually so much cheaper than trading the underlying basket that stock arbitrage (selling the ETF and buying stocks, or vice-versa) is unprofitable. That’s especially true for the most liquid ETFs which (as Chart 2 shows) have the tightest spreads.

Another way to show this is to look at creations and redemptions each day.

Creations and redemptions usually occur when liquidity providers have bought (or sold) the underlying stocks to hedge their ETF trades, whether with clients or because the ETF was rich (or cheap) enough to arbitrage. A creation allows the market maker to send their long stock position to the issuer and receive new ETF shares in return. That neutralizes the arbitrage position, eliminating inventory costs on an arbitrage; or the ETF can be delivered to directly the customer cheaper than the ETF was trading.

Chart 4a: ETF creations allow a market maker to exchange hedged stock positions with the issuer for new ETF shares which also reduces their net inventory (net position)

Each year creations and redemptions amount to roughly $2.8 trillion per annum. That sounds like a lot, but over a year it’s just 3% of U.S. stock trading, which adds to around $59 trillion of buying and selling each year.

Why focus on buying and selling? Despite the growth from net inflows to ETFs, creations and redemptions are close to equal. That means some reflect stock buying while others reflect stock selling. So it’s more correct to compare ETF creations and redemptions to the gross buying and selling of stocks, which adds to almost $120 trillion each year.

Chart 4b: ETF creations (and redemptions) are a fraction of ETF buying (and selling), and even less of gross stock or futures trading

5. Different ETFs are used for different things

Retail investors, banks and hedge funds are all active users of ETFs. That’s testament to their cheap spreads and deep liquidity and close tracking vs. net asset value thanks to efficient arbitrage. But a deep dive shows that some ETFs are better suited to hedge funds while others are preferred by individual investors.

Chart 5 reveals the following about short interest (as a percentage of AUM) and turnover:

• Most ETF have relatively low short interest and turnover close to 1x.
• But around 100 ETFs have much higher turnover and also tend to have more short interest (the blue dots making the hockey-stick shape of chart 5). Although these ETFs represent just 4% of all tickers they make up 85% of all ETF liquidity. Those ETFs tend to offer thematic and index exposures. They act like futures providing predictable factor exposure for low costs.

Hedge funds and banks are the majority of investors doing short selling (thereby creating short interest). Not surprisingly, they prefer very liquid, often very cheap to trade, ETFs. They also tend to hold them for shorter-term thematic exposures, increasing their turnover.

Other ETFs that have higher proportion of retail participation and often more complex portfolio construction sometimes including more dynamic stock picking. That includes many of the smart beta and more active ETFs better designed for longer-term holding and outperformance, as Chart 3 here also shows.

Chart 5: Some ETFs have much higher turnover and short interest than others

What does this all mean?

One of the great features of ETFs is how well they work for so many investors.

That’s a testament to their cheap spreads and deep liquidity and close tracking vs. net asset value, which itself is thanks to efficient arbitrage and the creation and redemption process.

But just because ETFs trade a lot, doesn’t mean they make underlying stocks trade. There are enough buyers and sellers of many ETFs that they don’t trade in a “stock arbitrage” zone much at all.

That’s something the trading data also supports.

Five Surprising ETF Facts was originally published by Nasdaq.

As a worldwide economic recession pinches IT budgets, data centers are seeing the financial services sector as a pocket of strength. 

In particular within finserv, the workhorses are the bank broker-dealers and electronic market makers who are the biggest institutional securities traders. Such firms have been boosting their presences in colocation data centers for years, and with 2020 probably the most electronic, least in-person year in modern history, operators have seen another leg up. 

“There is demand from financial services to continuously invest in financial infrastructure, be it for electronic trading, or artificial intelligence workloads, or other workloads,” said Bill Fenick, VP Enterprise at Interxion, a data-center operator and connectivity hub.  

“The demand does not stop. You would have thought okay, the trading shops have put enough infrastructure in, but then boom, they say they need more,” Fenick continued. “The largest market makers, at least in London, are saying we need more space, we need more power, we need more capacity.” 

The rise of electronic trading is a long-term trend that seemed like it had mostly run out of steam, as adoption rates had decelerated and even plateaued in some asset classes. 

But COVID-19 has forced traders around the world to work mostly from home since March. Despite the unexpected, unprecedented situation, markets functioned smoothly even amid volatility, giving remote-work skeptics pause and giving fresh momentum to the financial industry’s electronic trading complex. 

Mike Powell, CEO of trading-technology provider Rapid Addition, said 2020 has effectively broken the taboo around working from home, prompting some firms to rethink their cost structures and where to best deploy capital longer-term.

“If I’m a major sell-side bank, sitting on some of the most expensive real estate on the planet in downtown New York or Canary Wharf in London, why am I paying for thousands of staff to be in a crazy expensive building when I’ve just been through six months where we’ve proven we can work remotely?” Powell said. “At some point a light bulb flips on.”

Physical trading floors, heretofore diminished to a largely symbolic role and a small slice of total market volume, have taken a hit in 2020. The London Metal Exchange’s Ring, the last open-outcry trading floor in Europe, has been closed since March, with all activity shifted to the exchange’s electronic system. In the U.S., The New York Stock Exchange’s iconic trading floor and Cboe Global Markets’ Chicago trading floor had two- and three-month shutdowns, respectively; the floors are back up and running, though at limited capacity.   

Industry Shift

The outlook for a return to in-person trading is unclear, as the virus is a stubborn foe. But through it all, algorithm-driven matching engines, immune from COVID, execute trades. Huge data centers in the City of London and its outskirts; Secaucus, Mahwah and Carteret, New Jersey; and Aurora, Illinois are the backbone of electronic trading, and the facilities are humming, as financial firms continue to shift resources away from internal enterprise data centers. 

Ben Stirk, Director at CBRE’s Data Centre Solutions Advisory Group in London, said seven of his 12 banking clients are currently active in managing their data portfolios. 

 “The financial sector is very active,” Stirk said. “Our core banking clients, who are big global multinational firms, are bolstering their data real estate by right-sizing and consolidating, moving away from ‘on-prem’ and moving into colocation environments.”

For co-location data centers, i.e. off-premises, cloud-hosted facilities, revenue from financial firms increased 1-3% in the first half of 2020, compared with recession-induced declines of up to 10% in sectors such as oil and gas, healthcare, hospitality, and retail. That’s according to Dell’Oro Group, a market analysis and research firm. 

Financial services “outperformed that of other enterprise sectors when it comes to colocation infrastructure spending,” said Baron Fung, Research Director at Dell’Oro. “We still see investment going toward building out infrastructure for financial services.” 

For a trading firm that reallocates capital spending away from physical and toward digital, aside from the bottom-line savings of reducing office footprint, a company can also generate top-line growth via cloud, data and automation initiatives. This can be especially useful for mid-sized and smaller firms competing against deeper-pocketed rivals.  

Deciding whether to pare back physical space comes down to “A, does it improve margin, and B, does it free up some discretionary budget to innovate around technology?” Powell said. “I see infrastructure spend as the way forward. Firms can invest in infrastructure to create different cost dynamics, which is pretty exciting.”

Cboe Global Markets has agreed to acquire BIDS Trading, the alternative trading system for equity blocks in the US, as competition in on-exchange trading has increased with three new entrants.

BIDS Trading will operate as an independently managed trading venue separate from the Cboe U.S. securities exchanges, and will be led by Tim Mahoney, chief executive of the ATS.

Learn more about our planned acquisition of @BIDSTrading at https://t.co/1Qbf5a2XPb. pic.twitter.com/3QFBw4CRCB

— Cboe (@CBOE) October 16, 2020

David Howson, president of Cboe Europe, told Markets Media: “BIDS is the largest block-trading ATS in the US and gives Cboe a foothold in the off-exchange segment where BIDS is a market leader. Along with our acquisition of MATCHNow in Canada, these deals give Cboe a very strong presence in the North American equities off-exchange segment.”

Cboe completed its acquisition of MATCHNow, the largest equities ATS in Canada in August this year. MATCHNow had nearly 65% of market share in total Canadian dark trading, or approximately 7% in total Canadian equities volume, according to the exchange.

The Covid-19 pandemic has triggered a major shift in US equity trading volumes away from exchanges this year according to a report from Greenwich Associates.  Off-exchange trading reported to the Trade Reporting Facility remained relatively stable last year at between 35% and 40% said the consultancy.

“In all of 2019, there were 16 days with TRF volume above 40%,” added Greenwich. “In contrast, as of early June 2020, the reporting to the TRF had already exceeded 40% of market volume 58 times.”

In addition, competition in US equities trading on exchanges has increased with Members Exchange (MEMX), MIAX Pearl Equities and Long Term Stock Exchange (LTSE) all launching last month.

BIDS Trader

Another attraction of the acquisition is BIDS Trader, a proprietary buy-side front-end trading platform which seamlessly integrates with existing order/execution management systems.

Howson said the BIDS’ trading platform is part of the workflow of 450 global asset managers and provides Cboe with a potential opportunity to launch into new asset classes and geographies.

“It is a differentiator that the BIDS model does not disintermediate the sell side, allowing for a mix of rich interactions between the sell side and the buy side,” he added.

The partnership between Cboe and BIDS Trading began in 2016 with the launch of Cboe LIS in Europe. Cboe licensed BIDS’s proprietary technology for the pan-European equities block trading platform, which is the second largest in the region with average daily volume of approximately €240m.

“There are approximately 220 buyside firms using Cboe LIS,” added Howson. “The BIDS network has approximately 450 asset managers so there is runway to onboard new clients.”

In addition BIDS’ buy-side network could potentially benefit Cboe Europe Derivatives, an Amsterdam-based futures and options market that the US exchange is planning to launch in the first half of next year, subject to regulatory approvals.

A very interesting series of deals for CBOE in 2020 – first MATCHNow, a Canadian ATS, and now BIDS Trading, a US ATS.

The message CBOE's sending is "if equity volume is going off-exchange, we'll go off-exchange"

Similar strategy to TP ICAP's Liquidnet purchase.

— Hide Not Slide (@HideNotSlide) October 16, 2020

Sylvain Thieullent, chief executive of Horizon Software, a provider of electronic trading systems to financial institutions, said in an email: “As part of a wider industry drive to better serve the end-investor, exchanges like Cboe know they have a responsibility to ensure trades can happen in a fair and well-balanced market. As the bigger venues continue to get bigger, it is paramount that members are not trading too far away from what could be considered to be the fair value price.”

Legal advisors to Cboe Global Markets on the transaction are Davis Polk & Wardwell and WilmerHale, and financial advisors are Goldman Sachs and Centerview Partners. Legal advisor to BIDS Trading is Morgan, Lewis & Bockius LLP, with Broadhaven Securities as financial advisor.

Third quarter outlook for exchanges

Kyle Voigt, an analyst at financial services boutique KBW, said in a report that he had decreased his estimated earnings per share for exchanges for the third quarter.

He added that MEMX, MIAX Pearl Equities and LTSE have only garnered a small share of trading in the quarter and earnings will present an opportunity for the exchanges to address the new competition.

“Alongside CBOE’s September monthly metrics release, CBOE guided to 3Q20 cash equities revenue capture of $0.016 per 100 shares (at the midpoint of its guidance) following quarterly fee changes,” said the report. “Voigt believes the changes are in part due to the continued volume shift off-exchange partially driven by the retail trading surge; however, it is also likely a defensive move made ahead of the MEMX launch.”

Other areas of focus for the results are M&A integration and the London Stock Exchange Group’s sale of Borsa Italiana. The UK firm sold Borsa Italians to Euronext in order to satisfy the European Union’s anti-trust concerns ahead of LSEG’s planned purchase of data provider Refinitiv.

ICE has also completed its acquisition of Ellie Mae, which provides technology for the mortgage industry, so he expects updates on integration efforts and contributions to results.

Voigt said there could also be potential impacts from a possible Joe Biden presidency.

“This includes the potential for an increase to the U.S. corporate tax rate to 28% from 21% previously, as well as a potential return of a DOL-like (Department of Labor) fiduciary rule, among other topics,” he wrote.

In addition the US Securities and Exchange Commission has signed a memorandum of understanding with the Department of Justice to look into cash equities exchange market data.

The report said: “Voigt thinks investors will try to gain a better understanding of what can be expected from now through year-end as well as what a new administration could mean for the momentum behind these issues.”