Analysis : Equity markets in Europe : Winter 2019/20

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January 20, 2020

LiquidMetrix analyses consolidated performance figures for equities and ETFs traded in Europe in the previous quarter.

LiquidMetrix’s unique benchmarking methodology provides accurate measurements of trends in market movements. We have seen many changes to market microstructure over the last year, and here we present statistics based on three quarters of 2019 as a guide on the current trend.

To give an overall indication of the market in 2019, we are comparing the Value Traded in Europe against the % Traded LIS. The trend over the year was a steady increase in the %LIS against the general increase in value traded to its peak in June although slightly declined in to the last two quarters and remained at a consistent level. The Value Traded decreased from mid year, but then increased into the Autumn with some volatile peaks during the last two quarters.

One criteria to assess Venue quality is the % of times the Venue has a Best Price in the market. This is a measure of how competitive the Lit markets are as its based upon the major index constituents of each market, and includes both price ties and unique best price.

The Lit markets in Q4 continued the trend from Q3, with the strength of the Primary Venues a factor as there were more decreases in % time best price across all MFTs across most markets with the exception of MIB where Bats and Aquis increased % time and Turquoise on CAC.

The Market liquidity picture was mixed in Q4, with FTSE and CAC losing liquidity on most Venues, but DAX and MIB gaining on all venues apart from Turquoise. OMX-s lost liquidity on the Primary, but gained on ChiX and Bats. The most significant decrease was on the CAC Primary with a reduction of €58m on the Primary.

The tables above provide a method to asses performance of Dark Pools in Europe with the Value Traded, average trade value and measure the % of times there is a corresponding movement on the lit market. Overall, there was an increase in Trade Sizes across all Dark markets in the period and Turquoise increasing its ranking on OMX-s with MIB the only market where it is not in first rank.

For the Periodic Auction Pools, the rankings stayed consistent with the previous quarter, but overall, the average trade sizes increased in all Venues, but to a lesser extent than the Dark Pools.

As has been previously noted in Q4 we observed an increase in Trade sizes across the Non-Lit Regulated markets, but what is the trend on Value traded if we add SI flow as a comparison.

The chart below shows the trend in daily value traded in Dark Pools, Periodic Auction Venues and SI for major index constituents across Europe in 2019.

We can see from the chart above that the trend in Dark value traded increased slightly in Q3, but had a slight reduction in Q4 together with a corresponding decline in Periodic Auction Value traded. The interesting trend is the relative dramatic increase in SI Volume mid way through Q3 and into Q4. Not all of the SI value traded is fully addressable, but even taking this into account the increase in value traded is significant. The other observation (not shown on the charts) is that we observed an increase in the number of Blocks Traded SI in Q4, and this may account for a proportion of large increases in value Traded in Q4.

ISS LiquidMetrix are pioneers in the measurement of European Fragmented markets, and provide research,TCA best execution and Surveillance for financial market participants and regulators – www.liquidmetrix.com

©BestExecution 2020

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Industry viewpoint : Dr Robert Barnes : Turquoise

By

Ian Rycott

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January 20, 2020

TURQUOISE PLATO UNIQUE LIQUIDITY.

Dr Robert Barnes, Global Head of Primary Markets & CEO Turquoise, London Stock Exchange Group offers his insights of Primary & Secondary Markets innovations.

Primary markets.

In 2019, fintech remained an important sector with Nexi’s listing on Borsa Italiana being crowned the largest IPO in Europe in 2019 and Network International the biggest IPO on London Stock Exchange.

In London, seven new jumbo listings of companies above £1bn market capitalisation included Coca Cola European Partners at £18bn. International offerings accounted for 22 of 47 new London listings in 2019, representing half of capital raised, reflecting the increasing trend of globalisation against the backdrop of low interest rates.

Since rates turned negative in Europe in 2015, London as a financial centre has increasingly attracted international companies. For example, in 2017, they represented nine out of ten of the largest IPOs on London Stock Exchange. Two were global depositary receipts (GDRs) denominated in US dollars and settled in Euroclear Bank.

This trend continued in 2018 with significant dual listings from emerging markets, most notably the successful issuance of Slovenia’s Nova Ljubljanska Banka (NLB) – the largest bank IPO in EMEA – as well as Kazatomprom from Kazakhstan. In both cases the community of international investors active in London contributed the majority of risk capital, and are great examples of co-operation and the ability to deliver successful investments back to the home market. In fact, Kazatomprom returned to the London public markets in 2019 for another successful follow-on issue.

The insight is that investors are seeking growth, and are open to gaining exposure to companies from countries such as China without negative interest rates. Last year, saw the launch of Shanghai-London Stock Connect on London Stock Exchange’s new Shanghai Segment on the International Order Book (IOB). This offers the same developed market customer buying and selling experience as FTSE 100 securities. The first issuer, Huatai Securities, which raised $1.7bn on Shanghai-London Stock Connect, is considered a great success.

Meanwhile, in Europe, since MiFID II, stock exchanges in the region have registered as SME European Growth Markets. AIM, a leading growth market continued to lead peers in Europe, accounting for approximately 60% of all IPO and further capital raised among SME European Growth Markets. AIM Italia similarly achieved a stellar year in 2019, its 10th anniversary, with 31 IPOs, a new record.

Sustainability
Last year also saw sustainability become even more significant in the aftermath of the Financial Stability Board Task Force on Climate-related Financial Disclosures (TCFD) which met in October in Tokyo. It highlighted the importance of the transition to a low carbon economy as well as relevant, quantitative disclosures. London Stock Exchange launched the Green Economy Mark for Equity Issuers and the Sustainable Bond Market for Fixed Income, innovations among Primary Markets.

On another note, London Stock Exchange was privileged to be selected as the sole Primary Market for the first public bond listing by Saudi Aramco. Its landmark bond issuance raised $12bn with books reflecting demand via London of more than $100bn.

Funds in London also did well, attracting over £5bn further capital during 2019, more than all of 2018 (£3.5bn).

Secondary markets
Secondary trading markets in Europe continue to offer a full suite of execution mechanisms to help investors deploy capital into equities markets, as well as minimise slippage costs of buying and selling. This is important, particularly in an economic environment of low interest rates, where long term investment returns are so important.
During 2019, Turquoise added further to its catalogue of empirical examples of unique liquidity. This includes Turquoise Plato™ whereby pre-trade the price and size of orders are not displayed, it is considered the industry leader in midpoint and electronic block trading – particularly via Turquoise Plato Block Discovery™. There is also Turquoise Plato Lit Auctions™, the frequent batch auction mechanism that caters also for large sizes and is transparent pre-trade.

These Turquoise mechanisms provide consistency in quality of execution, evidenced by low price reversion after the trade and the potential to trade larger sizes. Executions at midpoint also offers potential price improvement. It’s worth noting that issuers and investors using Shanghai-London Stock Connect also benefit from the Turquoise LSEG ecosystem.

Figure 1 displays trades on 26th June 2019, where the Y-axis is price and the X-axis is time. The bubble size reflects value per trade (NB Shanghai-London Stock Connect starts at 9am UK time instead of traditional 8am start on London Stock Exchange). On this day, London Stock Exchange’s gold coloured trades are most active morning and afternoon. Turquoise midpoint channels add incremental liquidity as investors find trades find trades matching at the midpoint of London Stock Exchange’s best bid and offer. Together, London Stock Exchange and Turquoise enable investors to trade throughout the day.

Independent firm Rosenblatt Securities confirmed Turquoise Plato™ as the largest European dark order book, rating us No.1 of 21 venues by value traded, setting new records again in 2019 – thank you to our customers.

Figure 2 highlights continued growth of monthly value traded and new monthly, weekly and daily records set in 2019 via the Turquoise Plato Block Discovery™ service, designed for larger sized orders within the Turquoise Plato™ order book.

A further trend is the growth of Turquoise Plato Block Discovery™, from less than 5% to more than 45% of all the Turquoise Plato™ midpoint value traded by calendar 2018, reflecting a significant change in investor behaviour by sending much larger orders to the market.

By November 2019, customers using Turquoise Plato Block Discovery™ traded over €250bn – more than any other provider as a fully automated service, without the fading associated with manual firm-up models. The insight is that Electronic Block Trading at midpoint works, and Turquoise is fully adopted by the global investor community, ready to scale beyond UK and European markets.

Customers on Friday 13 December 2019 set a new daily record of €1,064 million value traded via Turquoise Plato Block Discovery™, contributing to a new weekly record of €3.29bn during 9-13 December 2019.

Turquoise Plato Lit Auctions™ offers pre-trade transparency and multilateral liquidity for trades of all sizes. Quality is high with low price reversion recorded after trades. While average sizes of European equities remain around €10,000 per trade, and other Frequent Batch Auctions match many trades with small fill sizes, trades matched via Turquoise Plato Lit Auctions™ range from small to large, including a material portion above Large In Scale (LIS), and trades above €500,000 in size spanning stock names of 15 countries. If one is not accessing Turquoise Plato Lit Auctions™, how can one be sure one is achieving best execution?

Figure 3 shows unique liquidity example on 31st October, the day Fiat and Peugeot announced a merger. Investors using Turquoise Plato Lit Auctions™ achieved trades in large multi-million sizes, and this clearly differentiates the unique liquidity profile of Turquoise compared with that of other Frequent Batch Auctions’ venues.

Furthermore, Turquoise allows, via single connection, members to trade securities of 19 European countries – developed and emerging – and settle each trade in the respective country’s Central Securities Depository. This means neither the cash nor assets leave the respective home country, by which Turquoise enables investors extra ways to buy and sell to get their business done. More than a decade of innovation has refined the specialised Turquoise offerings designed in partnership with the largest global asset managers and leading LSEG member firms.

Turquoise has established a track record of innovation and partnership supporting efficient capital markets, and we look forward to continuing co-operation with the global investor community in 2020.

For more information on Turquoise please visit: @tradeturquoise or www.linkedin.com/company/turquoise

For more information on global fintech listings in London, see: https://www.lseg.com/sites/default/files/content/documents/LSEG_Fintech_Comes_of_Age_Report_2019.pdf

www.tradeturquoise.com

©BestExecution 2020

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Buyside profile : Nick Wood : Millennium Global Investments

By

Ian Rycott

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January 19, 2020

ALL POWER TO THE BUYSIDE.

Best Execution spoke with Nick Wood, Head of Execution at Millennium Global Investments, about innovation in FX trading and the impact of a low liquidity, low volatility market.

What trends have had the most impact on FX execution this past year?

The major trends that impacted markets in 2019 are a continuation of trends we saw in 2018. For example, transaction cost analysis (TCA) continues to be a valuable tool in improving the execution process. Three years ago, it was a tick-box exercise, but greater access to data and analytics both pre and post trade has enabled us to question the process and ask whether it needs to be improved significantly or marginally. Another notable theme has been the lower levels of liquidity and volatility which has driven a rise in algorithmic trading.

What has been the impact of MiFID II and its requirements on best execution?

What is key for my team in the concept of best execution is that it is not just trade by trade but covers the whole process, from the origin of the trade to the settlement, and the application of the different segments of the workflow in between. You now need to have a structured reason why you executed a trade in a particular manner. The conversations are different though, depending on the nature of the trade. If you are talking about liquid currency pairs such as euro/dollar, you can see the available liquidity and you can take a low-touch approach. Liquidity drops down when you are looking outside of the G5 and requires a higher degree of sensitivity around execution.

How is technology changing the market and what are the drivers?

It has been an evolutionary process, starting with the shift from voice brokers who were the controllers of liquidity, to the spot and option traders on the sellside. Now you are seeing the power pass to the buyside – a process that is being turbo-charged by regulation. There is a greater push towards transparency but also the sellside can no longer warehouse the trades as much as they used to because of their own capital constraints. The change has meant that end-users have better access to data and systems where they can be more specific about how they want to execute those trades.

At Millennium, we have an order and execution management system designed to facilitate different workflows. All trades come into the OMS and then we decide how we will execute – low- or high-touch. We also have a new TCA system and there is a greater focus on algos than we had in the past. We also look at post trade analytics to unearth elements of the workflow that we need to improve. There are also several initiatives such as peer-to-peer trading which has the potential to become an important part of the toolkit for execution. It is in its infancy, but we are monitoring its development.

You have mentioned that TCA has become an important part of the process. Do you have an internal model or do you use a third party?

We use a third party, but went through this rigorous onboarding process where we brought in multiple providers to get a better understanding of what they were actually offering. This process helped us whittle down the list. We then opened the discussion to stakeholders such as portfolio management, compliance, legal and marketing to get a different slant on the providers.

There is a lot of talk about the explosion, and importance, of data but market participants also complain about the lack of good quality of data. Is this the case in FX?

It is often said that data is the new gold. If you think about the number of electronic communication networks (ECNs) on the market, it is an expensive process to not only consume all the data but also to have the ability to clean and store it so as to be able to better understand metrics such as market depth and liquidity. The TCA providers and banks may provide increasingly granular data but the buyside needs to dig under the bonnet to understand what they are getting. We belong to the Investment Association, which has an initiative to create a questionnaire that buyside participants can send to banks to help build a greater sense of accountability and transparency.

Do you think there will ever be a consolidated tape for FX?

In an ideal world, every buyside practitioner would be using the same FX tape and be able to see the same prices and portray TCA in the same way. Because of market fragmentation, this is not the case today. Certain providers are able to access price data from multiple primary markets and ECNs but the data sets are still incomplete and that means that you may not be able to get accurate information on the price points traded at a specific time.

I think in order for a consolidated tape to work you will need to have an exchange or an equivalent consolidator but I do not expect to see that happen as soon as I had once envisaged.

How has Millennium responded to this changing environment?

In general relationships have always been important to us. This is especially the case in less liquid pairs because you are not necessarily trading electronically. You need to have the ability to access liquidity and to work across both phone and electronic venues. With low-touch, it is important to understand hit ratios and reject rates, as well as the relevant compliance rules and any other constraints involved. In general, there is a greater adoption of algo trading due to the low volatility, but I will be curious to see how they perform in a higher volatility environment.

Overall, the way we respond is to keep an open mind with all systems and workflows. After all, what is right today may not be the case tomorrow. We also focus on how we can improve our processes and also to ensure that we understand the new developments such as peer-to-peer trading and what that means for us and the industry. It is important to be fluid, to understand that change is good and to create greater efficiencies.

Are you introducing any new services?

We have launched a standalone execution and advisory service. It has been especially well-received by small to mid-sized asset managers where currency is an ancillary area and they do not have a large internal team. Their cost base is under greater scrutiny and they want to up their game. They often want to outsource as much of their workflow as possible to us, but we always work in partnership with them because they still have to make the strategic decisions inhouse.

How do you see things evolving in 2020?

One of the key challenges next year will be surrounding liquidity and volatility. It has been low this year and if it rises significantly that will have an impact on the market. More broadly, I think we will continue to see greater electronification in more liquid pairs but whether that trickles down to emerging markets will largely be dictated by the amount of volatility and liquidity in the market.

Biography:

Nick oversees all trade execution for the specialist currency investment manager Millennium Global Investments. Prior to joining the firm in February 2007, Nick spent five years in the fixed income and currency team at Aberdeen Asset Management and Deutsche Asset Management. Nick is registered with the Financial Conduct Authority.

©BestExecution 2020

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Buyside focus : ETFs : Lynn Strongin Dodds

By

Ian Rycott

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January 19, 2020

PASSIVE INVESTING ASSERTS ITSELF.

There has been a discernible shift to passive from active investing. Lynn Strongin Dodds looks at the trend and the response of asset managers.

It is not easy being an active fund manager these days. Passive strategies are capturing the hearts and minds of investors as the regulatory focus on fees and poor performance becomes sharper. The competition is only set to become tougher as fund managers on both sides continue to mine data and technology for shinier and newer product offerings.

On the surface the active segment looks healthy with figures from Willis Towers Watson’s Thinking Ahead Institute showing it accounts for around two thirds of the hefty $91.5tn assets under management of the world’s largest 500 asset managers. A closer look though reveals that their passive counterparts have enjoyed steady growth from 19.5% to 22.4% between 2012 and 2017. Although, this was not the case in 2018 reflecting an overall decline in AUM across the industry.

The pace quickened again in 2019 with a milestone reached in the US last August. Data from Morningstar revealed that for the first time, assets in US index-based equity mutual funds and exchange traded funds (ETFs) totalled $4.27tn, exceeding the assets of their active counterparts. Its research also showed that for the first half of 2019, roughly $30bn had been pulled during the first half from US and European active funds, the highest rate for three years.

There are several drivers behind the trend, according to Andrew Wilson, head of asset manager solutions EMEA at State Street Bank. “There is an immense amount of regulatory pressure around transparency including the areas of fees cost and charges,” he adds. “That is happening in parallel with rising costs of technology and competition.” Combined, it is “leading to a broader conversation about the performance of active managers and how they should respond.”

In some countries such as the UK, the Financial Conduct Authority has been shining an ever- brighter light, launching a review of the asset management industry three years ago while MiFID II introduced two years ago ushered in a new era of cost disclosures. More recently, policymakers in the UK, Europe as well as in the US have been naming, shaming and fining the so-called closet trackers who levy high charges for returns that can be cheaply and easily replicated. One of the most notable cases has been Janus Henderson which had to pay a £1.9m penalty to the UK watchdog.

Overall, active managers have been taken to task for missing the mark for almost a decade. S&P Dow Jones Indices annual report last year noted that for the ninth consecutive year, the majority (64.49%)) of large-cap funds lagged the S&P 500. Their cause was not helped by the suspension of Neil Woodford’s Equity Income fund and the problems at GAM which saw the liquidation of its absolute return bond fund range as well as departure of one of its star fund managers, Tim Haywood, after a high-profile dispute.

The ETF boom

One of the main beneficiaries of this fallout has been ETFs and products which offer low cost, transparent and liquid assets. The latest report card from independent research and consultancy firm ETFGI show that total assets hit $6trn by the end of October, doubling in size in less than four years. Smart beta funds and products have played a pivotal role in their growing popularity, with separate ETFGI research showing that on the equity front alone, assets jumped by 26.1% from $618bn to $779bn in the first nine months of 2019. This translated into a five-year compounded annual growth rate of 19.9%.

These hybrid structures which sit between the two realms incorporate insights found within actively managed funds into a rules-based indexing methodology. They cover a spectrum of well-known factors such as value, momentum, low volatility and quality to diversify risk and potentially enhance returns. However, a new paper from research Affiliates called “Plausible Performance: Have Smart Beta Return Claims Jumped the Shark” warns that investors need to look beyond the hype. This is because performance back tests are often used as evidence to “prove” a smart beta strategy is “better” than its competitors.

The problem, according to the paper is that these results are easily data mined. Testing 28 funds on the Research Affiliates Smart Beta Interactive (SBI) tool on the firm’s website, it found most long-term winners lagged behind their benchmark for five to six years, meaning they couldn’t deliver excess return consistently. This does not make them less worthwhile but there needs to be a recognition that “any strategy whose performance deviates (even successfully) from the market’s performance, is virtually guaranteed to have multiple years of underperformance over a 10-year holding period,” according to the study.

“Investors have to understand that when you have quantitative or systematic based investing you are getting beta and not always active returns” says Keshava Shastry, head of ETP Capital Markets at DWS. “What these products give investors is a full spectrum of flexibility. We see some asset managers use them as long-term strategic holdings in a developed market portfolio while others may use them to gain exposure to emerging markets. We are also seeing hedge funds use them for intra-day and technical trading.”

Other active managers are employing them as part of their portfolio construction or to help lower their overall fees. “There is a perception that ETFs are just used by passive investors, but that is not the case,” says Marc Knowles, head of ETF and index practice at consultancy Alpha FMC. “Active managers who have a large conviction will have a core active portfolio but then use an ETF as a satellite to apply a tilt or to gain an exposure quickly.”

Blurring lines

Looking ahead, the lines may get blurrier especially with the introduction of the so-called actively managed non transparent ETF in the US. Although it may not easily roll off the tongue these newly minted products approved by the Securities and Exchange Commission are attracting both attention and controversy. The reason is that managers do not have to disclose all of the fund’s investments on a daily basis which has been the main selling point of the traditional ETF.

Last April, the SEC gave to green light to Precidian Funds to roll out its product called ActiveShares which has US fund providers including American Century, BlackRock, Capital Group, Columbia, Gabelli, JP Morgan and Nuveen signing on as licensees. This suggests there will be a plethora of ETFs based on the structure in the future.

The main attraction is that “It allows managers to keep their secret sauce,” says James Hockley of consultancy Sionic Global. This will mean that managers can put more strategies into an ETF. However, what will not change is that the authorised participants will ultimately remain the main sources of liquidity. I do think that investors though will have to look more carefully at the quality chain of the products as ETFs become increasingly complex.”

The same is true for the active space. Not all managers fail to deliver. “Active managers drive the benchmark,” says Yves Choueifaty, president and chief investment officer of TOBAM, a quantitative asset manager focused on strategies to maximise diversification. “It is the benchmark that replicates active managers, not the other way around. When the benchmark does well, it is thanks to active managers, they compose it and decide the price of assets.”

Although the rivalry between the two will continue, Dean Crouch, associate director at Kingwood, believes one optimal solution is to have a blend of active and passive strategies within a portfolio. He notes that passive investing is considered more suitable for investing into liquid larger cap stocks that are on one of the main indices. However, if an investor wants to generate additional alpha through exposure to an emerging market country or something more specialised, like a healthcare or technology theme, he would advocate a more active approach to utilise the experience and knowledge of the underlying fund manager.

©BestExecution 2020

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Fintech : The cloud : Jannah Patchay

By

Ian Rycott

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January 19, 2020

THE CLOUD CHALLENGE.

Although financial service firms understand the benefits, Jannah Patchay explains why they have been slow to embrace the technology.

As recently as two or three years ago, financial institutions still approached cloud technology with more than a few degrees of caution. Whilst many, if not a majority, of firms have moved towards some degree of cloud migration and adoption, questions of cybersecurity, resilience and regulatory compliance still loom large on their agendas.

There is though, a widespread recognition that greater cloud adoption is an absolute necessity in order to remain competitive and innovative in today’s market. This can be attributed to greater regulatory certainty around treatment of cloud outsourcing as well as the disruptive potential shown by emerging cloud-native financial service providers.

Indeed, the rapid ascendance of artificial intelligence (AI) and machine learning (ML) has been primarily enabled through the availability of large data sets and vast computing power in the public cloud. Conversely, those wishing to leverage the power of AI / ML to its full potential must first have a cloud capability.

Picking up the pace

Trade organisations such as Association for Financial Markets in Europe (AFME) are hoping to accelerate the pace of acceptance. In a recently published paper entitled “The Adoption of Public Cloud Computing in Capital Markets,” it underscores that the adoption of the public cloud is vital to the whole industry, including banks, cloud providers and regulators. AFME lists numerous benefits including “greater business agility and innovation; improved overall cost management; increased operational efficiency; enhanced client experience and service offerings; and effective risk mitigation.”

AFME members also identify cloud technology as one of four key technologies that has the potential to radically transform their industry, and a core building block for enabling adoption of other new technologies and innovations. However, the very participants surveyed also responded, in the same breath, a generally negative view towards widespread adoption of the public cloud in their industry over the next five years. Only 29% of respondents believed this would occur.

One reason is the prevailing view of the public cloud. Despite recognising the advantages, AFME members also indicated that their preferred style of cloud solution was a “hybrid cloud” encompassing elements of both public and private clouds, bound together by some interoperability of technology. This is perhaps symptomatic of a long-standing barrier to tech migration in financial institutions – the prevalence of legacy systems that may not be portable or supported by cloud platforms.

It is also borne of the trust issues historically associated with the cloud. Yousaf Hafeez, head of business development at BT Radianz, however, believes “This hybrid approach is the one we see most often among larger institutions. A hybrid solution gives customers all the benefits of a public cloud with a private cloud for applications or data they don’t want to put on a public cloud.”

In the EU, regulatory concerns around cloud usage have been widely assuaged by the introduction of the publication, in February 2019, of the European Banking Authority’s (EBA’s) Guidelines on Outsourcing Arrangements. These provide a comprehensive framework for the classification and treatment of outsourcing arrangements and service level agreements (SLAs). This is useful for cloud providers themselves, who can now incorporate these requirements into their own contractual documentation and practices.

There is also a growing awareness, and indeed, adoption of public cloud by regulators themselves. In the US, for example, FINRA is using Amazon’s AWS cloud service to store, manage and analyse the data that it utilises for market oversight. The UK’s FCA, on the other hand, is also migrating its MiFID transaction reporting and analysis capability to the cloud.

As for the issues of cybersecurity and resilience, Fiona Willis, an associate director at AFME and one of the report’s authors, says “We tried to draw out in the paper that actually, there are a lot of security benefits from moving to the public cloud. If you don’t know anything about the cloud, it probably seems like a less secure option than having data and applications hosted on premises. But actually, when you understand it, you see that it’s far more secure, it’s more resilient. We need to address the skills and knowledge gap in understanding how public cloud services work.”

Cloud native

Being cloud-native – designed and built on the cloud from inception – offers huge advantages to new market entrants. Historically, hardware and platform costs would have constituted a significant overhead for challenger banks – not to mention the complexity and expense of disaster recovery sites, failover and business continuity plans. Cloud-native firms can leverage many of these capabilities that are offered out of the box by experienced cloud providers.

In addition, they benefit from the ability to rapidly scale up and down in terms of resource utilisation, as required and based on fluctuations in their user and client activity. This enables them to focus people and resources on their core business strategy and offering to clients.

Twenty years ago, establishing a fully authorised banking institution that could challenge the incumbent market shares at far lower cost, whilst offering a customer-centric and responsive experience, would have been inconceivable. “Without cloud computing, Starling Bank wouldn’t exist,” says the bank’s chief technology advocate, Jason Maude. “It’s not that it would exist in a smaller form – it just wouldn’t exist.

He adds that: “The cloud essentially enables us to access the infrastructure that is needed to run a bank, without having to make any giant capital outlay at the start. It enables our culture of innovation, in that we can try things out and deploy them quickly and at low cost on the cloud, and if they don’t work then we can move on to the next idea.”

The mark of a cloud native firm is to have the innovation built into the culture of an organisation. Integral, a full-service workflow automation and trading technology partner in the FX markets, has been cloud-native since its inception 20 years ago. Integral offers liquidity, pricing tools, distribution, risk management and data science, in addition to a high-performance trading platform. Its clients include banks, brokers and asset managers – many of whom may not even have realised that they were using a cloud-based technology provider.

Vikas Srivastava, Integral’s Chief Revenue Officer, cites the ability to offer bespoke services as a key differentiator for a good cloud technology partner. “Don’t forget, we are talking about the OTC market,” he says. “To really serve your customers’ needs, you cannot ask them to contort to fit your requirements.”

He adds, “You need to serve them across all products, protocols and different regulatory requirements and you need to do that in an extremely reliable way. The needs of the customer have evolved and they are asking for more. If you don’t meet their requirements, they may seek out someone else that will.”

Richard Hall, CEO of CloudOrigin, a firm advising multiple sectors on cloud adoption and innovation, is more bullish on public cloud adoption, particularly in light of advances in AI / ML. “I don’t think the financial entities have grasped the fact that computing is almost commoditised to nothing,” he says. What would you ask if you had a genie to whom you could ask any question? Tell me who are my most profitable customers. Tell me what products and services they want, and give me the simulations that prove I should offer them. The magic genie is there. And it’s sitting and giving answers to other, smaller competitors now. Imagine the power if you could look at IT resource in that way.”

©BestExecution 2020

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FX trading focus : Overview : Gill Wadsworth

By

Ian Rycott

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January 19, 2020

HOLD ON TIGHT.

After a relatively quiet year in FX markets, 2020 could be a lot more volatile. Gill Wadsworth explains why.

Foreign exchange traders had a fairly easy time for most of 2019 especially when compared to 2016 and Britain’s referendum on EU membership. There was relative calm with only bouts of spikey volatility.

Speaking before the UK election, Adam Seagrave, head of global sales trading at Saxo Markets, said “Sterling reached its highest level since May as the polls gave the currency another boost and [President] Trump’s visit to the UK unfolded relatively smoothly. FX traders will now ponder which way the risks are skewed. Some traders feel that the easy money has been made and with GBP well above the August lows, the risk to the downside is substantially higher.”

Seagrave’s view might have been temporarily confounded by the unexpected scale of the Conservative victory, with Sterling surging against the US dollar in the wake of the result, but then sliding back due to renewed fears over a ‘no-deal’ Brexit at the end of 2020. So, the impact may not be long-lived. Tim Graf, head of macro strategy, EMEA at State Street Global Markets, argues that despite election success for the Conservatives the pound may find itself back in the doldrums, saying “Sterling’s recent honeymoon may soon come to an end.”

Prime Minister Boris Johnson has signalled he will enshrine in law a hard stop to the transition period which kicks in on 31 January and will have a hard stop after the year. It can in theory be extended once by up to two years, if the UK and EU jointly decide to do so before July 1 2020. The decision to rule out an extension is intended to signal to Brussels that Johnson is serious about securing what Downing Street called a swift “Canada-style free-trade agreement”, a deal similar to that struck between Brussels and Ottawa that would focus largely on goods, not services. However, it has been reported that EU officials believe that the quality of the talks will benefit from more time.

Brexit and the British elections are not the only political events though upsetting the FX applecart. The US House of Representatives kickstarted impeachment proceedings right before Christmas although it is too early to determine the impact this will have on his re-election chances next year. He could very well be celebrating another four years in office, or the world’s largest economy could have a new head of state.

Whatever the outcome, the election next year will hang heavy over the US economy – and in turn the global one. According to ING’s 2020 FX forecast: Diamonds in the Rough, loose fiscal policy, either through lower taxes, more spending, or a combination of the two typically results in the Federal Reserve running tighter monetary policy. “Historically this has been a positive backdrop for the US dollar,” the report states.

However, it goes on to note that tighter regulations may be interpreted as a hindrance to business activity which may in turn may impede growth despite regulators attempting to provide safeguards and create incentives. The report notes, “The perception of slightly weaker growth may result in lower interest rates and be a mild dollar negative.”

Finally, there are concerns about protectionism. In its third online survey of e-traders – most of whom are in FX – JPMorgan asked for insights on the macro market trends. More than half (55%) said the evolution of the US trade strategy would have the biggest influence on global markets.

ING says Trump’s aggressive tariffs have hurt business sentiment by creating uncertainty and raising costs. In retaliation, China has imposed its own levies, damaging the health of itself as well as its US rival. This has not been the case for the dollar which has been given a boost by the ongoing tensions. “Amidst weak global growth the US economy has outperformed, and the dollar has stayed firm. If trade tensions were to persist then this could maintain a safe haven bid for the dollar. Should they ease then this could create an environment for better global growth and see investment flows start to move out of the US dollar,” ING says.

The US elections are a key focus for JRCA’s director Chris Towner, who argues that Trump will aim to bolster the domestic economy to improve his chances of re-election. “Trump has been pressuring trade negotiations with China and that has slowed global economy,” he says. “He knows that strong economic performance is what gets presidents reelected so he will be keen to get a trade deal done to improve his chances next year.”

Going strong

Away from the unpredictable and unsettling political sphere, FX markets enjoyed considerable expansion this year. According to figures from the Bank for International Settlements daily volumes have grown from $5.1tn to $6.6tn. This huge growth runs contrary to the traders’ concerns reported in the 2019 JP Morgan survey. Two-fifths of respondents said their biggest challenge in carrying out their daily business was liquidity (see Fig 1).

JCRA’s Towner attributes the increase in volume to FX swaps to being used to manage the timing of FX hedges for both businesses and funds. “FX swaps volumes have ballooned by a third over the past three years,” he adds. “This surge is down to the rise of private debt funds. They have seen extreme growth over the last few years and helped by low interest rates these funds have become a growing competitor to the traditional providers of debt, the banks.”

Towner explains that the competitive landscape and relatively tight margins within this sector mean funds lending in currencies outside of that with the fund itself, must hedge the FX risk to protect their returns.

“For an example, a euro fund with £500m in assets would hedge these £500m back to sterling every three months. This would involve a series of swaps and despite the volume of the hedge being only £500m, the annual volume of swaps will amount to £2bn as four swaps would be required to cover the year,” Towner says.

It is not private debt funds alone that are engaging in FX swaps. The rise can also be attributed traders rolling their longer-term positions more frequently, according to Alan Dweck, chief operating officer at BidFX. “We have seen long only asset managers talking more about monthly rolls when in the past they looked at quarterly rolls,” he says.

Dweck also reports a jump in the use of options over futures as a means of managing FX risk. This is a threat that most traders are keen to get off their balance sheets as they grapple with regulations such as Basel III which impose more demanding capital requirements.

The move to options also suits the trend to more FX electronic trading. “FX options are interesting; they are much better placed to be traded electronically than they were in the past. Familiarity in products is higher and as people get more comfortable, they increase usage. We were pushed to build FX options functionality by buyside clients last year,” Dweck says.

After a relatively peaceful year where volatility was less of an issue and liquidity was easier to come by, FX traders may have a more challenging year in 2020. Geopolitical tensions make for a choppy marketplace and there is no one who can really predict with any certainty how the elections will play out. However, as Dweck says: “It’s the unpredictability and challenges in FX that keep it exciting.”

©BestExecution 2020

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FX trading focus : Clearing : Paddy Boyle

By

Ian Rycott

-

January 19, 2020

FORGING ITS OWN PATH.

Paddy Boyle, Global Head of ForexClear explains how trading and clearing FX differs from other asset classes.

Paddy Boyle is Global Head of ForexClear. Prior to joining LCH in 2016, he spent 16 years at Goldman Sachs as an FX Options trader, where he was a partner and global head of FX Options trading. Additionally, Boyle set up the FX CVA trading desk and was responsible for capital and margin strategy in Goldman’s FX business. He was a member of the Bank of England’s FX Joint Standing Committee from 2013 to early 2014. Boyle received his BA and master’s degrees in mathematics from Trinity College, University of Cambridge, in 1997.

What have been the biggest trends impacting FX trading in 2019?

On the geopolitical side, Brexit, the UK election, and the US/China trade wars have all had an impact on currency markets and volumes. From a trading perspective, one of the biggest trends has been the increased focus on best execution. Execution desks have become much more sophisticated and are using a wider array of tools, which are independent of liquidity providers, to look at the total cost of trading in greater detail. As for liquidity, banks continue to be more risk averse due to capital and credit constraints.

What have been the key technological trends?

For us, one of the biggest changes this year has been the link with State Street’s forex platform FX Connect in September which allows the buyside to clear trades in an effortless, seamless and efficient way. The platform allows for exception-based automated matching, trade and settlement confirmation, as well as third-party messaging. This reduces the operational burden which is among the biggest challenges to clearing FX. The link also comes at a time when there is an increased demand for clearing services due to the uncleared margin rule, coming into effect next year, for the largest asset managers or those who are clearing aggregate average notional amounts of Ä50 billion. We expect that a significant number of platforms will connect to FX Connect in the next 12 to 24 months.

How do you see the uncleared margin rules impacting the industry?

Firms will have to set up new accounts, calculate, agree and exchange initial margin with all their counterparties. The benefit of clearing is that it reduces the burden because firms are able to post less margin and this takes them out of the scope of the regulation. This is why we have, for example, seen an increase in funds, who have FX hedges, clearing non-deliverable forwards (NDFs, which are used to hedge or speculate against currencies when exchange controls make it difficult for foreigners to trade in the spot market directly).

How has the shift to clearing changed the market?

The move to NDF clearing in the FX market is not recent, but we have seen a dramatic increase over the past five years. It is tied to firms looking at the total cost of their business and turning to clearing because it not only consumes less capital but there are also greater operational efficiencies, lower initial margin requirements and fewer credit line restrictions. If you look at the OTC asset classes, there has been a significant increase in volumes to clearing and we are planning to extend ForexClear’s service to include non-deliverable options in 2020.

How has the development of FX clearing been different to other asset classes?

With every other asset class, clearing started out with the most liquid products and then gradually moved to the less liquid. For example, in derivatives it began with interest rate swaps before slowly adding overnight index swaps as well as those with longer tenors. It is the reverse for the FX market. Clearing began with NDFs, which only accounted for 2% to 3% – the smallest percentage of the overall FX volume at the time – and has since increased to 5% to 6%. Clearing has since moved onto FX deliverable options and then FX forwards. The reason that it happened this way is because deliverable FX deals with physical delivery and it is complicated to satisfy the requirements of the different users.

I see that you expanded LCH’s deliverable FX offering to include FX forwards? Why is that significant?

It was definitely a big move and it substantially broadened the proportion of the FX market which is able to be cleared. We had NDFs and then launched deliverable FX options clearing in 2018, and their spot and forward hedges in line with customer demand. The move incorporated the first physical settlement service for cleared FX products. The benefits are that the FX forward service enables us to bring greater margin and operational efficiencies to an even larger segment of the market. We are clearing FX forwards on the eight most traded currency pairs – Australian dollar/US dollar, Euro/US dollar, Sterling/US dollar, US dollar/Japanese yen, US dollar/Swiss franc, Euro/Swiss franc, Euro/Japanese yen and Euro/Sterling, with physical delivery.

What are your plans for 2020?

Over time we would like to add more currencies on the deliverable side as well as expanding our non-deliverable service to offer options on emerging market currency pairs as well as tenors on existing G10 pairs. We are also focusing on onboarding new clients as they become covered by the next phases of the uncleared margin rules.

©BestExecution 2020

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Profile : Rebecca Healey : Liquidnet

By

Ian Rycott

-

January 19, 2020

SHIFTING SANDS.

Rebecca Healey, global head of market structure & strategy at Liquidnet assesses the leading trends in equities markets and what we might expect in a post-Brexit landscape.

Rebecca Healey is global head of market structure & strategy at Liquidnet and is considered to be one of Europe’s leading industry voices on market structure, regulatory reform, and financial services technology. She joined Liquidnet in July 2016 and is also co-chair of the FIX Trading Community’s EMEA Regulatory Subcommittee. She has held prior roles at TABB Group, Incisus Partners, the British Embassy in Bahrain, Credit Suisse, Goldman Sachs International, and Bankers Trust International.

What do you think the impact of Brexit will be in light of the recent election?

If it is a hard Brexit, then the FCA (Financial Conduct Authority) would no longer be governed by ESMA (European Securities Market Authority), but would still be subject to EU law until the end of 2020 during the transition period. The real question is what direction the new UK government will choose to take – soft Brexit or hard line – however, the political uncertainty surrounding the future relationship between the UK and EU27 is likely to lead to additional legislative changes post 2020. We have already seen a gradual divergence in regulatory approach from both the FCA and the European policymakers.

One area of concern over equivalence pertains to where European and UK shares could be traded in the future. Guidance from ESMA provided clarity on the scope of the EU STO (Share Trading Obligation), which applies to all shares traded on EU27 venues with EU ISIN (International Securities Identification Numbers) only. If there is no equivalence, all UK venues including UK systematic internalisers (SIs) will no longer be eligible for trading by European investment firms for those instruments that are dual-listed. This would have a significant impact on liquidity at a time when ESMA is emphasising the importance of liquidity in light of the suspension of Neil Woodford’s Woodford Income Funds.

How has liquidity changed over the year? What were some of the key findings in your recent report ‘MiFID II Landscape Liquidity Q3 2019’?

The report was very timely given that the MiFID review that is underway will look at the successes and failures of the regulation thus far. We found that in the past two years liquidity has shifted. For example, we saw a substantial 23% rise in the market share of SIs from March to the end of the third quarter 2019. The increase in activity could comfort regulators’ view that in the event of a hard Brexit, the enforcement of STO would push more volumes to European SIs, where the numbers have increased over the past year.

The question though, is whether these would operate according to ESMA Opinion regarding third country branches of SIs, or merely operate as a back-to-back model bringing together third party buying and selling interests across entities and jurisdictions to circumvent the impact of the EU STO. If the policymakers believe the use of SIs is not in the spirit of MiFID II and that they are being used for back-to-back trading, or as a means to match orders across jurisdictions, we could see further scrutiny and potential regulatory tightening.

What about closing auctions?

The report found that closing auctions have grown in the last 18 months reaching 25% of lit market volumes in September 2019. This can be attributed to the growth of index investing and ETFs (exchange traded funds), but participants also feel they get a fairer deal than on continuous lit order books. However, there may also be further regulatory scrutiny here. The French regulator, AMF (Autorité des Marchés Financiers), recently conducted a study that showed the proportion of shares traded at the close rose significantly, reaching 41% of the volume traded on Euronext Paris for CAC 40 stocks in June 2019. The reasons include a wish to avoid high-frequency trading, a rise in algorithmic trading, as well as the increase in best execution obligations under MiFID II to provide end-investors with greater transparency regarding transaction costs and market impact. This was also seen as encouraging more at-close activity.

However, it also notes that any reliance on closing auctions creates operational risks for traders, pointing to a 9% increase in utility company Suez Environment during the closing auction in May 2018 which incurred a trading loss of Ä2.2m.

What were the findings for periodic auctions?

We found that periodic auctions have plateaued in recent months at ~Ä1bn per day, down from the highs of Ä1.3bn in June 2018. The average execution size remained stable for uncapped names at around Ä6,000, while it had risen for capped names in June 2019 to roughly Ä10,000. It is worth noting though that the majority of the activity executed on these venues is now in uncapped names. Conditions could tighten in the future due to the recent ESMA Opinion which aims to limit the conditions under which periodic auctions can operate. For example, where the activity taking place is deemed non-price forming but eligible to operate under the Reference Price Waiver (RPW) – such as the use of pegged orders or systems that lock in prices at the beginning of an auction – it would be subject to the double volume caps (DVCs).

On that note, what impact has the DVC had?

Our report showed that dark activity has stabilised at around 7% of total volumes while LIS (large in scale) trading still accounts for around 33% of the dark market. There is still a conflict over dark trading which needs to be addressed, especially in light of the European Commission’s Capital Markets Union (CMU)* which aims to create more end-investor protection in the hope of generating greater retail activity by 2024. *The overall objective of the CMU is to boost investment flows and economic growth across Europe by removing barriers to fund sales, harmonising rules for covered bonds and ensuring legal certainty in cross-border transactions.

However, there are reasons why asset managers trade in the dark, such as wanting to improve best execution or to protect the end-investor from negative market impact due to unnecessary information leakage. There is no one-size-fits all solution and it depends on the asset managers’ objectives as well as market conditions and types of orders. This explains why there has been a rise in the use of periodic auctions and SIs as alternative methods of sourcing liquidity.

What impact do you think unbundling has had on the market?

The aim was to break the established model and under MiFID II, we have seen that the buyside is paying for research from its own P&L, which has enabled them to choose the best-in-class providers for both research and execution. With the data that firms now have on research procurement, they are able to better establish where to get best value for money. We are also seeing more detailed pre-trade data being fed into the investment process which is improving the timing of an execution as well as uncovering hidden liquidity by analysing previous executions to select the most appropriate venues and minimise unnecessary information leakage.

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Regulation & compliance : Diversity & inclusion : Francesca Carnevale

By

Ian Rycott

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January 19, 2020

THE BRIDGES THAT NARROW THE DIVERSITY GAP.

Narrowing the gender gap and eliminating ethnic, age and disability related bias in the workplace have met with, at best, only moderate success across the global financial services spectrum. Is a level playing field unobtainable, or is the future brighter than we think? Francesca Carnevale reports.

Diversity/inclusion (D&I) is now a touchstone of the enterprise culture, for good reason. D&I drives firms to adopt better policies that benefit all employees. It encourages a more tolerant and collaborative culture; promotes an improved work/life balance, raises staff retention levels, and spurs innovation say retail investment pressure group PIFMA and think tank McKinsey. Moreover, regulators are now on the case; think the UK Treasury’s voluntary Women in Finance Charter and the UK government’s gender pay disclosure requirements. So is the private sector, with initiatives backed by specialist industry bodies, such as ICMA, Innovate Finance and Tech UK.

With so many initiatives in train, women, minorities, LGBTQ+ and older workers should find themselves in a workers’ wonderland. Sadly, despite the rhetoric, there is much still to be done. The World Economic Forum’s latest data (2019) suggests at best Western Europe won’t close the gender gap for another 61 years, at today’s rate of change. Not as bad as North America (165 years) or Asia-Pac (171 years), but time’s clearly a bandit as far as diversity and inclusion is concerned.

Downstream, the numbers are barely better. Women account for only 14% of enterprise executive committees; they earn only 18% of computer science bachelor’s degrees in the US (barely up from 13.6% in the 1970s); and only 22% of artificial intelligence (AI) professionals globally are female. Moreover, research by online professional talking shop LinkedIn this year found, for instance, that in AI there are no signs that the gender gap is closing. Upside, the numbers suggest men and women are adding AI skills at a similar rate; the downside is that while women are not falling behind, they are not catching up.

In financial services and fintech, it adds up to no change. Worse, cautions Tim Dinsdale, CTO Europe at OpenFin, “we have actually gone backwards. The percentage of women qualifying with computer science degrees has gone down since the 1980s [37% at the time]. This translates directly into hiring data. It doesn’t yet show us the subsequent promotion or retention numbers. Achieving gender equality is urgent, rather than a badge of honour.”

There are other nuances too. LinkedIn found in general, women with AI skills are more likely to work in the use and application of AI, with common positions including data analytics, research and teaching. By contrast, men typically work in the development of the technology itself, which is reflected in the skills they report, such as deep learning and neural networks.

Talk the talk

One issue is the language of compliance. Much of the debate has homed in on value in equality. However, highlights DiverCity podcaster and financial services influencer, Julia Streets, the big kahuna is the enterprise value that diversity brings. “There is a new appreciation of what large spectrum diversity can bring – inclusive of race, age, LGTB as well as gender – to business. For the first time, there are five generations of experience in the City, with a measurable impact on corporate culture, innovation and sustainability,” says Streets.

Even so, acceptance of D&I is not ubiquitous across financial services. Clearing and settlement services rank highly in the equality stakes. The Options Clearing Corporation (OCC), for instance has five female directors out of 20 seats and 33% of the clearer’s officers are women, some way above the norm. Explains John Davidson, OCC’s CEO, “The products that institutional investors, pension funds, mutual funds, exchange-traded funds need, [require…] a whole variety of different approaches. Those different approaches are most available if you have a diverse number of perspectives in your organisation.”

By contrast, private equity and hedge funds exhibit a lower propensity for change. Elsewhere, there are significant stirrings in both venture capital and, in particular, asset management. Why so? The business case for change is irrefutable, explains Frédéric Janbon, CEO of BNP Paribas Asset Management (BNPP AM), who believes that the financial community is “now at a crossroads”, and a new direction of travel includes D&I.

This year BNPP AM initiated a Global Sustainability Strategy, supported by three E pillars: equality, the environment and energy transition; including a firm commitment to include more women on its executive board. The initiative is one of the levers it uses to engage new customers and retain the best talent. As Janbon explains, “It reflects our increased ambition and outlines a blueprint to mainstream sustainability in all that we do, through our investment processes, but also engaging with our staff, companies, policymakers and wider society. This is central to our firm’s strategy and our ability to deliver sustainable, long-term investment returns for our clients.”

OpenFin’s Dinsdale runs with the theme, underlying Janbon’s view that ultimately what’s good for the diversity goose is particularly good for shareholders. “Recruiting and training is very expensive for big knowledge economy firms,” he says. “Employee churn is bad for shareholders. Companies have a commitment to their investors to attract and retain as much talent as possible; and that absolutely includes a genuine commitment to D&I. If a company is not serious about gender equality, they are more likely to promote the same kind of people that are already in power.”

Dinsdale adds that this “can be very detrimental because it can exclude talented employees who do not fit into this box and consequently leave. The fact is that the more opinions you bring to the table, the more likely you are to uncover the right solution to a given problem. I have seen this many times in organisations. If your employees have identical life experiences, you are not achieving the best outcomes.”

The next stage

All well and good; though as Janbon highlights, we are at a nexus. In the UK, government infers British workers will get priority on public procurement projects after Brexit. An attendant danger is the bias will filter down to other business segments as public procurement projects cover a broad range of gender-lite industries such as construction, engineering, financial services and capital markets, let alone fintech. It is a potential problem not only in the UK long term, but also Europe and North America where nationalism is on the rise. Can these trends trump the gains to date made in a meaningful drive for D&I?

Influencer Streets remains upbeat. Competition for business and talent, she believes, will temper any dampening tendencies. Moreover, she thinks it will inevitably widen the search for new and old talent outside the traditional confines of financial hiring, revitalising both industry and regions across countries. “Schools and universities are where the search begins. Groups such as Innovate Finance are already opening dialogue across the country to begin to tap into this wellspring of talent. I’m hopeful for both the near and long term.”

Ultimately, maintains Streets, the onus is on the D&I community itself to help leaders hire. “They are the key to success and need to demonstrate the sustained economic value of diversity and inclusion to the board, shareholders and the company at large. It’s about culture and leadership. If D&I professionals are proactively delivering value across the enterprise and if performance is baked into their hiring managers’ scorecards, then the benefits of diversity and inclusion will be valued as a both commercial and organisational imperative.”

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Trading : Exchange innovation : Dan Barnes

By

Ian Rycott

-

January 19, 2020

INCREASING IMPORTANCE OF AUCTIONS RAISES HACKLES.

Dan Barnes looks at the new models launching to fight for a share of primary exchanges’ business.

European markets have seen a significant move in trading activity towards the closing auction in recent years. However, market participants and operators are voicing concerns that such a concentration could create problems.

The figures say it all. Primary exchanges have seen a move from around 20% of their volume happening at the close prior to 2018, to nearly 40% happening at the close today. Tabb Group estimates as much as 25% of a stock’s average daily trading volume during some months can be conducted via closing auction. The proportion of major indices’ volume run via the close has grown from around 15% to 20%+ (see Fig 1).

“I question whether it’s healthy for the markets if some European exchanges have nearly 40 per cent of the day’s volume going through in the close,” says Matthew McLoughlin, head of trading at buyside firm Liontrust, which has £17.9 billion in assets under management (AUM). “It’s probably something that, as an industry, we might want to address and potentially discuss whether there are any other benchmarks that we could use in addition.”

Simon Gallagher, head of Cash and Derivatives at Euronext says, “There is one concern which we are looking at very closely with the other regulated markets. Simply, that the more you do at the close then it creates a higher concentration risk. If anything were to happen at a closing auction before, maybe 20 per cent was affected, but that would be 33 or 34 per cent today, so there is a concern from an operational risk perspective.”

Some operators are also seeking to get a slice of the action, by offering ways to access the auction with a potentially wider pool of liquidity. However, to date none has gained critical mass.

Closing time

The big change that hit the market in 2018 was the revised MiFID II which led to a wholesale shift in the way firms sought to execute trades. In splitting up dark pools of liquidity – which exercised no pre-trade price transparency – into multilateral trading facilities and systematic internalisers (SIs) – the latter allowing operators to trade only against their own book – the directive was intending to increase the level of trading on venues that do support pre-trade transparency such as exchanges.

However, the desire to show orders to the rest of the market is very low for asset managers trading large blocks of stock. It provides firms that make trading decisions at microsecond speeds with an opportunity to take the other side of the market and trade against the asset manager’s position.

Gallagher believes there is a consensus in the market as to why the close has become such a focus for activity. The first is the rise in passive investment strategies which require several creation/redemptions of units at the end of the trading day, while the second involves the complexity of proving best execution in the post-MiFID II trading landscape. Last but not least is the weight that trading algorithms and smart order routers give to orders, based on historical volumes.

“A lot of customers see the closing auction as a safe haven at the end of the trading day,” he says. “They know that they can get sizes done on average around between 80,000 and 100,000 Euros in one clip, with no information leakage.”

For the most part traders do not see any harm in executing within the closing period and report no major problems from a trading perspective, although events can be more exaggerated in an auction than in continuous trading.

“It is not necessarily good or bad; it has evolved this way resulting from market forces,” says Jeremy Ellis, European head of equity trading at T. Rowe Price which has US$991 billion AUM. “We are cognizant of the opportunity that is there, we try to maximise our opportunity to engage with that liquidity when it makes sense to do so.

However, the cost of trading at the close is often higher than trading in the continuous trading period and that could create higher trading costs for investors.

“The close only happens on the primary exchange at the moment,” says Peter Whitaker, head of market structure, EMEA cash, UBS. “We know that the primary exchanges tend to have a premium or higher rate for trading in the auction than for continuous trading, barring Xetra and the LSE.”

Creating an alternative

The only way to force prices down using market forces over regulation is to introduce competition. Yet a fragmentation of closing auctions for equities listed on a given exchange would create two or more closing prices which would create challenges for firms who use the closing price as a benchmark.

“There have been various attempts to fragment price formation and liquidity formation in the closing auction over the last 10 years and it’s never really got much traction,” says Gallagher. “With the rise of the closing auction we see another wave of attempts to fragment the closing auction for private markets. The asset management community do not want two closing prices.”

Some efforts have been developed in order to support competition without creating a new closing price. Aquis Exchange’s Market at Close (MaC) function allows orders to be sent to the Aquis venue as a first port of call accepting the market of listing’s (MoL’s) closing price for execution with unfilled trades then being executed on the MoL’s closing auction in order to gain access to additional potential liquidity.

“You don’t want to have two prices for the close of a single stock, I think that’s very confusing for asset managers, for investors, for portfolios themselves and how they value,” says Alasdair Haynes, CEO at Aquis. “We wanted to do something where you end up with the same closing price and a method whereby people could actually seek liquidity in a transparent environment.”

Whitaker says UBS started to use Aquis MaC this year after looking for a better way of engaging in the close, while introducing healthy competition, without introducing anything that threatens price formation.

“Using a regulated exchange [like Aquis] is appealing given the dynamic with SIs at the moment, and some of our clients cannot receive an SI fill so an on-exchange solution has a broad reach,” he says. “It is pre-trade transparent and multilateral, so we can find matches with other participants’ flow. We went live at the start of August and as a default from September and it is operating well, client engagement is high from our side, everyone was for the idea. Our peak day saw $600 million of business through it and it was seamless, although it took work and effort on our side to deliver that seamless process.”

Equally some sellside firms have been developing offerings that would allow them to build a book of orders prior to the auction in order to support client execution.

“Their case is that if buyside firms tell them what they want to do – and some of the runways are 15 minutes ahead of the auction – then they will put together natural business and give their clients a better outcome,” says Ellis. “I think in such circumstances, you have to factor in the associated signalling risk that is inherent in such a process with no guarantees of the right outcome.”

While these solutions could potentially tackle the increased trading costs that result from greater closing auction volumes, the operational risk that Gallagher noted is potentially more disruptive – one trader observed that avoiding a ‘flash crash’ in an auction could only be prevented by strong limits and balances on trading activity – and that unsophisticated firms could get caught out in the close.

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LiquidMetrix analyses consolidated performance figures for equities and ETFs traded in Europe in the previous quarter.

TURQUOISE PLATO UNIQUE LIQUIDITY.

Dr Robert Barnes, Global Head of Primary Markets & CEO Turquoise, London Stock Exchange Group offers his insights of Primary & Secondary Markets innovations.

ALL POWER TO THE BUYSIDE.

Best Execution spoke with Nick Wood, Head of Execution at Millennium Global Investments, about innovation in FX trading and the impact of a low liquidity, low volatility market.

PASSIVE INVESTING ASSERTS ITSELF.

There has been a discernible shift to passive from active investing. Lynn Strongin Dodds looks at the trend and the response of asset managers.

THE CLOUD CHALLENGE.

Although financial service firms understand the benefits, Jannah Patchay explains why they have been slow to embrace the technology.

HOLD ON TIGHT.

After a relatively quiet year in FX markets, 2020 could be a lot more volatile. Gill Wadsworth explains why.

FORGING ITS OWN PATH.

Paddy Boyle, Global Head of ForexClear explains how trading and clearing FX differs from other asset classes.

SHIFTING SANDS.

Rebecca Healey, global head of market structure & strategy at Liquidnet assesses the leading trends in equities markets and what we might expect in a post-Brexit landscape.

THE BRIDGES THAT NARROW THE DIVERSITY GAP.

Narrowing the gender gap and eliminating ethnic, age and disability related bias in the workplace have met with, at best, only moderate success across the global financial services spectrum. Is a level playing field unobtainable, or is the future brighter than we think? Francesca Carnevale reports.

INCREASING IMPORTANCE OF AUCTIONS RAISES HACKLES.

Dan Barnes looks at the new models launching to fight for a share of primary exchanges’ business.

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