Equities trading focus : Dark pools : Robert Cranston

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April 10, 2016

BLOCK TRADING – WHAT LIES AHEAD.

Robert Cranston, Head Equity Product Management, SIX Swiss Exchange.

The block trading space in Europe has become very active recently. Large changes are underway due to the continuing need for asset managers to move large positions and MiFID II’s proposals for non-displayed trading. The important question investment firms need to answer is, with all the upheaval, how do you continue to service the needs of clients looking to execute large sized trades with minimal market impact?

According to estimates from the latest Rosenblatt Let There Be Light report on dark trading in MTFs and BCNs in Europe, approximately 13% of consolidated turnover was traded in non-display pools in January. In addition, except for Liquidnet, there is a very small proportion of this flow that is actually traded in block sizes (they use a trade value of E200K to approximate block trades).

Only 8% of flow, on average, is traded in blocks on venues measured. This matches other research in the industry that has shown blocks account for a relatively small proportion of all dark trading. All of this is happening as average trade sizes in the lit markets have continued to plummet, making it much more difficult to trade truly large orders without market impact.

Originally, non-displayed trading was presented to the market as a way for traders to move positions with reduced information leakage. For block trades it is a critical trading consideration, although, today it is not only used for blocks. It is important to realise that non-displayed trading is not the same as block trading, and that a relatively small percentage of non-displayed trades in Europe meet the criteria of being a block.

Trading outlets

Few venues cater to block trading. This is reflected in the majority of non-display trading venues having average trade sizes that match, or are even smaller than, lit market averages. The other way to measure the acceptability of trading blocks on venues is by looking at information leakage. In the data analysed by Liquidmetrix (see Figure 1), we can see how the different pools perform when looking at price movement after a trade. By either of these measures most of these venues are clearly not serving block size trading. Others, such as Liquidnet show average execution sizes significantly larger than lit markets due to their focus on block execution.

Fortunately, there is no shortage of new markets and order types to fill any gap. Turquoise (Block Discovery), LSE (Dark Mid-Point), Deutsche Börse (Volume Discovery), BATS (Periodic Auctions) and PLATO in Europe as well as the rumours of BIDS or IEX voyaging across the pond are just a few of the options.

Trading participants as well as buyside firms will need to look at all of these options to determine the best strategy, but the inevitable outcome in the immediate future is fragmentation of block liquidity. Hopefully, the long term will see an eventual consolidation as new order book and technology solutions are rolled out to the market and either succeed or fail.

Interestingly, what has happened so far in response to regulation is largely focussed on technical changes around new trading books and models, as well as completely new venues. The natural by-product in the coming years is additional work for all firms looking to interact with these many new ideas for block trading, some of which will thrive, while others will disappear. This is on top of the already large burden of work regulation will cause for firms.

Nearly five years ago SIX Swiss Exchange identified a similar potential need for block trading from their members. At this time the exchange had the choice of either bringing a new facility to the market, or working with an existing pool of liquidity to address members’ needs. Rather than creating their own pool of liquidity from scratch, their answer to the problem was SLS, the SIX Swiss Exchange Liquidnet Service. This service allows all members of the Swiss exchange, and their clients, the ability to route committed orders to Liquidnet which are eligible to match and cross with participating liquidity within the largest block liquidity pool in Europe.

By providing this access, it helped to answer two important questions for the exchange. First, how are we making it easier for our members to trade blocks, and second, how are we actively innovating to help unify the overall market and facilitate block trading in the market whilst maximising the ability to find true natural contra liquidity. SLS is accessed via standard exchange connectivity, using a standard FIX protocol, and is fully supported by our existing interoperable CCPs, making it the only exchange-supported block pool for trading in 11 European markets.

SIX Swiss Exchange Liquidnet Service

Partnership for Block Trading with Liquidnet, the largest block pool in Europe
Markets covered: Austria, Belgium, Denmark, Finland, France, Germany, Netherlands, Portugal, Sweden, Switzerland, UK
Central clearing and CCP interoperability
Average trade size 2015: Over 300,000 CHF (Double 2014)
Turnover increased 101% from 2014 to 2015

©BestExecution 2016[divider_to_top]

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Equities trading focus : Market Abuse Regulation : Mark Ford

By

Ian Rycott

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April 10, 2016

SURVEILLANCE NEEDS UNDER MAR.

Mark Ford, principal consultant, head of Global Sales and Marketing at LiquidMetrix looks at the impact of the new regulation.

What impact will the delay of MiFID have on the Market Abuse Regulation (MAR) since the two are related on some issues?

The MAR comes into place this July and that means there is a longer gap between its implementation and MIFID II, which has now been delayed until 2018. Although there is a major time difference between the two new pieces of legislation, industry participants need to consider some of the aspects contained in MIFID II this year because MAR includes the provision for wider monitoring of asset classes and is not a directive but a regulation. This means it’s required to be implemented in full in all EU member states without the need for local legislation. In the past, many participants relied on exchanges and local regulators to carry out monitoring of potential abuses but this was always problematic, because they do not see every part of the trade lifecycle. Going forward all participants will be responsible for the oversight and monitoring of their trading activity.

What are some of the key changes under MAR?

The regulation covers both buy and sellside firms. Asset coverage and trading platforms will be widened to include financial instruments traded not just on regulated markets and MTFs, but on organised trading facilities (OTFs). Also, OTC trading has to be considered. Other key changes are that MAR covers cancellations of orders, and modifications or terminations to an existing order, where there is evidence of potential abuse. The current requirement to make Suspicious Transaction Reports (STRs) is expanded to Suspicious Transaction and Order Reports (STORs). This means there is both the existing obligation to report suspicious transactions as well as now suspicious orders. Attempted market manipulation becomes an explicit MAR offence, as does the attempted manipulation of market benchmarks such as LIBOR.

What impact will this have on a firm’s infrastructure?

The regulation recommends using electronic surveillance systems where applicable, but we have found that many industry participants are still using largely manual or old legacy systems to carry out their monitoring requirements. The older systems are clunky, weighed down by data, and especially not able to cope with fragmented markets. Most are geared towards monitoring prices on the primary markets only but not MTFs, which now account for a significant proportion of trading activity. Research figures show that the primary market share on some instruments is now below 50%, with the other half of the volume traded on MTFs. The other issue is that the legacy systems tend to be siloed according to specific business lines and are now not appropriate for the new regulations.

What are some of the key challenges?

Data is one of the key challenges. We already have the situation where orders or trades on one venue can be used to influence prices on another. However, under MAR, participants will need to collate and reconstruct trades across multiple venues as well as manual and electronic trading. They also need to take a holistic view of their trading activity and look at the flow from all angles, whether it is on exchange, MTF or proprietary. For example, if trading in European stocks, a participant would need order book price information from potentially six lit markets to be monitored as well as the various dark and OTC venue volumes.

There is also more accountability, which means firms need a clearer picture of the context of a potential abuse. The information has to be presented in a meaningful form and should show the market conditions surrounding the potential abuse. The order book needs be more granular than is currently used so that activity including a participants own direct market order messages are used, as well as each outgoing order message, in order to satisfy the requirement to monitor for spoofing or layering manipulations.

What is the level of preparedness?

Meeting the new regulations requires significant investments in infrastructure and information storage, but it is impractical for all but the largest institutions to initiate lengthy, expensive projects to undertake the surveillance needed where the participant subscribes to each individual source of information. For example, if I am a member of five European trading venues, I will need five separate data feeds and the infrastructure to support the data collection and storage, even before the actual requirements of the surveillance system have been considered.

The older legacy systems are rarely flexible enough to adapt to new market conditions, so we believe the best approach is to have a utility service from a vendor that still gives the participant the desired level of surveillance monitoring, but at a fraction of the cost. Although I have not seen any studies, estimates show that moving to a utility could be a quarter of the cost of implementing a strategy in-house.

The other benefits of using a utility are that it allows firms to focus on their core strengths and competitive advantages – as satisfying a compliance requirement is rarely a competitive benefit.

How do you see the market evolving?

I think we will see a scramble as firms really need to be prepared for MAR in July, and that over the longer term we can be sure that markets will continue to change. Systems are required to be flexible, but also be able to carry out ‘what-if’ scenarios, which will become increasingly important and help users determine the features and changes required to market abuse alerts as the market environment continues to evolve.

©BestExecution 2016[divider_to_top]

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Equities trading focus : Digital transformation : Saoirse Kennedy

By

Ian Rycott

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April 10, 2016

DIGITAL TRANSFORMATION IN EQUITY MARKETS.

Saoirse Kennedy, Senior Consultant, GreySpark Partners.

The percentage of US and European equity trading, covering cash equities and equity derivatives, that takes place electronically has plateaued as a percentage of total market volume. While the high-frequency trading (HFT) share of the market has declined since the 2008 financial crisis, this decline is levelling off in both the US and Europe, with US equity markets remaining ahead in terms of total market volume executed via HFT. Since 2008, algorithmic trading continued to capture an incrementally larger share of the electronic equity markets. The regulatory environment that has shaped equity market structure since the 2008 financial crisis pushed trading towards electronic mediums, such as swap execution facilities, multilateral trading facilities and organised trading facilities, ensuring the expansion of algorithmic trading and bringing the efficacy of dark trading venues into question. At this point, equity market structures are not expected to further undergo such fundamentally significant changes as a consequence of regulations.

Volatility within equity markets plays an important role in the growth of algorithmic trading and HFT as a percentage of all equity trading. Between 2012 and mid-2015, US and European equity marketplaces were characterised by an extended period of low volatility. While markets did persist in rallying over that period, growth was slow and heavy. HFT relies on volatility to drive trading and profits, and without volatility the ability of high-frequency traders to act quickly on markets brings no advantage. As volatility disappeared from markets over the 2012-2015 period, profits from equity HFT declined. Today, equity markets, in both the US and Europe, are characterised by a return to volatility as evidenced in Figure 1 and Figure 2, that show the primary volatility indices in each marketplace, the VIX and the VSTOXX, respectively.

The so-called ‘double dip’ in US equity markets – with a first dip in August 2015, followed by a January 2016 dip – is a market correction in response to falling commodity markets, particularly oil prices. Meanwhile, market analysts do not forecast a near-term economic recession.

As equity markets become opportune for HFT, moves are being made by some market participants to position themselves favourably to capture an anticipated upswing. Global Trading Systems, a high-speed electronic market maker and technology firm, have agreed to purchase Barclays’ NYSE equity market-making business, which will make them the largest designated market-maker on the NYSE. The agreed purchase also represents the departure of the last investment bank from the NYSE trading floor, which is a significant development with respect to market structure and the continued weakening position of investment banks in financial markets. In buying Barclays’ NYSE equity market-making business, Global Trading Systems will join high-speed market makers VIRTU and IMC on the exchange’s floor, entrenching the trend of non-bank market-makers that specialise in market-making technology as providers of brokerage services. Additionally, the hedge fund Citadel is in talks to buy Knight Capital Group’s market-making business on NYSE.

Moves are being made by some structural participants in equity markets to mitigate the impact HFT may have. For example, the Investors Exchange (IEX), a buyside-owned equity securities trading venue, that uses a ‘speed bump’ designed to discourage aggressive trading strategies, recently applied for full stock market status with the US Securities and Exchange Commission in a move away from its alternative trading system origins. Though the IEX platform’s speed bump would appear, thus-far, to be ineffective, it is controversial as it represents an unfair advantage for attracting market makers. Allowing venues like IEX to gain full stock exchange membership would change the nature of equity markets. Further to this, the European equity trading venue Aquis Exchange wants to ban predatory HFT tactics. Aquis’ platform would send aggressive trading away from the venue in an attempt to lure in block-traders. Aquis is also authorised by the Financial Conduct Authority to introduce a speed bump on its venue, similar to that of IEX, though it is not yet clear if the company will choose to do so. These considerations by IEX and Aquis are further to regulations on co-location and high order-to-trade trading strategies in the US, and regulatory action on flash crash measures and clearer definitions on market manipulation in the EU.

These changes to equity marketplaces are indicative of three emerging trends:

Innovative technology-based market-making firms are paving the way forward for the next generation of electronic trading venues and the direct market-maker business, not investment banks;
Buyside firms are reinforcing their desire to trade on equity exchanges without perceived interference from non-bank algorithmic or HFT market-makers – this is causing them to gain ground in areas where investment banks are losing ground; and
HFT is expected to make a resurgence, but structural market participants, such as IEX or Aquis, are preparing to create new competitive spaces in a retaliatory move that is already supported by US and EU regulations impeding the most aggressive elements of HFT.

These three trends are a strong indicator that equity markets are at the early stages of a digital transformation, which, in the capital markets space, is generally seen as being driven by regulation, technology innovation and the strength of buyside institutions.

The buyside space is now characterised by institutions that have amassed assets under management the scale of which was previously unheard of in capital markets. Their grip on liquidity, coupled with investment banks that are struggling to manage Basel III capital requirements and leverage ratios, leaves the buyside in an enviably powerful position. Liquidity in equity markets fragmented as a consequence of market structure changes, leading global investment banks to rationalise their operations and embark on a process of regionalisation. Fragmented, regionalised markets are difficult for investment mangers to trade in, and this pushes them from executing with investment banks due to cost considerations. This has encouraged non-bank providers of equity brokering services to come to the market, widening the supply of service providers to the benefit of cost-savvy investment managers. Buyside firms also have the capacity to bring services such as transaction cost analysis (TCA) and risk management in-house, further ostracising investment bank-provided services.

The strength of investment managers is again apparent in the development of Luminex, a buyside-only trading platform launched at the end of 2015. It is a product of a consortium of investment managers including BlackRock, BNY Mellon, Capital Group, Fidelity Investments, Invesco, J.P. Morgan Asset Management, MFS, State Street Global Advisors and T.Rowe Price. The development of Luminex is in line with a move away from dark, or grey bank-run alternative trading venues.
As investment banks struggle to find a position in the evolving equity market landscape, they must look to the post-trade space and focus on developing innovative service offerings. Digital transformation translates as the restructuring of the manufacturing and distribution of products and services, and it will be evidenced as multi-channel, straight-through processing. The days of cost cutting are numbered; equity market participants must on-board digital capabilities that will require internal re-organisation and investment in business processes alongside investment in product and service development. E-commerce business and technology offerings must be brought in line with the digital ecosystem, which requires agency-centric equity trading units and an orientation towards post-trade services, which is the last nook of competition for banks. The demand for post-trade services is seen in the Australian Stock Exchange’s upgrade of its equity clearing and settlement system in tandem with Digital Asset Holdings, a US blockchain technology provider. This is part of a wider intention to upgrade all trading and post-trade platforms over the next three years.

Equity markets are poised to go digital, but the readiness of the investment banking elements of this market is questionable. If banks do not find plausible answers to the questions being asked of their equity trading business and technology models, then they will be left behind.

©BestExecution 2016[divider_to_top]

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Equities trading focus : TCA : Ian Domowitz

By

Ian Rycott

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April 10, 2016

EXECUTION ANALYSIS IN THE WORLD OF TCA.

Ian Domowitz, ITG Inc.

What is the difference between execution analysis and TCA?

Nothing.

So, what changes based on the use of execution-level data as opposed to just orders?

Everything…

Huh?

…if the lens through which you see data evolves with the data themselves.

Data are neutral. Consequences of changes in data can be enormous. In that spirit, I will try to sort out what this Q&A means.

Transparency

Enhanced granularity of trading data delivers transparency. Dashboards are popular for algorithms and routing. Post-trade analysis follows suit. Whereas order-level TCA contains average order sizes, durations, cost, market conditions, and so forth, this information now is available at the level of individual algorithms. New metrics appear, such as price reversion and fill size by strategy.

There is more. Distributions of fills by market cap, by start time, by number of placements… need we go on? Absolutely… distributions of algo usage by market conditions, fill sizes, duration, and number of venues. There is a blizzard of data once granularity has reached the level of individual fills.

But this is all just TCA, or more aptly, transaction cost reporting. It is “observational analysis” conducted with different data. In contrast, the trend in order-level TCA has been to navigate a smaller blizzard to isolate actionable information. In execution level analysis, we almost achieve a count of distributions of outcomes equal to the number of data points in order-level TCA. That exercise has left granular TCA unchanged from its aggregate cousin: the setting of performance results in the context of market conditions and trader activity.

Outliers

The most popular report requested in order-level TCA is an outlier report. It may be as simple as the five best and worst outcomes. It may be as complicated as the breach of user-defined bounds in particular market conditions.

The most popular report requested in execution analysis is also an outlier report. We have more possibilities for the definition of “outlier.” Examples include prices at the millisecond level and reversion statistics.

The aggregate and granular concepts are the same. Beyond extra metrics, there is no change in moving from order-level to fill-level analysis. There are some pitfalls, however.

Granularity and noise

In my experience, every outlier has a story, which could not be captured in the assessment of the trade. Studies of trader physiological and psychological behaviour suggest that these stories be interpreted with caution. After the fact, trader opinions may be disconnected from market conditions and uncertainty.¹ There is physiological truth in the axiom, ‘you are what you trade, not what you say’.

One person’s stories are another’s noise. While granular data may amplify resolution, like pixels on a screen, they increase uncertainty. Peering closely at a pixelated face delivers more about the nose than desired, while missing the shape of the chin completely.

How many outliers ought one to expect, viewing them as noise? A pragmatic standard is five percent of the data. That’s 50 outliers for 100 orders resulting in 1000 executions. The trick will be to establish methods which find patterns in that many outliers. Such methods could turn a poor data situation into something more useful.

Best price and best execution

There is no commonly accepted definition of best execution. This uncertainty has driven some market participants to think about best execution as best price. Execution analysis has a tendency to promote this belief, perhaps because prices are the only things truly moving at millisecond intervals.

Best price at the fill level is not best execution. Best execution entails the best outcome under the circumstances surrounding the implementation of an investment decision, i.e., surrounding the order. Consider the following example.

If one followed a passive participation strategy, getting the best price at every fill, this order would cost 75 basis points (bps). The strategy used resulted in a cost of 60 bps.

There are no obvious outliers in the implementation of this investment decision. We can, nevertheless, do better based on execution analysis, albeit with the right lens.

Strategies as outliers

The lens through which execution analysis differentiates itself must focus on trading strategy. Granularity of data then adds value, and strategy is the core contributor to the final result. Strategy analysis is actionable. Conditional on the investment decision, best strategy choice leads to best execution.

Strategy is the target of a lens which evolves with the data. Continuing the example of Figure 1, any price path can be differentiated through trading strategies.

A more aggressive strategy drives price, incurring three times the trader’s price impact of the realised strategy. Nevertheless, the effect of momentum in the broader market is minimised, and competing orders are circumvented. Understanding the role of strategy and making the right choice in this context drops the cost of the order by over a third, to 40 bps. The circumstances behind the choice become the focus.

The spread between a bad strategy (passive participation here) and a good one is 35 bps, money worth fighting for. Strategies may be decomposed into effects due to market momentum, competing orders, and the trader’s own activity. These factors may be analysed in terms of market conditions and relative liquidity. Guidelines can be set and hypotheses tested.

The question of outliers can be settled in an entirely different fashion and without a blizzard of numbers. The trading strategy itself is the object of analysis. In the case considered here, passive participation is an outlier. In this example, it is obvious as to why. But generally, it is the “why” which elevates observational reporting to analysis.

Applications

Execution analysis sometimes goes under the rubric of execution consulting. In that guise, it has been an educational tool for brokers, applied to their own algorithms. The discussion above is relevant in a broker-neutral context. Are algorithms truly commoditised, and differentiated only by trader implementation? What are the usage patterns? How do strategy types react to market conditions?²

Venue analysis is a 25-year old theme, revived as part of execution analysis. A venue report is part of any execution study, but care must be taken. Consideration of trading strategy is an essential component in assessing venue performance. One cannot contrast two market structures, or assess individual venue quality, without controlling for the strategy used.³

Order-level TCA feeds applications such as portfolio optimisation, fund capacity analysis, liquidation studies, and fund NAV determination. Execution analysis exposes the core issue in day-to-day operations, trading strategy, and paves the way for real-time decision support. In the end, it is the suite of applications which will distinguish execution analysis from order-level TCA, along with questions which evolve with the data themselves.

Footnotes:

See, for example, John Coates, The Hour Between Dog and Wolf: How Risk Taking Transforms Us, Body and Mind, Random House, 2012.
For example, Algorithmic Trading Usage Patterns and Their Costs, Ian Domowitz and Henry Yegerman, Journal of Trading, Summer 2011.
Garbage In, Garbage Out: An Optical Tour of the Role of Strategy in Venue Analysis, Ian Domowitz, Kristi Reitnauer and Colleen Ruane, Journal of Trading, Fall 2015.

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News review : Derivatives trading

By

Ian Rycott

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April 9, 2016

PROGRESS IN THE MAKING.

The European Commission has formally granted equivalent status to US rules on derivatives trading, marking an end to a long running dispute between the country and Europe.

Late last year, the EU and its US counterpart the Commodity Futures Trading Commission (CFTC) finally reached an agreement on a common approach to equivalent recognition of central clearing counterparties (CCPs). However, this is the first concrete move to enable US clearinghouses to be used by EU trading firms.

The two sides, which oversee around 90% of the $553tn derivatives market, have been at loggerheads over mutual recognition of each region’s clearing regime for the past three years. This was mainly due to the European Market Infrastructure Regulation, which dictates that home grown firms can only clear using a non-EU CCP if its rules are deemed to be the same standard as its regulation.

The main items of contention were over initial margin with the Europeans arguing that their two-day period was more stringent and necessary for covering a position of a defaulting member. They also favoured operating on a net basis, which means that clearing members can offset corresponding positions for more than one of their clients in order to reduce the amount of overall margin passed on to a CCP.

Be32-JonathanHill-EU-275x407

By contrast, the US works on a one-day and gross margining framework whereby clearing members pass on the full amount of client margin to the clearinghouse. The CFTC contended that its method produced higher levels of margin and therefore offered greater protection.

The lack of a deal would have been especially problematic for Europe, where the bloc’s own regulations would have meant banks and other financial firms faced dramatic rises in their use of margin for US clearinghouses such as CME Clearing.

Under the agreement, both sides will adjust their respective rules related to margin; the capital collected to offset possible losses if one side of the derivative trade defaults. Basically, this means that European policy makers will move closer to the US on rules regarding the amount of margin that clients of banks must post to clearinghouses, according to CFTC officials.

European Commissioner Jonathan Hill hailed it as “an important step forward for global regulatory convergence”, and added that the EU will “look forward to the CFTC’s forthcoming decision on substituted compliance”.

There are though still some obstacles to overcome. The CFTC must issue its own procedures for recognising EU CCPs used by US traders, which will cover broadly the same areas as the EC decision. There is also no agreement between the Securities and Exchange Commission, which regulates equity markets in the US, and the EC, although this is seen as less of a concern than securing equivalence between derivatives regulators.

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News review : Equities markets

By

Ian Rycott

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April 9, 2016

A MATCH MADE IN HEAVEN?

Stock exchange consolidation is back in vogue with the London Stock Exchange Group (LSEG) and Deutsche Börse unveiling their deal of two equals in a move that they hope will fight off have any gatecrashers and persuade regulators to bless the union.

If successful, the £21bn deal will create one of the world’s largest exchanges operators, trading more than E5.2tn in equities and over 3,200 companies listed on its markets.

In addition, it would form a regional rival in derivatives trading to take on the world’s largest markets operators, CME Group and Intercontinental Exchange (ICE) of the US and Hong Kong Exchanges and Clearing Limited (HKEX). Cost savings are estimated at E450m a year, in addition to any savings that had already been planned by the groups.

Carsten Kengeter, chief executive of the German exchange said the transaction was the best chance of Europe’s bourses competing on the world stage.

“If this merger does not take place, the European capital market architecture will probably soon be in American hands. And one does not need to be the CEO of the Deutsche Börse to shudder at that thought,” he told the German media.

“The clock is ticking in Europe, not just for the LSE but also for us. If we do not strengthen ourselves quickly, then the company will eventually be so weak that it can no longer act, but only react.”

The big question looming is whether ICE, which owns the New York Stock Exchange, will formally enter the fray. It signalled its intentions to bid for the LSEG in early March and now has more time to mull over its options.

The previous March 29 deadline to make an offer no longer stands now that the LSE and Deutsche Börse have made their merger official. ICE though may not be the only suitor as the CME and the Hong Kong Exchange are also considering their options.

This is not the first time that merger mania has swept over European shores. In 2000, the LSEG became the subject of a hostile takeover approach from Sweden’s OM Gruppen, forcing the company to abandon previous plans to merge with Deutsche Börse. Four years later, its German competitor returned with a £1.35bn offer, which was rejected by the LSE because it undervalued the company.

Although the two companies describe the tie-up as a merger of equals, Deutsche Börse is paying a takeover premium to the LSE.

Under the terms of the deal, LSE shareholders will receive 0.4421 shares in the combined group for every LSE share they own while Deutsche Börse shareholders will receive one share. This means that LSE shareholders would own 45.6% of the combined group while Deutsche Börse shareholders would hold 54.4%.

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News review : Regulation & compliance

By

Ian Rycott

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April 9, 2016

A ROCKY RIDE.

Hopes were dashed for a smooth ride when the European Commission rejected three specific aspects of the MIFID II regulation claiming that they do not reflect the views of the European Parliament. It has asked the European Securities and Markets Authority (ESMA), which drew up the MiFID framework, to re-write the standards governing trading on commodities, exemptions for companies providing ancillary market services, and displaying prices in fixed income markets.

ESMA has just six weeks to revise the proposals, and has been ordered to take into account the European Parliament’s position more thoroughly. The glitch in finalising the so-called Level 2 standards has increased fears among market participants that it could lead to further delays in the implementation of MiFID II, which was recently delayed to 2018, from the 2017 implementation date.

Be32-MarkusFerber-250x250 However, Markus Ferber, member of the Euroean Parliament, warned that the redrafting of the rules should not further delay the MiFID II timeline. He said, “The latest drafts were far from being acceptable for the European Parliament. The Commission is right to be afraid of the technical standards being rejected by the European Parliament – hence, further work is necessary.”

The bond transparency rules have proved particularly controversial. Banks, brokers and asset managers want ESMA to reduce disclosure around the price and size of bond orders, fearing the current proposals would make it difficult to trade in a market already suffering from a lack of liquidity.

One of the main complaints of the Parliament, through its influential Economic and Monetary Affairs Committee, is that they fail to allow for current market practices and no longer represent the original intent of the lawmakers when they first finalised MiFID II in so-called level one procedures.

As with bonds, over-the-counter derivatives also have transparency requirements under the new rules. There are also concerns that the position limits for commodity derivatives, which place restrictions on how much trading in a specific commodity can be undertaken by one firm, are not calibrated properly.

Members of the European Parliament also are worried that non-financial firms could be caught by MiFID rules when they seek to use financial markets to hedge aspects of their business such as their payroll through foreign exchange futures and other derivatives.

Be32-VanessaMock-250x250 Vanessa Mock, a spokeswoman for the EC, said that while it intends to endorse the “majority” of the standards written by ESMA, these three in particular require “fine-tuning.” She added: “That is why we have written to ESMA informing them that, in the case of three of the 28 standards they have sent us, we intend only to endorse them provided that certain changes are made.”

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News review : Fixed income & regulation

By

Ian Rycott

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April 9, 2016

START YOUR ENGINES NOW.

Industry participants may feel they have more breathing room now that MiFID has been delayed by a year to 2018 from 2017, but they should not become complacent. A poll at the recent FIX EMEA Conference showed that they have their work cut out for them.

When asked if the firm’s best execution policy incudes a sufficient quantitative component to meet the upcoming requirements, only 25% of those polled in the audience said they had an internal system and accompanying policies that should be sufficient while 24% were leveraging vendor systems and had an adequate policy in place (Fig 1). This meant that over half were just at the reviewing stage, looking at alternatives to upgrade their policy and the underlying technology.

As for preparations for fixed income, which for the first time will be under the best execution regulatory scrutiny, again nearly half – 47% – do not have an adequate best execution policy in place while only 17% do. The remainder do but they are currently being reassessed (Fig 2).

All agree that the requirements for fixed income will be among the greatest to meet. Under the current MiFID II proposals, the regulators’ objectives are to encourage all organised trading on to regulated trading venues, similar to equities, and mandate a consistent level of pre- and post-trade transparency for all clients. The main concern is that while this works for equities, a greater number of fixed-income instruments currently trade over-the-counter (OTC). In addition, as research from TABB Group points out, “a company may issue only one or two classes of equity, but will issue debt spread across a range of products, most or all of which are rarely likely to trade, making it challenging to find continuous liquidity.”

Around half of the respondents believe that one of the main obstacles will be getting hold of sufficient and accurate enough data to create a statistical dataset while 21% see difficulties in the ability to evaluate classes of financial instruments with sufficient granularity (Fig 3). Other stumbling blocks include understanding the regulators’ requirements and fitting best execution into the current dealer market where clients respond to merchandise or submit request for quotes.

These views reflect other studies that show market participants are not ready. In a recent, MIFID webinar survey of 500 participants conducted by consultancy and technology provider Sapient Global Markets, only 10% said they “very ready” for the new regulation, while 90% said they were “not ready” or just “somewhat ready.”

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A New Model For Fixed Income

By

GlobalTrading

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April 8, 2016

With Enrico Melchioni, Director, LIST Group
LIST’s experience of best execution began in 2007 when the first MiFID directive came into force. In Italy, one of List’s operational countries, the directive was applied immediately to both equity and fixed income.
Back in 2007, the basic approach to best execution was to implement a “static best execution” logic: given the list of venues included in the Investment Firm Execution Policy, the best trading venue for each security (or security class) was defined on the basis of the statistical analysis of historical data performed off-line. Incoming client orders were then routed to the “best venue” simply taking into account the security parameter of the orders.
We decided to push the best execution process one step further, introducing the “dynamic best execution”: we use the same statistics to prepare a basic ranking of possible execution venues, but just before executing the trade, live market data collected from the different trading venues are analysed, computing an estimated total consideration that includes broker fees and exchange taxes. By bringing a wider variety of broker and venue real time data into the metrics, we can integrate more holistic pricing and liquidity data, so that when an order is executed, it is done on the basis of a comprehensive and updated set of information, achieving a deal-by-deal, pre-trade best execution.
This model, initially devised for the equity space, has been adapted to also incorporate the specificity of fixed income trading.
Move to the buy-side
In the past few years the fixed income market has evolved and is now quite a different landscape from the one we were used to 10 years ago. Trends on the buy-side show that there is broad interest in speaking with multiple dealers or to join one of the many new initiatives for fixed income trading which promise peer-to-peer trading or pre-trading facilities.
The reasons for this are two-fold: we are experiencing very low rates in the Euro area (that drives investments toward riskier, less liquid assets in search of higher yields), and the increased regulation forces a higher cost of capital onto the banks. The combined effect of these two factors is that it becomes economically difficult for the sell-side to keep a position on a bond and so the buy-side cannot find liquidity when it wants it.
In this new scenario, the buy-side needs tools to connect to more than one execution venue, be it a sell-side, a buy-side network or a crossing venue. Technology can greatly help in this process, supporting the trader in retrieving the relevant information from a variety of sources, pulling all the data together in a single place and evaluating the best execution based on the updated and aggregated information.
We have already witnessed similar trends in the equity space: when MiFID I went into force, the concentration of trading on national exchanges was removed, so that all of a sudden a number of different exchanges flourished and the same equity was traded in different places. What firms really needed was some re-aggregation that allowed them to connect to the different trading venues and reconstruct the trail.
MiFID II is now creating a similar scenario for fixed income. Firms need to perform best execution across multiple execution venues, but in this case, the trading models are different: the prevailing market model is not the limit order book; rather liquidity is fragmented across different platforms mainly based on request for quote (RFQ) models.
Our clients ask us to be able to connect simultaneously to multiple platforms and to aggregate data from different sources (regardless of the trading model) so that they can have a comprehensive view of how the market is behaving.
When it comes to illiquid products, some logic that works perfectly well with liquid security does not represent the optimal solution. A process that takes into account OTC circuits and RFQ based venues is needed.
Last but not least, we are witnessing the birth of several initiatives that propose new business models based on peer-to-peer cooperation and pre-trade information sharing. The trading system must be capable of easily integrating with new trading models to take advantage of new opportunities.
All these specificities of the fixed income market may suggest that the buy-side industry needs to start thinking like the sell-side in terms of technology; being able to connect with different venues and to analyse data. This points to many questions including whether to outsource the technology or to develop it, and how best to do so given that the final shape of the regulation is still unknown.
MiFID II best execution implementation
Any execution desk has best execution as its goal. Most desks already have best execution logic in place. The problem is that MiFID II requires a specific set of obligations, with varying degree of compliance in each firm. Therefore, the actual impact of implementing MiFID II will vary from firm to firm. MiFID II also requires a standardised approach, which means that even if a firm already has a best execution policy in place, the firm will have to modify the parts of it that are no longer compliant.
However, firms that have started work on this will have an advantage when the final regulations are announced.
On the other hand, it could be argued that other aspects of MiFID II, such as the post-trade reporting, are very complex and that they are not adding any value to trading activity. So this element is likely to be one that people will try to implement at the last possible moment.
Post-trade to pre-trade
Trading platforms are generating vast amounts of data, which is only going to increase in quantity over time. These large data lakes contain a wealth of information that can be reaped with the proper technology. Firms need to start thinking in terms of data mining and Big Data technology in order to analyse the information that is already available within their systems.
By analysing trading data it is possible to create a link between pre and post-trade worlds: information retrieved from post-trade data can be fed back into the pre-trade activity, enhancing the execution process.
Data analysis can help the buy-side in understanding which brokers were efficient in serving a specific bond or bond class. For the less liquid fixed income products, the buy-side and sell-side are both focussed on keeping track of who is willing to trade a particular securities. This requires considerably more data and relationship management than for an automated asset class like equities.
Data mining technology can help answering the above needs, and also provide new perspectives. We have been conducting some research in applying advance clustering algorithms to trading data in order to understand what clients are doing and to find temporal correlation among the trading activities. For instance, it can be quite easy to identify those firms that lead and those that follow after a given stimulus from the market.
The industry is transitioning from an era where the execution tool was the only item firms needed, into an era where firms also need to manage the information alongside the ability to execute because the market is becoming more complex and fragmented. It is a period of transition where firms should try to act on all possible information that is available within the system.
A continuation of this transition is the growing importance of industry initiatives that involve the buy-side. Decisions are being driven by those firms who are actively involved with industry initiatives as they try to find ways to solve the problems the market is facing.
When firms make decisions about their technological infrastructure, they should envisage an infrastructure that is capable of managing all the exiting trading models and is also open to new initiatives, so that it is easy to integrate with new market models that may arise. The largest buy-and sell-side firms will probably already have internal development teams that can work toward this goal, but smaller companies will be looking to outsource this ability.
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A Fixed Income Perspective

By

GlobalTrading

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April 6, 2016

With Jutta Schneider, European Head of Fixed Income Trading, Allianz Global Investors
We currently trade 80-90% of our fixed income electronically, so we are ahead of the curve compared to many other involved counterparties. Over the last two years an increasing number of new trading platforms has been introduced to the market to meet the new requirements and provide trading possibilities despite low liquidity. We took this opportunity to continuously test and evaluated those different trading systems in order to stay well informed and ensure best liquidity for our trading.
Obviously, we cannot test all of them, as there are over 40 new initiatives by now. Nevertheless we have met with a representative sample (new trading platforms as well as new information systems) which for instance also opened up buy-side to buy-side access in addition to the usual buy-side to sell-side trading we usually do.
A mandatory requirement for onboarding a new system is the direct connection to our OMS. This is true even for those systems that allow us to only monitor liquidity as opposed to a trading system.
We have witnessed that the markets are becoming increasingly illiquid and sophisticated due to new regulations and capital control measures. This implies that the requirements for trading overall is becoming more complex. In this demanding environment the question whether the buy-side will become a major provider for liquidity arises more and more. As far as I can estimate neither the buy-side desks nor the numerous new trading platforms will become the new major liquidity sources. This will continue to be the task of the sell-side. However establishing new possibilities for the buy-side counterparties to match interest directly on an anonymous platform is opening up new opportunities and increasing transparency.
Taking all this into account it remains essential to maintain close relationships with the sell-side for sourcing liquidity and being able to trade efficiently in the market.
Another key area for us is the internal relationships between traders and portfolio managers. At Allianz Global Investors we have established an intensive communication and interdepartmental cooperation which has been running a long time now. This means we are not only focused on the pure execution but providing an extended function by supporting the portfolio managers in various ways. We provide feedback on liquidity, present trading ideas and show them relevant axes.
Yet we are not only involved in secondary business but also for the setup of new portfolios and new trading instruments. Usually the PMs ask us for our opinion on any planned bond purchase and schedule to carry out the planned set up.
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BLOCK TRADING – WHAT LIES AHEAD.

Robert Cranston, Head Equity Product Management, SIX Swiss Exchange.

SURVEILLANCE NEEDS UNDER MAR.

Mark Ford, principal consultant, head of Global Sales and Marketing at LiquidMetrix looks at the impact of the new regulation.

DIGITAL TRANSFORMATION IN EQUITY MARKETS.

Saoirse Kennedy, Senior Consultant, GreySpark Partners.

EXECUTION ANALYSIS IN THE WORLD OF TCA.

Ian Domowitz, ITG Inc.

PROGRESS IN THE MAKING.

A MATCH MADE IN HEAVEN?

A ROCKY RIDE.

START YOUR ENGINES NOW.

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