International TraderForum - Reflections on the Alternative Liquidity Panel

Last week Tradeweb’s Adriano Pace, head of equities for Europe, participated in the opening panel at Institutional Investor’s International TraderForum conference in Rome.   

Entitled, “Industry collaboration: evaluating alternative liquidity sources” the panel discussed the impact of the emergent liquidity models resulting from MiFID II before a capacity audience of international senior traders from leading asset management firms, sell-side firms, vendors and venues.  

One of the key takeways was that liquidity is key to any successful execution strategy and any industry innovation is very much welcomed, particularly when designed for the ultimate benefit of the end investors. That said, it is recognized that recent changes have not been without some impact and MiFID II compliance has incurred significant cost. The fragmentation stemming from the introduction of Systematic Internalisers (Sis), periodic auctions and conditional venues has created complexity that some market participants believe has resulted in opacity - even confusion - about different providers’ liquidity models and execution quality.  

There were several other points that stood out from the discussion.

The significant evolution of the liquidity landscape, TCA adoption and evaluation of venues

The landscape has evolved significantly since MiFID II with the introduction of periodic auctions, multiple SIs and alternative venues.  From the outset, the buy-side has been keen to recognize, measure and understand the differences, roles, functions, models and opportunities presented by the many disparate liquidity venues.

Transaction Cost Analysis (TCA) is very much embedded in the evaluation and decision-making process. Some buy-side firms have invested in internal TCA tools and teams to evaluate brokers’ request-for-quote (RFQ) quality and venue selection.  Others prefer to outsource to independent third parties to gain an objective and comprehensive view, and determine a fair means of comparison.

In evaluating the venues’ ability to meet their best execution obligations, the TCA consideration extends beyond simply determining best price, size and volume, and assessing market impact and opportunity cost. In determining which liquidity venues will deliver best overall performance, the venue cost structures also come into play, an important consideration given the rising costs of trading.  

The buy-side considers itself the best measure of peer performance across the liquidity pools. Sometimes sceptical of venue, broker and market maker performance reporting, and mindful of the lack of standardization and harmonization that exists today, buy-side firms are increasingly keen to set their own benchmarks and peer review metrics.  

Close collaboration with the buy-side is therefore hugely important.  Understanding how the buy-side evaluates and measures execution performance, and therefore ultimately rank and reward, will not only drive greater standardization of reporting - albeit over time - but can help participants and venues to hone and refine their propositions and models. From this panel and subsequent discussions, it was abundantly clear that buy-side firms are open-minded to this collaboration and can see great benefit for the best execution assessment, monitoring and reporting process.

The mix will continue to change, with specialists making both a mark, and markets

Venues must differentiate, demonstrate and deliver value.  As bank and broker models are becoming increasingly commoditized, specialist offerings delivering dependable performance will likely do well.  

Liquidity providers may need to customize their offerings to the request of the clients. For example, they may need to adapt quote sizing to meet the sweepable versus non-sweepable criteria or, offer specific capabilities for particular asset classes, such as RFQ models for cash equities risk trades, an offering we are planning to introduce this year.

We believe the market will only become increasingly specialised, as has been our experience in the ETF trading world.  As such, we envisage a changing mix of specialist market makers and electronic liquidity providers, and it will be interesting to observe how this develops in equities trading.

High touch trading is on the rise

There is a perceived drop in low touch in favor of an increase in high touch trading due to changing order sizes and the need to find liquidity in less liquid mid-cap stocks.  While this  depends on the trading strategy, in a world that is gradually moving towards greater automation, the benefits of allocating resources more intelligently and efficiently cannot be denied.

It’s all about the data and automation.

Firms that can standardize, automate and embed the transaction cost and reporting data way upstream within the trading lifecycle could well gain a competitive edge.  And this applies throughout the market, irrespective of whether buy- or sell-side, market maker, alternative liquidity provider or exchange. Harnessing the power of data and deploying automation are commercial imperatives in the fight for flow, to ultimately return investment performance and deliver best execution.