Hayley McDowell: What’s your take on MiFID II so far this year?
Richard Parsons: The industry has spent so long preparing for MiFID II and now that it has actually happened we are starting to see more of a period of reflection. I think some initial trends are already becoming evident especially around unbundling. With more focus on execution and execution quality, firms like Instinet are seen as a beneficiary. From a preparation perspective I would say we were further along the line focusing on equities here in Europe. As a broker we have always focused on services like commission management or liquidity aggregation and we have seen a natural evolution of the business in that sense.
The industry was aware that MiFID II was going to have a big impact, but then as the deadline approached, suddenly there was this realisation that the introduction of MiFID II was going to be a global issue. Global managers were adopting their practices globally to accommodate MiFID II, and because of that, there has been an awful lot of time and money spent by the industry to ensure they were ready. I always thought that MiFID II would have more of an impact during 2018. If you think about the buy-side and how they operate, with for example voting processes around their broker lists, really for the true impact of unbundling, it will probably be the first or second quarter before banks start to see any effects and those votes start coming in. I think we will begin to notice a complete delineation between execution and research, with clients forced to evaluate brokers on an execution-only basis to ensure that they have the data and the means to do that. This won’t necessarily result in a consolidation of broker lists, but the buy-side will be keen to understand why they are using the broker and what their execution capabilities are in the absence of any other driver. The buy-side’s relationship with brokers is somewhat deeper now than it used to be.
Those trends will continue certainly through the first six months of this year and probably longer. Of course the market structure changes have been more immediate and starker. We’ve seen some very big changes quite quickly. Shutting down the broker crossing networks (BCNs) and bid and offer books in multilateral trading facilities (MTFs), alongside a rise in large in scale trading, I think clients are continuing even now to adjust their workflows. As clients continue to automate all of their processes or evaluate the impact of these changes, typically the analysis that is done is after the event, but they will continue to change how they trade and it’s up to the brokers to respond to that.
HM: There was talk at TradeTech of potential consolidation and ‘deeper partnerships’ amongst sell-side institutions over the next few years. Do you agree this will happen and what could drive this trend?
RP: There has been discussion around consolidation on the sell-side for a number of years now, and while some brokers may exit certain parts of the business, I do think that ultimately clients drive the products they are consuming. There will definitely be an adjustment to brokers’ business models over the coming year or two. We can take research as one example where there may be more focused changes. On execution again, some brokers will want to be in that business and others won’t. It’s hard to see a future where there won’t be consolidation, but that being said, even at this stage now brokers are looking to outsource parts of their business to technology firms or firms that have a strong technology platform so that they still stay prominent. The winners will probably be the brokers that continue to innovate and ensure they have deep relationships with the buy-side. There are different drivers behind various bank platforms, for example some may be proprietary in nature while others may be agency. If we look across the whole of Europe I think it’s hard to see quite so many players staying in their position.
HM: Instinet made two important liquidity streaming agreements with Virtu Financial and Sun Trading ahead of MiFID II. How have these partnerships been received by clients and do you plan to make similar agreements with other market makers in the future?
RP: The partnerships were a first for Instinet. A couple of well-known buy-side firms started talking quite publicly about having relationships with liquidity providers, and I think that was a bit of a shock at that stage. For us, the market structure changes were coming and we’ve always had a strong background in liquidity aggregation and we knew that with the changes to dark pools and the closure of BCNs, that there would be new participants like systematic internalisers (SIs) emerging. At Instinet the key was about giving our clients a choice. If these new participants are going to be there and we think they could be substantial in a post-MiFID environment, then we need the data around that. We decided to go with both Virtu and Sun Trading, and there wasn’t any bias in that, it was just that those two firms were ready and able to stream liquidity. We established those partnerships prior to MiFID II so that we had a three-month advantage where we were able to look at the impact of streaming quotes from SIs.
When we went to clients with this arrangement, and we held roundtables and various other events to discuss why we were doing this, we wanted to explain our rules of engagement with those types of liquidity providers; how we attract them, why we attract them and on what terms. And this is all on an opt-in basis; We gained three months data and the results were favourable. When we went back to clients and shared that data with them the vast majority of clients opted-into this type of liquidity, which I thought was very interesting.. I see that continuing to emerge this year and we will end up in a scenario where we have bucketed types of liquidity. One of our goals will always be around trying to aggregate that in the best possible way. Again, this isn’t because we have a bias towards flow-type market making firms or anything like that. We’ve always been agnostic to the venue that we offer clients, it comes down to execution performance and the client’s choice. We continue to evaluate the performance which has been good so far, and again that is interesting. The next move around that will be the size of the liquidity that those types of venues can offer. For the market making-type SIs, which may have been prevalent alongside the BCNs before, was that we were trading against those firms before in BCNs. But instead of trading against that BCN, I’m now looking at individual SIs and can evaluate that firm knowing exactly who I am going to.
HM: BlockMatch is in fierce competition with various other major block trading venues across Europe. Instinet recently added RFQ functions to the platform. How else has Instinet tried to distinguish BlockMatch in such a competitive market?
RP: Instinet supports all of those venues, and we offer them all to our clients. We are not necessarily looking to compete with all of them but instead we look at it as part of our liquidity strategy. Under MiFID II we can go to all of those venues and give clients access to them, and we do. We look at it from an aggregation perspective, and so we become very agnostic as to which venue has the block as long as I can take our clients to that block. I think it’s that type of workflow solution that clients are now looking for and will continue to look for. The request-for-quote (RFQ) function on BlockMatch, the first for equities, wasn’t about competition against those block trading venues. It was about giving clients the option to trade in that fashion. It has been interesting so far and I think that will continue to evolve as we go through the year, but we now have buy- and sell-side firms making prices in an RFQ fashion.
You’re right it is competitive, and time will tell how many of those venues will survive and how many new entrants will come into that space. If we look at client behaviour, those block trading venues are becoming more important. If we link that back to what we were saying about broker consolidation, suddenly an awful lot of business is being executed on these venues. It’s an interesting trend showing what clients are looking for, and the block trade is an automated process so that shift from high-touch to low-touch will be quite stark this year. High-touch traders will still have access to these types of block trading systems and platforms, but it’s a good indicator of how clients are thinking about market structure. From another client perspective, under MiFID II where you have open and fair access to all of the multilateral facilities (MTFs) clients will be looking at a point of entry to get to that liquidity, rather than have the same liquidity on multiple venues – that’s the next dilemma clients are starting to look into. But I believe there will be more scrutiny around the venues from both the buy- and sell-side. We certainly see the buy-side is much more engaged with our rules of engagement with the venues and the liquidity process.
HM: In terms of MiFID II SIs and periodic auctions, and the recent debate surrounding pre-matched activity, how likely is it regulators will re-address rules around trading venues in the near future?
RP: The best way to start my response here is to look at what happened at TradeTech this year with the chairman of the Autorité des Marchés Financiers (AMF), who made his views on periodic auctions very clear to delegates. It wouldn’t surprise me, if it is addressed in future. It’s only natural that with such a tremendous change to the industry and market structure that there is a period of reflection where the industry looks back at everything.
There’s also going to be a ‘look-back’ from a regulatory perspective around the implementation of MiFID II, so we could see something then, but it’s a complex issue. We take in quotes from SIs and we have to analyse that behaviour very closely, but if there is any wrong-doing or any pre-matched business in those SIs, then it wouldn’t surprise me if regulators take a firmer look. If the debate around SIs and the interaction with SIs has been relatively muted for bank SIs, I’d say client opinion on periodic auctions is tremendously split. Some clients are l questioning whether firms have re-created a BCN and if they are therefore going to be under more scrutiny, while others say it’s a liquidity event and if the broker is happy, then they are happy. For Instinet, if it’s a credible venue with credible liquidity and it fits our execution policy and the needs of our clients, then we will provide access to it.
HM: What has Instinet got planned for the rest of the year?
RP: It’s going to be two-fold. Firstly we are going to continue to help other broker-dealers outsource trading capabilities where they are looking to do that, and secondly we will continue our focus on liquidity aggregation and the workflow side. Innovation around the block trading space and innovation in terms of the aggregation of all of the different liquidity types, providing our clients with one entry point to various liquidity types. That seems to be the key driver and key message from our institutional clients at the moment. It’s about being able to navigate all of these new venues in a way that ensures minimum information leakage in an agency environment, which for us obviously plays a big part in that process, and I think that’s the clear direction that we are on. I don’t see us deviating from that at any point in the short-term. We will continue to build our data set and make informed trading decisions for our clients so that at the end of the day, Instinet can deliver execution performance.