Buy-side throws doubt on RFQ for equities as “last chance saloon” for liquidity

Ahead of the anticipated launch of RFQ for equities from two major trading venues, Hayley McDowell speaks to senior buy-siders and finds out that most are very sceptical of the idea.

Two major trading venues are set to launch a request for quote (RFQ) functionality for cash equities trading later this year, but some senior buy-siders are sceptical of the idea and have questioned the need for such a tool in a liquid market.

Typically used for trading in more illiquid markets, such as fixed income, exchange-traded funds (ETFs) or derivatives, RFQ allows traders to ‘request a quote’ from counterparties based on the security and quantity.

Both Tradeweb and the London Stock Exchange Group are due to go live with their respective RFQ systems for cash equities by the end of the year. Both systems are similar in what they offer, but they will operate differently in several ways. According to several senior buy-siders, they never saw the trend coming, and some are unsure of where the RFQ function will sit in the equities market.

“I don’t think the buy-side was crying out for RFQ in equities, so it’s a little odd that everyone is getting so excited about it,” says Neil Bond, partner and head of trading at Ardevora. “I’m not sure how it will play out, but I do know that RFQ has been quite successful for the illiquid fixed income instruments and ETFs.”

This sentiment is echoed by various other senior buy-siders who have been trying to understand the need for RFQ in a liquid market. At the same time, asset managers continue to adapt and attempt to navigate the new trading landscape, with several trading venues having entered the scene under the MiFID II regulatory changes, such as systematic internalisers, periodic auction systems and block trading platforms.

Fabien Oreve, global head of trading at Candriam Investors Group, tells The TRADE that with actionable IOIs (indications of interest) already firmly placed in the market, it’s difficult to see how RFQ will add value in equities.

“We do not see any interest in using electronic RFQs for cash equity because we currently have easy access to IOIs from our brokers who advertise reliable tradable sizes and prices,” Oreve says.

Actionable IOIs have suffered a bad reputation in the past, in terms of determining which indications were representing true liquidity, but they were reformed a few years ago with an industry Code of Conduct introduced by the Investment Association and AFME.

“IOIs have much gained in quality since the European industry agreed on an IOI reform and a new code of conduct some years ago,” Oreve adds. “The IOI reform introduced a classification model that has improved transparency and helped investors like us find liquidity… By using those IOIs, decent size orders can be filled in their entirety at a predictable market impact. From my point of view, the RFQ protocol in cash equity does not add value to the current IOI model in place.”

Similarly, JP Morgan Asset Management’s head of equity trading, Neil Joseph, questions the valid use cases for RFQ in the equities market, stating that his trading desk will likely use the function more in ETFs. However, he adds that the tool could potentially help aggregate market maker liquidity or offer another route to liquidity on periodic auctions.

“There are conceptually some valid use-cases for RFQ in equities, although these are currently limited,” Joseph tells The TRADE. “For our specific order flow, it will likely be utilised for a lower proportion of orders than RFQ for ETFs and in a different manner.

“However, it’s clear that there could be a variety of usages of these platforms, from aggregating market maker liquidity, through to providing an alternative platform to periodic auctions…  [Furthermore], information leakage should always be considered but we would evaluate each RFQ platform on its own merits, as each one functions differently.”

Liquidity finds a way

For Daniel Nicholls, head of trading at Hermes Investment Management, the RFQ is widely considered to be the “last chance saloon” when sourcing liquidity. He questions why the buy-side would use RFQ and risk signalling to the equities market that you can’t find natural liquidity, adding that information leakage is a great concern to the buy-side and “it pays to be paranoid”.

“The drive for innovation is motivating the rise of RFQ in equities, and it’s turning the market on its head,” says Nicholls. “RFQ for equities is just a potential alternative way of accessing different sources of liquidity.

“A lot of buy-siders are sceptical on the idea. Since MiFID II has tried to limit access to traditional liquidity sources with the double volume caps (DVCs) to drive liquidity to lit venues, the sell-side is forced to develop alternative routes to match the best price. To misquote Jurassic Park – ‘liquidity finds a way’. The RFQ works well for fixed income and ETF trading, but these are very different instruments to equities.”

Tradeweb and the London Stock Exchange Group are due to go live with their RFQ function in cash equities by the end of the year. The differences in how both systems operate will likely determine which comes out on top, but it is clear that for some buy-siders, the idea of the tool in equities is somewhat redundant due to actionable IOIs, the liquid nature of the market, and the unjustified risk of information leakage. It will take time before the industry sees if RFQ in cash equities will truly take-off.

Research from TABB Group has, however, suggested that as buy-side trading desks continue to battle rising costs, liquidity concerns and compliance pressures, the RFQ for cash equities could represent a needed and plausible innovation for the industry.

“There is clearly an increasing role for any alternative trading model that assists clients in seeking block-sized executions with limited market impact,” writes Tim Cave, analyst and author of the report at TABB Group.

A more in-depth analysis on the rise of RFQ in equities, as well as a look into the RFQ functions to be launched by Tradeweb and the London Stock Exchange Group, is due to be published in The TRADE Magazine, Winter Edition 2018.