How has buy-side electronic and quantitative trading behaviour changed in light of current market conditions?
One of the biggest challenges facing traders in the market is the lack of liquidity, particularly during continuous trading, a theme we heard continually during the recent ITF conference in Lisbon. During September, average daily on exchange volumes have been 35% lower than those seen in Q1 2022. With lower volumes the natural reaction is to become more passive in trading styles, utilising more POV or VWAP type strategies. These strategies help spread the risk of strong intraday price movements and give traders time to react to market events. This low appetite to take risk is also evident in the smaller number of very large blocks, i.e., those >20x large in scale (LiS), being executed in the market. During Q3 2022, the notional traded of blocks >20x LiS has fallen approximately 65% vs Q1 2022.
Do you think regulators in Europe are changing their tune on transparency, why?
Creating different conditions for liquidity formation and challenges to execute order flow would inevitably create different outcomes for end investors, which has been evident in the application of the European Share Trading Obligation (STO). Recent noises from regulators are encouraging as it appears they may have started to hear the concerns from the firms they regulate. The removal of the double volume cap (DVC) I believe would be welcome as it has not achieved its initial aim of forcing more liquidity back on to lit markets, rather just created a barrier to execute in the dark, at mid-point, which is proven to lower execution costs and reduce market impact. Related to this is the consultation regarding the floor for Reference Price Waiver trades executed in dark venues. Hopefully regulators are realising that creating an arbitrary floor in EU venues would significantly affect the execution outcomes for trading in EU names vs. UK ones.
What role do dark trading and quasi-dark trading venues play in the market?
Dark trading continues to be a significant part of the equities market structure, accounting for approximately 10% of the on-exchange volume during Q3 2022. The market impact savings from executing large blocks are well known and our members continue to value the ability to execute against natural order flow, in large size. Periodic auctions have become an established venue type in the market, offering the ability to trade in a similar way to dark venues, with very little pre-trade transparency and low levels of post-trade movement. Depending on the decisions taken by EU regulators, i.e., to restrict trading on dark venues, there is the potential for periodic auctions to become even more prevalent, with us believing they could become 6% or 8% of the on-exchange volumes within the next 12-18 months.
What are the most impactful reforms being suggested in the Mifid II update?
Firstly, to talk about a positive reform, and one that actually applies to both sides of the channel, is the broad agreement I believe that exists to a consolidated tape being a positive change to the industry. Whether regulators can establish a mechanism that delivers what the industry would like however remains to be seen. The changes to SIs will have a significant impact on the ability for banks to provide risk via this mechanism. Over time, the attitude towards SIs has softened, with traders engaging more readily with liquidity via these channels. However just as attitude changes, regulation will potentially reduce the liquidity available. The divergence in attitude on these venues is clear and it will be interesting to see how the market reacts to these changes.
Where do you expect the UK and Europe to continue to diverge post-Brexit?
While there will be differences nestled in the details of each different venue types, waivers and calculations being done by regulators, the more general approach on how to regulate secondary equity markets and shape how liquidity is formed offers the clearest point of divergence between regulators. The UK have generally come forward with regulatory changes that remove some of the barriers to trade in certain ways and largely encourage the market to innovate. In contrast, the changes proposed by the EU appear to restrict the ways participants can execute, where liquidity can form and how innovation can occur. Some of the recent noises from the EU suggest they are reviewing this approach, which can only be welcomed.