‘Hidden’ OTC trades hamper best execution

The fragmentation of post-trade data for over-the-counter (OTC) equity trades in Europe is preventing effective transaction cost analysis and impairing the ability to observe best execution principles, according to market participants.
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The fragmentation of post-trade data for over-the-counter (OTC) equity trades in Europe is preventing effective transaction cost analysis and impairing the ability to observe best execution principles, according to market participants.

“There are a number of solutions to tackle trading fragmentation, such as smart order routing, but fragmentation of trade reporting is a challenge that technology has not yet been able to resolve,” Stephane Loiseau, managing director and deputy global head of execution services at Société Générale Corporate & Investment Banking, told theTRADEnews.com.

Since MiFID came into force in November 2007, brokers have been able to choose whether to report trades on regulated exchanges, multilateral trading facilities (MTFs), third-party reporting venues or proprietary arrangements. As well as allowing trades to be reported elsewhere than the exchange on which they were executed, MiFID adds to post-trade fragmentation by permitting some trades to be delayed.

Several brokers have opted to use Markit BOAT, a reporting and dissemination service for European OTC equities trades owned by data vendor Markit. According to figures from market data vendor Thomson Reuters, 23.35% of pan-European traded value and 22.96% of traded volume was reported to BOAT in March 2009. By contrast, OTC trades reported to NYSE Euronext, the next-biggest OTC trade reporting venue in Europe, only accounted for 6.34% of the value and 2.46% of the volume in March. Trades reported OTC are typically bilateral transactions, such as those that take place in independent crossing networks or brokers’ internal dark pools.

Some argue that because they charge dissemination fees, off-exchange OTC trade reporting firms are limiting access to data.

“Trade reporting venues distribute data for a fee, so it is not available either on a centralised or free basis,” said Loiseau. “This creates a lack of transparency for market participants, and means they may be using partial data to assess trading volumes in a particular stock, for example.”

He adds, “If volume is being reported away from the main legacy exchange/MTF venues it blurs traders’ vision and it quite significantly impairs the ability of market participants, whether buy-side or sell-side, to make informed decisions when they trade.”

A further problem is brokers can report trades in markets far removed from where the execution took place in an attempt to hide the trade. A frequently-cited example is a western European trade being reported to the Bratislava Stock Exchange.

Though permitted under MiFID, some feel this is a rare occurrence. Will Meldrum, managing director and head of equities data at Markit, says he is only aware of that one instance. “MiFID is fairly clear on the fact that companies need to let clients know where they are going to trade report,” he said. “Reporting in less-observed locations may have happened a little to start with, but I haven’t heard anything recently.”

However, Guy Sears, director, wholesale, at the Investment Management Association, a UK buy-side trade body, believes the buy-side needs more confidence in where brokers are reporting and why.

“The intent of the broker reporting isn’t the important point. What is important is to ensure that the data can be consolidated and there are predictable places in which that data can be found,” Sears said. “It would be very helpful if firms to who use OTC printing venues made an annual statement or have some sort of list that says, ‘this is where our trades can be found’.”

Loiseau at SocGen said the true problem is the lack of a US-style consolidated tape of post-trade data for Europe, which all reporting venues would be mandated to send data to and which all market participants could access.

“Regulators are discussing this, both at a local and European level, and I believe introducing a centralised trade-reporting repository is one way we could improve MiFID.”

While many believe the market should be left to provide its own solutions for a pre-trade consolidated tape, Loiseau thinks the post-trade equivalent requires regulatory impetus.

According to a spokesman for the Committee of European Securities Regulators (CESR), the body charged with maintaining consistency across Europe’s financial watchdogs, CESR is looking into post-trade transparency as part of its continuing study of MiFID’s impact on the functioning of secondary markets. The relevant CESR expert group is due to discuss the issue this week.

One challenging feature of MiFID’s post-trade regime that a consolidated tape would not help is the ability to delay trades of certain sizes, up to a maximum of three days after the trade has taken place. The delays are designed to reduce the market impact of very large block trades. The European Commission published a ‘delay matrix’ detailing what size of trades can be delayed for how long under MiFID.

However, the number of delayed trades has reduced dramatically in recent months. According to data from Markit BOAT, the percentage of turnover reported to the facility that was delayed fell to 13.33% in February 2009 from 48.40% in May 2008.

“One of the reasons is that some banks to start with were delaying proprietary trades, which is not allowed under MiFID,” Meldrum explained. “Those trades have since been cleaned up. We have also worked closely with banks to make sure they are aware of how they are using the delay matrix.”