Instinet Europe’s chief executive has claimed that many of MiFID’s benefits “are illusory to the end-investor”, despite the agency broker reporting that it had achieved an average of 5.72 basis points of price improvement for clients in Q4 2008.
“We pass all price improvement back to our customers,” asserted Instinet Europe’s Richard Balarkas. “But there are a whole host of models on the sell-side. There seems to be little appreciation on the buy-side of the opportunity cost of using a broker that internalises a large percentage of flow, compared to one that opens up to as many external venues as possible,” he said.
Price improvement is generally defined as the difference between execution price and the best quoted price on the primary exchange at a given time. Instinet Europe data is based only on executions that remove liquidity from MTFs over the period in question.
Instinet Europe said it routed nearly 28% of its European equity trades away from primary exchanges by value traded in Q4 2008. The agency broker was among the first sell-side firms to connect to the multilateral trading facilities (MTFs) launched last year: BATS Europe, Nasdaq OMX Europe, Turquoise and dark pool NYFIX Euro Millennium. During 2008, the firm also executed the first trade on SWX’s Swiss Block dark pool, launched its own MTF, BlockMatch, and, along with Credit Suisse, became the first broker in Europe to offer reciprocal dark pool access. Instinet Europe executed 35.42% of its trades in French, German, Dutch and UK stocks on MTFs in the final quarter of 2008.
Other brokers have also been using smart order routing (SOR) capabilities to direct more client order flow to alternative venues. According to its latest monthly European Liquidity Report, Citi routed 53% of its UK orders to MTFs in January as well as similar proportions of its Dutch (56%), French (52%) and German (48%) orders. Citi, which does not publish price improvement data, also reported that MTFs captured roughly 20% of market share in these four markets in January.
Sell-side institutions point out that assessing the quality of execution achieved via brokers’ smart order routing capabilities is a considerable challenge. “Because routing orders in this increasingly fragmented environment is a very sophisticated and complicated process, headline numbers quoting price improvement can be overly simplistic and misleading without proper qualification,” said Mike Seigne, co-head of sales, algorithmic trading, Europe, Goldman Sachs.
Although price improvement comparisons can provide some insight into aggressive order execution quality, this is not the case for passive orders. “An SOR will typically route an aggressive order to the venue or venues with the best price, then take liquidity from those venues until the order is satisfied, with the price improvement being passed on to the client. But it gets more complicated to fairly measure the price improvement with passive orders because they inevitably give out information when posted to lit venues. It’s very difficult to measure the opportunity cost that is lost at a result of placing that order on any lit market,” said Seigne.
With the ability to choose between trading venues still in its infancy in Europe, Seigne said Goldman Sachs has been encouraging buy-side clients to be proactive in responding to the execution data the firm provides. One approach is to consider the contribution to the parent order of the broker’s order routing logic. “On their own, price improvement figures from child orders routed to MTFs might look good,” he said, “but you also need to figure out how and why they contribute to the parent order execution quality. The portion of contribution from the passive order in any lit market needs to be analysed to better understand the opportunity cost associated with that benefit. Hence questions focusing on relative fill ratios of venues, and the prices of the other lit venues at the time of those fills, need to be understood.”
Brokers also argue that market participants must distinguish more clearly between trading on a traditional exchange and an MTF, where a higher proportion of participants use smart order routing and/or are engaged in high-frequency strategies. “For someone to suggest that all their fills from MTFs are much better than from venues with a lower proportion of participants with SORs etc., clearly needs to be challenged more,” said one broker. “Firms are achieving beneficial fills from MTFs, but in venues where the spread is typically tighter, those traders demanding liquidity should do better than from demanding the same liquidity at a less favourable price elsewhere. However, those posting liquidity to less active venues – either at the same price or at a less favourable price than more active venues – carry a higher risk of a non-fill and/or get filled at a less favourable price. It’s hard to reflect these factors in data form.”
Notwithstanding the difficulties of ascertaining execution quality across exchanges and MTFs, Instinet’s Balarkas insists that many brokers have not fully availed their clients of the advantages of competition among trading venues, commonly cited as MiFID’s key achievement since the directive came into force in November 2007. A number of the buy-side firms complained of slow progress on reducing trading costs in their responses to the Committee of European Securities Regulators’ (CESR) recent call for evidence on MiFID’s impact on European securities markets. And at this week’s SIFMA European Market Liquidity conference in London, heads of trading questioned the benefits of more trading venues being introduced onto the European equities market. The principles-based regulatory framework established across Europe by MiFID does not exert sufficient pressure on brokers to deliver best execution to end-investors, said Balarkas.
“Under MiFID, there’s no real obligation on brokers to link to MTFs. And the idea that all the brokers across Europe are busy updating their best execution policies is fanciful,” he said. “There’s nothing wrong with principles-based regulation, but at some point someone has to come along with a big stick to remind firms that it’s not a case of anything goes. MiFID relies on informed customers asking detailed questions about how asset managers and brokers execute trades. But none of this is transparent, at present.”