Off-exchange trading has overtaken displayed market trading in Europe over the last two months, reigniting the debate on the effectiveness and reliability of the price formation process. But many market participants remain sceptical about the quality of the underlying data, emphasising the need for reform of MiFID’s trade reporting rules.
According to data vendor Thomson Reuters’ European equity market share reporter, over-the-counter (OTC) trading accounted for 47.09% of trading in May, up from 44.81% in April. By comparison, trading on displayed exchanges and multilateral trading facilities (MTFs) declined to 40.5% in May, from 41.40% in April. This is the first time OTC trading has accounted for more market activity since May 2009, when it was 46.23% compared with 40.48% in lit markets. OTC trades reported by Thomson Reuters include manually and electronically executed bilateral trades reported to trading venues and trade reporting facilities such as Markit BOAT. It does not include hidden orders or dark pool trading volume.
Noting that MiFID was intended to push trading to venues defined by the directive, such as regulated markets, MTFs and systematic internalisers, trade body the Federation of European Securities Exchanges (FESE) claims the current level of OTC trading in Europe is too high.
“While there may still be double counting and other issues with the quality of post-trade OTC data currently available, the margin of error is probably not sufficient enough to explain the high proportion of trading currently conducted off-exchange,” Burçak Inel, deputy secretary general, FESE, told theTRADEnews.com. “Europe needs to have a clear policy on how much of the market should remain pre-trade transparent to ensure price discovery for orderly markets and investor protection.”
However, sell-side firms continue to question the quality of the data, pointing out that buy-side traders continue to exclude OTC trading when conducting pre-trade analysis because of questions over its validity.
“An increase in OTC trading is not something we have necessarily experienced. There has been a lack of direction in the market, which means long-only buy-side firms are trading less, but the issues surrounding BP and Greece have cause more volatility, which has resulted in more high-frequency trading,” said Andrew Bowley, head of electronic trading product management, Nomura. “In its current state, I am very sceptical of the total size seen of OTC data and think it includes too many non-actionable trading reports to be of full value as a record of off-exchange liquidity.”
While he notes that erroneous double reporting has now been eradicated, Bowley asserts that needless OTC reports are still being generated under MiFID. For example, a broker is required to report a guaranteed-price VWAP trade both while it is executed throughout the day in the broker’s name and again after the trade has been completed and the price has been corrected to that promised to the client, via an internal cross.
The Committee of European Securities Regulators (CESR) has established a working group to explore post-trade transparency issues ahead of the European Commission’s upcoming review of MiFID.
Possible options for improving the quality of OTC trade reporting include better flagging of post-trade executions to highlight different types of trades such as agency crosses, guaranteed VWAP trades and internal transfers, and stripping out types of execution that are largely considered unnecessary.
“Adding more flags would make the post-trade data more complex, but the plus side is that you get a more granular post-trade data regime,” said Bowley. “People have different uses for data, for example pre-trade liquidity analysis and post-trade transaction cost analysis, so extra flags would allow market participants to pick and choose the data they consider to be most relevant to them.”
Additional flags would require a consensus on how brokers report manual versus electronically executed OTC trades. Currently both types are combined in post-trade reports and buy-side traders have argued that more granular OTC reports would help them to evaluate broker dark pools and better inform investment decisions. Brokers have tried to head-off too stringent reporting obligations. Most recently, six brokers teamed up with Markit BOAT to report aggregated data from their dark pools on a country-specific basis.
“Broker crossing network trades should be identified as being electronically executed, but in our view, there isn’t really a need for real-time attribution to the particular venue they came from,” said Natan Tiefenbrun, commercial director, Turquoise. “From a price formation standpoint, identifying them as trades executed in a broker dark pool would probably be sufficient.”
In its recent consultation paper on equity markets released in April, CESR suggested the creation of approved publication arrangements (APAs), which may help to set the standard for OTC reports. APAs build on the current trade data monitor regime and would be required to clean and validate post-trade data before sending it on to a consolidated tape provider – mandated or otherwise – for distribution.
“CESR is moving in the right direction with APAs but the market will need to come to a compromise on how much, and what type, of granularity is required,” said Tiefenbrun. “It will be important to ensure that the commercial interests of individual market operators or participants don’t affect the wider debate about what’s best for the market as a whole.”