Retail investing is an ever-evolving space. Its role and the way it interacts with institutional investors differs region to region. Looking into this sector, which is set to experience highly anticipated, yet arguably unpredictable, growth – note the GameStop saga of 2021 – The TRADE deep dives into some of the key considerations.
So, what does the rise of retail look like empirically? How can traders best engage with the retail market within the institutional framework? What needs to change, and how do we join those dots?
The role retail is currently playing in the market differs region to region, however panellists agreed that the Covid-19 pandemic had caused a spike in activity in the market globally.
Wail Azizi said: “Historically retail has been anywhere between 2-3% in Europe up until the Covid era where that spiked to 5-6%. I think the importance of retail far outweighs the percentage of activity that retail represents in the market.”
Dirk Donker added: “Covid has been a main accelerator for retail. For the moment we have seen retail stepping back but we believe that the population of retail investors will grow. We can’t just rely on our houses, pension funds, and saving plans anymore.”
The panel also unpacked exactly what retail investors are focused on, why investment in big US names has historically happened, and whether this is set to continue.
Azizi said: “The more investors are financially literate, the more they will venture away from the household names and big index constituents to more unchartered territories, as seen with GameStop.”
The global landscape
Expanding on this, panellists agreed that the role of retail in the current landscape not only differs continent to continent, but also country to country and touched on how societal customs play a significant part in retail participation across Europe.
Donker said: “In Europe, there is a very diverse landscape across the countries. For example, Italy’s [retail activity] is more than 20% and Norway as well, and in Ireland there is also a big retail population, but then in France and the Netherlands we only see around 3-5% of retail. This is not even close to the same level as in the US. It’s in people’s DNA to invest in capital markets in the US. It’s part of creating their financial future – not relying on pension funds is important. The scope of products is different compared to Europe.”
He added: “It’s a matter of divergence in Europe, we have a lot of retail investors, but we are still very domestic focused.”
The experts highlighted the Italian market’s preference for fixed income trading as a key example of how cultural norms can play a part in trading activities.
Nicky Maan said: “We’re looking at deep individual cultures within one continent. In Italy you see one of the highest levels of cash savings and the least amount of mortgages in property – it’s part of the Italian culture. Their interest in fixed income comes from the ‘fixed’ aspect. If you look at the bond market, the savings market, and you look at the use of leverage in Italy it’s not a coincidence that fixed income is something that does very well.”
When it comes to harmonising the landscape between the US and the rest of the world, this fragmentation within Europe was highlighted by panellists as a noteworthy stumbling block. However, harmonisation, the experts agreed, is inevitable as retail participation grows.
But in practice, how is harmonisation achieved? Is data access the key?
Azizi commented: “More harmonisation of the access to data is required. From that perspective, the CTP [consolidated tape project] plays a role in facilitating that simplification just like in the US. The question is – to what extent did that easy access to data in the US generate more retail business? It’s a combination of a lot of things that would facilitate that harmonisation, such as the capital markets union (CMU) and the revision of Mifid (we now see retail being at the heart of that review which was not the case previously), and the harmonisation of the tax regime and the fiscal incentive.”
Donker added: “We [Euronext] are afraid that the CT will be used as a validation for executing retail on a systematic internaliser or on a dark pool and this will come to the detriment of the multi-lateral order book. Retail flow will be moved away from multi-lateral trading platforms and this is where we are concerned – if we need to build a consolidated tape let’s do it together between the exchanges.”
It’s widely acknowledged that the ever-growing rise of retail has a positive correlation on market liquidity. Delving into this further, Martin Hendry explained: “If you take the institutional element out, retail investors trade in terms of frequency not volume on a day-to-day basis and that liquidity is interesting. Ten or 15 years ago, if you wanted to acquire part of a smaller company you’d speak to a market maker (RSP). However, now we have direct algorithmic routes to the RSPs. I can interact with that RSP liquidity and I can find the best price for that underlying retail client, so the retail client is getting the best level versus the competition.”
He added: “It’s become a lot more efficient due to technology, and that straight-to-market process is something that holders of these stocks should really look at to use that efficiency.”
The times of day retail traders operate also tied into this. Hendry confirmed that “the first two hours of the day are typically an opportunity to take advantage of retail liquidity and use that ‘non-toxic liquidity’. It sets price formation first thing.”
Speakers touched on market hours in their discussion, highlighting an increased appetite from retail investors to trade after hours.
Donker said: “We are seeing a bigger demand for trading ‘after hours’. [To have more of an overlap with the US] is absolutely an element that we need to consider because a lot of the population of Europe is trading US stocks so in that sense we need to align.”
Azizi added: “The main thing with retail is event-driven trading. Nothing else […] The main outcome here is event-driven trading as opposed to systematic trading or strategy trading or time-weighted trading.”
Institutional interaction
Delving into how retail and institutional investors are interacting, panellists discussed how common direct access is, in particular on the buy-side.
Hendry said: “To estimate, maybe two out of three are still using the traditional order to market maker route. Two or three providers have developed algos in the last couple of years. It’s growing. The UK works really well in terms of the interaction with the platforms and the RSP machine helps. Venturing into Europe as an institutional investor I would like an algo that could interact with the RSP – or the RSP equivalent – across Germany, France, Norway etc. To have that all in one place would be hugely valuable. The various structures and set ups and relationships in various countries make that quite a barrier.”
Azizi added: “We’re seeing more of institutional seeking to interact via routes such as the RSP, into non-RSP environments – which is basically the rest of Europe. This is a good thing for the retail to benefit from additional liquidity from firms that have most of the inventory.”
He added: “The value of liquidity coming from an asset manager or a hedge fund – someone who has inventory and that natural liquidity – is important and adds value to the market because it doesn’t withdraw necessarily during volatile markets.”
Donker highlighted that there were elements that may need to be closely monitored as the interaction develops: “If the strength of institutional seeking direct interaction with retail would come to the detriment of multilateral platforms, the spread will widen and the retail will not be part of the price discovery process, so market quality will deteriorate. That is something we need to watch carefully.”
Market infrastructure
The panel also touched on regulation and market structure, and the role the two are playing in fostering or hindering retail participation globally.
Azizi highlighted the similarity between China and the US, the largest and second largest retail markets respectively: “China has 212 million retail investors and there is no secret that that is down to organisation. It’s almost one single market. The US comes second as the largest retail market in the world and it is the same story here. Post-trade it is very much harmonised compared to Europe.”
Mann compared the situation in Europe: “The flipside of course is when you have competition you increase offerings. There are areas of regulation in Europe that are a little bit more sophisticated than its peers but it does have the downside that it is not completely harmonised and I think that has pros and cons both for retail and for institutions.”
Speaking on how to enhance retail trading, speakers agreed that it is post-trade where there is most to gain in Europe. A lot has been done to develop the execution side of things for retail, such as zero fees and low transaction costs, and post-trade processes are lagging behind, the panellists concurred.
Azizi: “In the trade space, we’ve seen dedicated venues that are specialised in improving that execution or access for retail. That’s something that doesn’t exist in the post-trade world. Clearing and settlement are done exactly the same way everything else is done, whereas the trade size is different, the trade frequency is different, the risk profile of retail trade is by definition very different to institutional.”
Mann: “Post-trade is really fragmented in Europe and is one area where if consolidation were to occur, it would both make life easier for other entrants […] The more you can reduce the friction in the back end, the more you would have a cost benefit and therefore lower the barriers to entry.”
Looking to the future
Looking at the next few years, panellists were asked how retail might operate differently.
Azizi: “A CCP is sooner or later going to fail in Europe, and how are we preparing for that? Retail is very small when it comes to market share or volume of business compared to other businesses […] so my view is that eventually post-trade will go through a consolidation phase to eventually fight those risks of failure and from there, retail would come at a later stage.”
“For now, the first steps are getting more retail into the market, increasing that market share from a trading perspective and from a volume perspective, which will naturally drizzle into the post-trade world.”
Retail participation has been growing quickly and becoming increasingly sophisticated since the massive market movement seen in 2021 with the meme stock saga. Panellists discussed whether safeguarding against these events going forward is a focus for institutional investors.
Azizi added: “Of course it’s a low probability, but also never say never. Risk controls are important. Both for the retail brokers but also for the institutional interacting with those retail.”
Hendry on the other hand expressed that it was a one-off case: “It was a perfect storm, people had more time on their hands, more cash to spend, and a social media presence promoting that trade idea to millions of people. I don’t think we are going to see it again.”