What are the buy-side’s key challenges, post-MiFID II?
Simon Steward: As a large asset manager, liquidity sourcing is paramount to what our trading desk and execution platform needs to do on a daily basis. The real challenge for us is to ensure that we have a robust and flexible toolkit to take advantage of liquidity opportunities in the market. It’s also about understanding the market microstructure in a very fragmented, post-MiFID II world.
How are you addressing these challenges?
SS: Technology is a major part of our strategy. The biggest challenge is identifying the ‘must haves’ against the ‘would be nice to haves’. We have been working on this over the last few years, taking an in-house build, rather than buy approach. And while we have not engaged third-party vendors to enhance our trading platform in the past, this is starting to change. Data and analytics will be crucial.
We have a Market Transaction Research Team, which has become fundamental within the global trading group. This team examines all our data, not just at the trader-, account- or fund-level, but also providing us with venue analytics. This enables us to have more enriched conversations with our counterparties and venues around routing practices and outcomes moving forward.
By bringing this onto the trading desk, we are looking to empower traders and provide them with the relevant information to validate their decisions, in the overall context of best execution and with respect to MiFID II.
How does Liquidnet view the market structure changes and regulatory requirements?
Mark Pumfrey: Certain aspects of the market have become more complex and we have seen some unintended consequences. Since the introduction of double volume caps, the systematic internaliser (SI) regime has accelerated, having almost doubled from where broker crossing networks were and there is a significant lack of transparency around routing practices.
The average execution size also remains relatively small, so I think the regulator will be looking at this in the future.
As expected, we have seen a reduction in the dark MTF market, which today only represents between 5-6% of daily order book notional, versus an average of 10% pre-MiFID II. Whilst dark volumes have fallen, the proportion traded LIS has increased to around 50% of dark trading, to meet the needs of institutions such as Capital Group who want to trade large positions.
Another big development has been the growth of periodic auctions, which are running at anywhere between 2-3%; questions are emerging around broker-preferencing, which the regulator is clearly examining.
The other aspect of MiFID II is, of course, that it is driving global standards and practices when it comes to unbundling and best execution, as firms around the world adjust how they conduct business.
Is MiFID II an opportunity from a global trading perspective?
SS: Very much so. MiFID II has brought best execution to the forefront, in particular how we approach the market, the data, and analytics that are part of the process.
We see a lot of similarities across markets, despite market structures in Europe, US, and Asia being so different. Our analytics team has started to embed those similarities throughout our trading and thought-processes across the group.
How are you looking at empowering trader decision-making in the context of MiFID II?
SS: The role of the trader has changed drastically in terms of the interaction with the portfolio manager (PM) and our investment group. It comes back to pre-, in-, and post-trade decision-making. The more integrated your trading group is around why the decision has been made to buy or sell a stock, the more effective the strategy discussion and the stronger the relationship with the PM.
Equally, it’s not just about extracting value when you’ve got orders on the desk, it’s also about finding liquidity when you don’t. The work that Liquidnet has done around Targeted Invitations gives us the ability to shop for stocks that are not live now, but in which we may have been active over the previous weeks or may look to be active in the near future. Embedding these capabilities into the investment process makes our traders far more effective.
How does Liquidnet view the evolution of technology alongside working with asset managers such as Capital Group?
MP: MiFID II gives trading desks the opportunity to become even more central in their organisation. Whereas it forces trading desks to take more control, to be more empowered, it also places a lot more responsibility for best execution upon them.
There is a huge requirement for the liquidity landscape to be well understood and accessed efficiently, and for information to flow from trading desks back into the market and up to the PM. It’s essentially the ability to get into the PM’s head and to source new liquidity.
Technology is required to get to this stage. We are focused on working with our members to ensure the tools we develop are highly relevant to them and help them bring liquidity back safely from the disparate and fragmented market. We are always innovating in this area – Targeted Invitations and Surge Capture being relatively recent examples within our Virtual High Touch suite of trading tools.
Another one is our acquisition last year of trading analytics firm, OTAS and the work we have done to bring this intelligent analytics tool to the trader’s desktop. In a world of information overload, the ability to crunch this data by exception and deliver actionable insights in a visual manner straight to the buyside trader’s desktop will provide asset managers and portfolio managers with a whole new level of empowerment.
The evolution of technology is being driven by buy-side demand post-MiFID II; how can you anticipate their requirements?
MP: We have a clear perspective on the marketplace, enriched by a deep understanding of our members, their workflows, and what they need. In our Liquidnet Labs we constantly evaluate innovations that may be relevant to them, assess the opportunity globally and prioritise roll-out based on relevance and member feedback.
SS: Post-MiFID II, there is no one-size-fits-all; you can’t have one generic fix which suits every asset manager. It’s up to us, on the buy-side, to identify issues and go to trusted vendors we can work with, given the complexity of our internal infrastructure and the flexibility we require from our partners.
How do you see the challenges and opportunities over the next 18-24 months?
SS: I believe that the current European market structure isn’t anywhere near what a post MiFID II world is going to look like from an execution standpoint. There are still many moving parts which are going to materialise over time including the growth of new venues and platforms and the evolution of the SI regime. We just need to ensure we understand it and feed that information and decision-making into our investment group, to continue to execute in an efficient manner.
Analytics is critical towards meeting MiFID II transparency requirements. We’re starting to get good sized data sources which are feeding into our overall process and enrich our counterparty conversations. I expect to see a further evolution of this journey over the next 12-18 months.
MP: Regulation will be the driving force, but it is then down to industry participants to create a better market structure by introducing competition, focusing on best practices and looking at where value exists. Whether you’re a FinTech or a traditional business, you have to be able to improve the efficiency of the marketplace for everyone’s benefit, but specifically the end investors and pension funds.
How will technology evolve to support buy-side trading desks?
SS: Despite words like ‘artificial intelligence’ (AI) and ‘machine learning’ being bandied around in our industry we are not looking to replace traders with machines. Far more importantly, we want to use technology to enhance our traders’ capacity and take these concepts and consider how they can be added to our workflow, our trading desk and our group. Embedding these into your workflow is always the biggest challenge.
MP: AI is a definite buzzword for the industry at the moment. Liquidnet is using artificial intelligence within our Virtual High Touch suite to help distil vast amounts of data into actionable insight tailored to every order on a trader’s blotter. But in a MiFID II world, it comes back to enabling the trading desk to position themselves as a major alpha centre within the organisation. This has always been Liquidnet’s position.
We are providing tools to make that happen; to make the alpha collection process of the PM more efficient, which ultimately results in better performance.
Change is primarily being driven by regulatory initiatives; would these changes have occurred without regulatory intervention?
SS: The move towards greater transparency and reliance on data to enrich and validate our decision- making would have happened without MiFID II. We were already on that path because we already viewed trading as a key part to our investment process and an area where value can be both added and preserved. But MiFID II has accelerated the process, certainly from a European perspective.
MP: Certain aspects that are healthy for the industry – such as unbundling and the separation of research and execution – would not have happened without regulation. MiFID II is accelerating a chain of events which has global consequences, not so much with the regulators in other jurisdictions, but the end investors – trustees and pension funds. Because at the heart of it, that’s what MiFID II is driving towards: best-practice investment services to benefit institutional investors and their end clients – our parents, grandparents, children, and indeed ourselves.