One year on from the introduction of MiFID II, buy-side equity trading desks are not only confronted with rising volumes, costs and compliance pressures, they are also facing challenges in accessing liquidity within an increasingly fragmented landscape. These challenges have led to a demand for innovative approaches to execution in the European equity markets, including the launch of request-for-quote (RFQ) platforms for institutional investors.
Tried and tested for many years across different asset classes for both liquid and illiquid instruments, the RFQ protocol is being introduced in cash equities to enable institutional investors to refine and improve their execution performance by selecting multiple sell-side brokers to price orders efficiently, whilst equally minimising the potential market impact.
Compliant liquidity access
As liquidity has become more fragmented, trading medium to large sizes on lit exchanges can be challenging. Buy-side firms are therefore more open than ever before to alternative methods of transacting and interacting with their preferred sell-side brokers, so long as that allows them to optimise their ability to transact.
The electronic multi-dealer RFQ mechanism provides a robust and tested mechanism for the provision of committed liquidity, allowing buy-side firms to efficiently source liquidity and conduct their business:
- Liquidity access: Electronic RFQ allows buy-side requesters to send enquiries simultaneously to multiple liquidity providers using pre-trade content and analytical tools to aid their selection, thereby reducing time to execution and execution risk;
- Price transparency: Efficient and auditable price discovery is ensured by the provision of ‘pricing screens’ that display composite indicative pricing-level information, or ‘axes’ to indicate strong buyer or seller interest;
- Operational efficiency: RFQ offers a seamless, standardised automated process that captures every stage in the transaction lifecycle; from pre-trade to clearing and reporting. It also provides analytics to both the buy- and sell-side on trades that they have requested for pricing or have priced.
RFQ automates trading in a fully MiFID II-compliant way. Buy-side firms are expected to show their best execution practices across instrument, broker and order type, including the use of previously high-touch block trading protocols. RFQ supports electronic audit trails, referenceable prices, and time stamps, thus helping to quantify trading risk and costs, on a scalable and trade-by-trade basis.
Furthermore, the RFQ model offers enhancements to the existing system of indications of interest (IOIs), with respect to the need for the buy-side to provide strong evidence around execution decisions under MiFID II. By aligning RFQ with IOI classifications, a stronger audit trail can be created and more data-driven information obtained in order to improve future broker selection for risk/block trading. IOIs can be put into competition, allowing buy-side firms to filter and refine the type of liquidity they want to interact with.
Trading in size has significantly changed with MiFID II, the introduction of double volume caps (DVCs) to restrict certain dark trading, and the shift of liquidity to emerging Systematic Internalisers (SIs), LIS venues and periodic auctions. In the midst of these shifts, accessing liquidity and transacting in the best interests of the end investor remains key.
RFQ offers a technological innovation in cash equity trading. In essence, RFQ enables both buy-side investors and liquidity providers to continue to realise the benefits of relationship-driven trading via a MiFID II-compliant platform. Ultimately, buy-side firms need to make informed choices across a wide range of execution options, and RFQ platforms help their dealers to do just that.