The policy decisions that result from the current MiFID review must be based on data that accurately represents ”executable' liquidity, suggests an author of TABB Group's latest study of the UK equity market.
The research report, ”Breaking down the UK equity market', found that of the €3.898 trillion executed in the UK equity market in 2010, only 65% (€2.53 trillion) was “meaningful and executable” liquidity, with the remaining 35% constituting reprints of trades already conducted. Of all the trades conducted over-the-counter (OTC) – which accounted for 45% of total liquidity – only 11% was considered to be meaningful liquidity.
The TABB study identified a number of instances in which different conclusions could be drawn on the nature of UK equity trading depending on the kinds of liquidity and trading venues analysed.
While 47% of total turnover in UK equities in 2010 was conducted on a lit order book, this rose to 72% for truly executable liquidity, according to the research consultancy. In addition, broker crossing networks (BCNs) were found to be 5% of overall UK liquidity, but 8% of executable liquidity. The TABB study also noted that while high-frequency trading (HFT) accounted for 35% of total UK turnover, the practice was responsible for 77% of volumes on lit and dark exchanges and multilateral trading facilities (MTFs), i.e. excluding BCNs and other OTC channels.
The research was based on a variety of sources including data from the Association for Financial Markets in Europe, a sell-side trade body, as well as submissions to regulatory consultations and interviews with buy-side firms, brokers, hedge funds and trading venues.
Will Rhode, research analyst and co-author of the report, argues that any regulatory decisions made as part of the MiFID review should take into account these differences.
“To draw accurate conclusions about the market, it's important to first cut out the 35% of reported trades that are in reality reprints of already-conducted transactions,” Rhode told theTRADEnews.com. “The overriding thing we learnt in the research is that people are drawing conclusions based on an inaccurate view of the market as portrayed by the trade report data. There needs to be better transparency and clarity in this regard.”
When considering how to deal with HFT, Rhode suggests that the shortage of natural liquidity in continuous markets – found by TABB to be just 23% – means buy-side traders should seek alternative execution channels.
“There's no doubt HFT provides short-term liquidity and has tightened spreads, but our research also highlights the massive need for pension funds to have alternative sources of liquidity they trust, such as those provided in the over-the-counter market, where they can execute large orders,” he said.
The European Commission launched a public consultation on MiFID at the end of 2010, which is due to end on 2 February. The consultation paper sought views on a wide range of topics including tighter controls on high-frequency trading, a new regime governing BCNs and the possibility of a size threshold for dark orders on non-displayed MTFs such as Chi-Delta or NYSE Euronext-operated SmartPool.
Debate has also raged on the exact size of OTC trading in Europe. Industry body the Federation of European Securities Exchange has previously argued that the total size of OTC trading in Europe is 40%, and needs reducing. Brokers counter this is much lower, with recent research from broker Nomura claiming that less than 10% is OTC trading.