Asset managers need to to invest in sophisticated analytics tools to demonstrate best execution and develop forward looking tools to enhance trading under MiFID II according to the inaugural research paper from Plato Partnership.
In September last year Plato Partnership announced its formal creation as a not-for-profit industry group representing asset managers and broker dealers with the aim of improving market structure, and achieving better results for the end-investor, in Europe. The paper, Shedding light on dark trading in Europe, was issued via Market Innovator (MI3), the body created by Plato to facilitate independent research on market structure.
Mike Bellaro, Plato Partnership
Mike Bellaro, Plato Partnership co-chair, said in statement: “The challenges facing the buyside as we approach MiFID II are significant and front of mind. This paper is a positive contribution to the dialogue taking place in the marketplace and comes at a timely moment for the sector, with just over six months until implementation.”
Professor Carole Comerton-Forde, Professor of Finance at the University of Melbourne, has examined the potential impact of double caps on dark trading and the closure of broker crossing networks in the European Union under MiFID II, the regulations covering financial markets in the region from January next year.
Comerton-Forde said in a statement: “ The buyside need to start changing their trading behaviour now in order to ensure the transition to the post-MiFID II world is a smooth one.”
MiFID II will change trading in the EU by introducing double volume caps on dark pool trading, which are more restrictive than those in the US, Canada and Australia, and not allowing brokers to cross internal flows without registering as a systematic internalizer. However Large In Scale (LIS) trades, above a certain size specified by the European Securities and Markets Authority, are exempt from the dark pool volume caps.
Comerton-Forde said: “The double volume caps are highly contentious and will have a dramatic and likely adverse effect on market quality. Such a blunt instrument will significantly disrupt the usual trading strategies for institutional investors, and as result impact their execution costs.
The paper cited data from Credit Suisse, which strips out trades that qualify for the LIS waiver, and found between January and March 2016 a little over 60% of FTSE 100 and FTSE 250 stocks exceed the 8% cap. “However, it is unlikely that any single venue will exceed the 4% cap, and it is expected that individual venues will manage the activity executed on their venues to ensure that the do not become subject to a six month shut-down,” added Comerton-Forde.
MiFID led to fragmentation across equity trading venues, an increase in the use of high frequency trading strategies execution algorithms and smart order routers to source liquidity across numerous trading venues. As a result, there was fall in average lit trade sizes from around €30,000 to €40,000 before MiFID to between €5,000 to €6,000 according to the paper. However there has also been a substantial fall in the implicit costs of trading over the same period.
Bellaro told Markets Media last month: “The buyside wants data and analytics to help traders become more informed about trading decisions as we head into the new world of MiFID II. There will either be a fragmentation of block trading or a race for speed so transaction cost analysis is an urgent requirement.”
To boost block trading, Plato formed its first partnership with Turquoise, the London Stock Exchange Group’s pan-European multilateral trading facility – the first between the buyside, sellside and a trading venue.
Turquoise rebranded its dark services as Turquoise Plato Block Discovery and Turquoise Plato Uncross. Uncross features random intra-day auctions which happen more frequently in more liquid stocks, making it harder for the auction to be targeted by aggressive trading strategies. Block Discovery facilitates trading in larger block orders by electronically matching block indications. On identifying potential matches, the service requires participants to send firm qualifying block orders to Uncross and their behaviour is monitored.
In May this year Turquoise Plato Block Discovery hit a record monthly value traded of €3.34bn, compared to just €0.28bn in May 2016. A new record daily value of €265.5m was set on June 1. Turquoise Plato Block Discovery has matched €21.3bn since launching in 2014, of which €17.3bn or 81% has been matched since the Plato partnership was announced.
Comerton-Forde said that in order for the buyside to be ready for MiFID II, they should look for trades which are eligible for the LIS or order management facility waiver, where possible. In addition, the buyside should carefully evaluate the merits of new venues and new order types to ensure they understand the costs and benefits of these new trading options, and the extent to which they assist in sourcing liquidity and minimising information leakage.
Nej D'jelal, Plato Partnership
Nej D’jelal, co-chair of Plato Partnership, told Markets Media last month: “Block trades need to be compared on an apples-to-apples basis. Although this will not be possible for every single trading scenario, there can be standard use cases and commonly understood benchmarks.”
The paper continued that choices will need to be made about how to achieve the best possible trading outcomes given the potential fragmentation of block trades across multiple venues and there needs to be discussion on how algorithms and smart order routers will be adjusted when dark trading is shut down in certain stocks.
“Historical trading data is unlikely to be helpful in making these changes,” said Comerton-Forde, “Instead, attempts to anticipate and model changes in behaviour by different types of traders/investors may be informative.”
She continued that MiFID II will provide a wealth of new data which will assist with evaluation of trading outcomes. “The buyside should consider the most effective ways to exploit these data to their advantage,” added Comerton-Forde.
