London Stock Exchange is introducing a pan-European request for quote for cash equities in the autumn, highlighting the expansion of the order type from exchange-traded funds and less liquid asset classes since new regulations went live in the European Union.
Brian Schwieger, LSE’s global head of equities, co-head equities, ETF and fixed income, secondary markets, told Markets Media: “To address block liquidity, London Stock Exchange is introducing a new pan-European RFQ for equities in the autumn. We will be automating the process so that the RFQ automatically matches to the best price, making it compatible with electronic trading.”
RFQs have traditionally been used in less liquid asset classes, such as fixed income, where the buy side has to send an RFQ for prices to a number of dealers.
However MiFID II went live in the European Union at the start of this year and aims to encourage trading on lit venues by introducing double volume caps on trading in dark pools. This has led to an increase in volumes of block trades and periodic auctions as there are waivers for large-in-scale (LIS) orders and trading in auctions.
Brian Schwieger, LSE
“Before MiFID II came into effect it was expected that there would be ‘equitisation’ of fixed income,” added Schwieger. “However we are seeing ‘bondisation’ of the equity market.”
He continued that RFQs are also usually used on a bilateral basis, which means each counterparty needs an available credit line for the other. Therefore LSE will be introducing a central counterparty so market makers can reduce use of their balance sheet.
The LSE faces competition from other firms who are also championing the use of RFQs for cash equities.
Competition
Agency broker Instinet was the first to launch an RFQ model in European cash equities with Blockmatch MTF in March.
Ben Stephens, head of EMEA business development at Instinet, told Markets Media in April that central limit order books are the most efficient for liquid markets where information is disseminated to everyone instantly but RFQs work well for less liquid securities. For example, he noted there are 28,000 equities in Europe but only 1,500 to 2,000 are liquid, and only 200 ETFs are liquid.
In May Plato Partnership and Tradeweb Markets, which provides electronic trading for fixed income, derivatives and ETFs, announced a strategic partnership to deliver Tradeweb Plato ‘eBlock’. Plato Partnership is the not-for-profit industry group representing asset managers and broker dealers which aims to improve market structure and achieve better results for end-investors.
Nej D'jelal, Plato Partnership
Nej D’jelal, co-chairman Plato Partnership and head of electronic equities product at Barclays, told Markets Media in June : “As part of Plato Partnership’s purpose to simplify market structure and reduce industry costs, we recognised the opportunity for an industry utility to play a role in the potential evolution of cash equity RFQs.”
The first phase is scheduled to go live in the third quarter of this year and will include the introduction of RFQs to enable targeting of broker principal risk liquidity on a regulated venue, Tradeweb’s multilateral trading facility. Tradeweb launched electronic RFQs in fixed income and has extended the protocol into other classes, including European ETFs, but the firm has not previously been active in cash equities. The firm also plans to introduce its own version of “blotter scraping” technology to collect orders and identify possible matching opportunities and to provide investors with an aggregated view of dealers’ principal risk positions in a stock, and relevant data on their behaviour.
Systematic Internalisers
Schwieger said: “We have had a lot of interest from prop firms who may be interested in using the RFQ process rather than becoming Systematic Internalisers as it is more cost effective.”
MiFID II also banned broker crossing networks so firms have to set up systematic internalisers in order to provide risk capital that facilitates trades, which brings regulatory obligations such as trade reporting.
Ollie Cadma, head of business operations at Vela, said on the trading technology provider’s blog last month that SIs represent a new channel for liquidity, and also a new business model and new mode of interaction between liquidity providers and seekers.
Cadma wrote: “Through SIs, electronic liquidity providers must now deliver liquidity directly, a development which may finally stop these firms being lumped together as high-frequency traders.”
He added that other electronic liquidity providers have grown into multi-asset liquidity providers developing close bilateral relationships with sell-side firms, or have different aims and inventory in their SIs.
“It’s far too early to tell which models will offer the best performance to the buy side and ultimately the end investor,” said Cadma.
He continued that ELPs used to provide undifferentiated liquidity to all buy-side clients in broker crossing networks, but some have now decided to provide multiple tailored price feeds to individual brokers.
“This means a buy-side firm may be offered a different price by an ELP-operated SI, based on whether its order is routed via broker X or Y,” Cadma said. “Further, brokers might by wary of exposing their SI’s price feed to the routers of other brokers - and vice versa - for competitive reasons. As such, the interaction of routers and SIs is very much a new and emerging science.”
More ways to execute trades
Market participants now need to monitor and interact with a complex array of trading venues – lit, dark, conditional and SIs – in addition to their traditional sources of liquidity to achieve best execution.
Schwieger agreed that the implementation of the double volume caps on dark pool trading has led to a rise in alternative methods of execution. This has boosted volumes on Turquoise, the exchange’s multilateral trading facility.
https://twitter.com/tradeturquoise/status/1012277061812146177
“We have seen a record in periodic auctions on Turquoise Lit Auctions and a dramatic rise in the use of the midpoint order, which operates under the large-in-scale waiver,” he added. “Total volume for midpoint order have grown to £3bn ($4bn) year-to-date, from £900m in 2017.”
Schwieger explained that the advantage of using midpoint order is that it interacts with both lit and dark activity for large blocks. For example, a buy order will interact with a sell order before crossing the spread if the minimum order size is reached.
The exchange changed midpoint order to make it more compatible with algorithms and has also introduced a minimum order size. At the start of the year there were three or four brokers using midpoint order and there are now more than 10 according to Schwieger.
He said: “Market structure is evolving very quickly and we will continue to see the impact of new regulation, such as CSDR, over the next 12 to 24 months.”
Brexit
Next year the UK will also leave the European Union and the LSE has to plan for various scenarios including a hard Brexit, where there is no agreed deal with the trading bloc. As a result the LSE has applied for licences in Amsterdam to be able to serve EU-based clients.
“We are one of the most global exchanges in the world with 75% of the revenues of the FTSE 100 companies coming from outside the UK,” added Schwieger. “Our primary role is to ensure continuity of service for our customers regardless of potential changes to the regulatory framework or operating model.”
In the first quarter of this year the average daily volume at LSE reached £6.2bn, the highest for almost 10 years.
