Private market infrastructure and market data provider Forge Global Holdings has announced plans to enter the European market through a strategic partnership with Deutsche Borse. Through Leveraging the Deutsche Borse network, the two firms will establish a digital marketplace for European companies and investors that provides access to Forge’s US liquidity network. 

Forge Europe product offerings will include liquidity programs for companies, a digital marketplace that brings together buyers and sellers and exclusive private market data.  

Forge Europe product offerings will include liquidity programs for companies, a digital marketplace that brings together buyers and sellers and exclusive private market data.  

The private market in Europe has demonstrated notable growth in recent years. More than 650 unicorn and pre-unicorn companies with a combined market cap of more than €625 billion fuel the growing demand from investors to access the thriving private market asset class. However, as private markets mature in the region, structural challenges persist – including a lack of liquidity, access for investors, transparent price discovery and digitiszed transaction facilitation.  

In the US, Forge has to date facilitated more than $12 billion in transaction volume – with more than $600 million in trading volume coming from European investors and companies, a precedent that could bode well for the growth of the European market.  

“The growing interest in private market investing and the growing need for liquidity by private growth companies transcends geographic borders,” said Forge CEO Kelly Rodriques. “As Europe’s population of high-growth technology companies continues to grow rapidly, creating an efficient and trusted private marketplace that can meet the needs of those companies and investors across a complex regulatory landscape is a challenge Forge is uniquely positioned to solve. With our innovative technology platform, credible experience and private market expertise – and with a strategic partner in Deutsche Börse that understands local market requirements and how to run scaled and regulated market infrastructure – we believe Forge Europe can deliver to European participants the benefits of a liquid, transparent and efficient global private market.” 

As a strategic partner to Forge Europe, Deutsche Börse will further leverage its growth ecosystem, including its network of private European growth companies and international investors, as well as contribute a substantial minority investment in Forge Europe. 

“Investing in private markets has grown significantly in Europe over the last decade, with record investments in growth companies last year. Forge impresses with its renowned private market expertise. Deutsche Börse stands out for its ability to operate a scalable and reliable market infrastructure and has established an extensive capital markets ecosystem. Together, we will be a first mover in Europe to build up a trusted, efficient and technology-driven global private market platform. This is how we will address the liquidity needs of growth companies and venture investors,” said Eric Leupold, Managing Director of Deutsche Börse’s Cash Market business. “For us at Deutsche Börse, this is a promising opportunity to expand into a new asset class with high potential.” 

Headquartered in Berlin, Forge Europe plans to launch in mid-2023 in Germany, the UK and France, before expanding to the rest of Europe.  

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The European Securities and Markets Authority (ESMA) has highlighted possible liquidity issues for European alternative investment funds (AIF). The warning came in its fourth annual statistical report on the AIF sector, released last week.

The regulator flagged a possible mismatch between the potential liquidity of the assets, and the redemption timeframe offered to investors.  

“While at aggregate level this mismatch is unlikely to materialise, it indicates that AIFs with a liquidity deficit would face challenges if large redemptions were to occur,” said ESMA.  

The AIF sector has shown robust growth in recent years, increasing by 8% in 2020 to €5.9 trillion in net assets, from €5.5 trillion in 2019. Funds of funds and real estate funds dominate the market, accounting for 15% and 13% of NAV, respectively. Real estate funds in particular are growing rapidly (9% in 2020 to a NAV of €766 billion). However, the illiquidity of their assets makes liquidity risk in these funds an ongoing concern.  

ESMA also raised concerns around the liquidity of funds of funds. “At the very short end, investors can redeem 40% of the NAV within one day, whereas only 14% of assets could be liquidated within this time frame,” warned the regulator. “If large redemptions were to occur, AIFs would face challenges due to this liquidity mismatch.” 

The report also noted that the European hedge fund industry has shrunk drastically as a result of Brexit. The UK’s departure saw the sector deplete from €354 billion in 2019 to just €89 billion in 2020.  

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According to a study from Liquidnet on the European liquidity landscape, the structure of the market and liquidity formation has remained steady throughout the month despite a jump in overall volumes.

Lit volumes – excluding auctions – surged from around 10% of market activity in February, to more than 20% of market activity, which was further highlighted by a sharp decline in the percentage traded in lit auctions. Liquidnet said the increase in continuous lit trading was likely due to a rise in algorithmic trading, particularly VWAP (volume-weighted average price), over the course of the day.

Traders have expressed concerns about the lack of intraday liquidity and the impact on continuous trading, in part due to the rise of volumes in the closing auctions.

The amount of total volume in closing auctions is not increasing, but the percentage of total volume has increased dramatically. This has sparked concern from some senior traders, particularly those among active buy-side firms, who largely agree that trading during the day has become more difficult as a result.

At the same time, while overall dark trading volumes peaked at more than 10% of market activity in October last year and January this year, as a percentage of overall activity dark trading has declined to between 8-9% despite the overall surge in activity. Dark trading that was large in scale (LIS) has also declined from around 40% of overall volumes in 2019, to 30% in March.

“With PMs (portfolio managers) preferring to work orders in current market conditions rather than trading blocks, the risk of further regulatory change remains a significant challenge,” Liquidnet said.

Europe could see some major changes to dark trading under MiFID II as European authorities are currently reviewing the rules. The European Securities and Markets Authority (ESMA) is considering removing the reference price and negotiated trade waivers, which would lead to the double volume caps being redundant. Liquidnet warned the move could have a ‘profound impact’ on dark trading activity.

“Current ESMA proposals to remove reference price and negotiated trade waivers could have a profound impact on the make-up of dark trading and any subsequent ability for traders to find price improvement to meet best execution obligations,” Liquidnet stated.

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Now in its fourth year, JP Morgan spoke with more than 650 traders primarily trading foreign exchange, but also other products, to explore trends in electronic trading and the liquidity landscape. The US investment bank found that liquidity availability is the biggest daily concern for a third of traders, followed by other daily challenges such as workflow efficiency, price transparency and best execution.

“As the number of liquidity providers is shrinking, we’re starting to see a lot of recycled risk in the system,” Scott Wacker, global head of fixed income, currencies and commodities e-sales at JP Morgan, commented on the results. 

“Clients really value good and efficient access to liquidity so it’s not surprising that it’s the major concern again this year. Coupled with this, this year we’ve seen some liquidity providers stepping away from the market, which will always heighten the focus on liquidity sourcing.”

Elsewhere in the survey, traders mapped out predictions on the percentage of their trading volume that they believe will be executed via electronic channels. Traders anticipate an 11% increase in the proportion of credit and rates e-trading, according to the results, with commodities and FX expected to increase by 6% and 5% respectively.

The results are in line with a recent report from Greenwich Associates, which found that e-trading has grown to account for 45% of all European fixed income trading volume in 2019, compared to 38% the year prior. The research added dealers that have prioritised investment in technology to support the shift towards electronic trading have gained a significant advantage.

“Traders are acknowledging that electronification is rapidly increasing,” JP Morgan’s Wacker added. “For dealers, developing the electronic market making and the algorithmic trading capabilities is paramount… More and more tools traditionally applied to equities and FX are being applied to credit and rates, driven by increasing available data and better understanding of how to use that data for post-trade analytics.”

JP Morgan was also recently recognised as the clear winner of Greenwich Associates’ 2019 European fixed income market share leaders table. Citi ranked second behind JP Morgan, followed by Barclays, Goldman Sachs, and then HSBC, BNP Paribas and Bank of America Securities, which tied for fifth place.

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The US-based liquidity provider published an analysis of aggregate order book data from direct data feeds of US exchange groups, revealing that several episodes of heightened volatility in the US equity market witnessed over the past 12 months had nothing to do with quantitative investment strategies and computer-driven trading activities.

Market participants and observers often point to changes in market structure, regulation, or the rise of electronic market makers, as factors behind periods of rapid stock price drops or diminished market liquidity.

“Given that the fundamental forces that have positively reshaped our equity markets have been at work for more than a decade, it seems unlikely that they are responsible for either impaired market liquidity or by extension, the episodes of volatility seen over the past year,” Citadel Securities stated.  

Citadel Securities described today’s market as “incredibly competitive”, with a new generation of technologically-sophisticated market participants having emerged as the “dominant liquidity providers”. Those participants have displaced legacy dealers, including large banks, that have been slow to compete in more automated markets.

“This new competitive landscape has been in place for the better part of the last decade, which again makes it an implausible cause of recent market swings,” Citadel Securities said. “To the extent banks today face constraints in conducting certain trading activities, it is difficult to see how that explains stock market volatility, given the negligible role banks have played as liquidity providers in these markets for over a decade.”

The study claimed that liquidity in US equity markets over the past eight years has, in fact, been “remarkably stable”, and the resilience of the market during the global financial crisis “compares favourably to bank-intermediated over-the-counter markets”, such as certain derivatives markets which suffered during that period.

An in-depth look at liquid stocks including Microsoft, Apple, and Google, found that the cost of executing large-sized trades has remained relatively constant, but spreads have decreased for medium and small-sized trades, contributing to the idea that liquidity has diminished.

Although this perception, which Citadel Securities labelled as flawed, is often derived from analysis of displayed size at the national best bid and offer, rather than full depth of displayed liquidity on US exchanges.

“Our size-adjusted spread measurement for a $1 million S&P 500 transaction, for example, has hovered at approximately two to four basis points (bps) for virtually all of the eight-year period measured. Similar patterns hold for $10 million (3-6 bps) and $100 million trades (9-24 bps) in this broad-market benchmark,” Citadel Securities’ analysis claimed.

“While recent and past decreases in liquidity depth (aka increases in size-adjusted spreads) have coincided with spikes in the VIX, this has not exclusively been the case and the data does not suggest that the depth or resiliency of liquidity is fundamentally different today than it has been over the past eight years.”

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The US investment bank’s third annual e-trading survey, which saw 200 of its largest institutional trader clients surveyed on market trends in 2019, revealed that a majority of 40% of FX respondents agreed that liquidity is the biggest daily challenge facing traders. 

In comparison, last year’s survey saw 29% of FX traders state that the availability of liquidity was the biggest daily challenge, with best execution requirements and precision of execution concerns topping the list for a majority of 37%.

The survey also found most traders believe that MiFID II, which came into force in Europe a year ago, has had a negative impact on the global liquidity landscape. A significant 73% of respondents said that the liquidity environment is either slightly, somewhat or significantly more challenging under the European regulation. 

When it comes to selecting a liquidity source, just under three-quarters of FX traders told JP Morgan that price consistency is the most important criteria when considering potential sources, with 63% identifying availability during volatile markets as another key requirement.

In terms of technology, JP Morgan’s survey revealed that FX traders are not convinced that blockchain will have a significant impact on the industry in the next 12 months, with just 9% agreeing the technology will shape the future of the trading. 

Artificial intelligence and machine learning technology, however, could have a much bigger impact this year, according to a large majority of 57% of FX traders. Mobile trading apps followed AI and machine learning capabilities, with 28% of FX traders stating they will shape the future of the industry.

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Ben Springett [head of European electronic and program trading, Jefferies]: We have a more holistic view of how the execution landscape has evolved because it is not possible to determine the impact of the SI landscape in isolation. How you would use SIs is partly down to which avenues you have available to execute at a certain point in time (volume caps, order size etc.) as well as what other liquidity is available in the market at that time. However looking solely at SIs, it’s clear that there are two very distinct flavours.

Ben Springett, head of European electronic and program trading, Jefferies

First of all, you have the broker SIs which have replaced the broker crossing networks (BCNs). I would say that functionally we use broker SIs in the same way we used to use the BCNs, and I think the initial focus from operators has been on replicating historic matching capabilities in the new regulatory landscape, often times utilising a combination of an SI and a periodic auction on a member preference-basis. The second type of SI is the market maker, or electronic liquidity provider (ELP) driven SIs, which are certainly a new dawn for us on the European trading landscape, albeit the liquidity provider operators were active in multi-lateral venues previously. These single dealer pools have been prevalent in the US previously, and as they have come into Europe they have elegantly met the definition of an SI as the legislation would expect them to look.

We’ve had almost 12 months of ELP SI usage in some cases, and it’s clear that not all are created equal. There are different firms, offering products with different strategies behind them that you should view differently. When you go to an ELP SI you need to have a clear view of how they operate, and we have been able to build up a meaningful amount of data on the variety of ELP SIs that we currently use, which we use to inform our future usage. Part of that is initially determined by how the operator describes their model to us – maybe they propose to have low short-term impact because they have a longer holding period or a natural risk offset available to them from other strategies. In other cases you expect to have more short-term impact because they are very much a short-term market making operator, but until you see the data, you don’t really know.

So, we have been building a dataset across a number of providers and that has informed our current adoption levels along with consultations with clients. Over the course of the past few months we have seen an increase in the number of clients that are opting in to use these services, but Jefferies’ default position is to have them switched off for clients. I think that a level of maturity and understanding has been reached, and people have had the time to digest and we’ve also got more data to share with our clients.

Matthew McLoughlin [head of trading, Liontrust Asset Management]: We have a variety of fund types and trading strategies, so we have used a number of the new and pre-existing venue types so far this year. I have been pleased with the innovation that we have seen from both brokers and execution venues. In aggregate we are reasonably happy with our experience from liquidity and reversion perspectives, although we have been quite selective with the venues we have interacted with. We really tried to understand each venue in terms of what they offer and the model behind that before we switched them on for trading. In general the buy-side is now comfortable using conditional or large-in-scale (LIS) order books and, now that we have more information about them, periodic auctions for orders below LIS too. Systematic Internalisers, however, are very different beasts and it is taking much longer for the buy side to get comfortable interacting with them.

Bank and ELP type SIs are obviously very different from each other and within each of those categories there are also distinct differences. Within the ELP category you have SIs which make markets off the back of their own strategies, others that make markets off the back of their exchange-traded fund (ETF) business, and then the more high-frequency trading (HFT) type SIs that don’t want to hold their risk for long at all and look to unwind reasonably quickly. You’ll see different prices, reversion rates and different sizes from each of those.

It’s important to understand that it’s not simply a case of “SIs are good” or “SIs are bad” and “an ELP SI is good” or “an ELP SI is bad”. You need to understand what their models are, what they offer, how they are different and which best suits your trading strategy. We met with all of the ELP SIs that we have switched on as well as ones that we decided we didn’t want to interact with due to them not providing the type of liquidity that we wanted to access. We tried to understand their models as best as an outsider ever can, because obviously there is a lot information that they don’t necessarily want to share with us. We obtained as much data as possible from the SIs themselves, but also from brokers who had already interacted with them both in their SI format, but also when they were operating within their BCNs last year. A difficult component to this is that if you just use broker data on SIs, then one ELP SI could look very good according to one broker’s data, but then look very different on another broker’s data due to the way each interact with their liquidity. That’s difficult for the buy-side to manage, and that’s why we try to get as much data from the SIs themselves as well so that we can question the brokers on their smart order router logic.

We have interacted with a number of SIs this year, both bank and ELP style. Now that we have our own data set we continue to analyse each liquidity source as this is a constantly developing picture. The data will ultimately decide which of the venues thrive and which cease to exist. The more data we get, the easier it will become for the buy side to select SIs to interact with.

BS [Jefferies]: I think it’s important to understand that this isn’t a static landscape. As one comes to an opinion based upon a selection of data, that doesn’t necessarily mean that particular experience will hold in the future. I think you see changes in individual participants or destinations that arise as the market evolves. In times of volatility, for example, you will see some changes in strategy and the providers may begin to model more on those that are interacting with them. So market participants are feeling each other out in a way to try and understand and then responding. With that in mind, it can be difficult to make static decisions around the use of SIs in general, or individual providers.

At Jefferies, we have scoring mechanisms that we apply to each trading venue we trade with – that can be ELP SIs, broker SIs, even lit order books – for a dynamic quantitative model that ranks each venue in real-time. When it comes to the time we need to trade, we know from our short-term experiences what to expect in our outcome. We have actually seen a number of the market maker pools that we trade on drop below some of the regular lit markets in terms of their relative priority. We aren’t triggered or incentivised by the fact that it’s free to trade on these venues for brokers, and we don’t have a cost logic in our routing process. When we are trading aggressively, we are only looking at where it is likely we will get the smallest amount of price impact, and we see quite big differences between the market maker destinations, which as mentioned we also compare with lit markets. A small element of price improvement from a market maker won’t be enough to tempt us, we really care about the impact that could manifest from that interaction on an ex-post basis.

Jonathan Finney, director, European business development, Citadel Securities

Jonathan Finney [director, European business development, Citadel Securities]: I would emphasise Ben’s point there. Not all brokers are the same and not all market makers are the same, so we see very different types of evaluation and results. What Jefferies is doing in collating and analysing data and evolving behaviour based on the results of this analysis, represents one end of the SI evaluation spectrum. With regards to how this landscape has evolved over the past year, overall volume does not appear to have changed dramatically. However, the composition of liquidity sources certainly has changed. To that point, SIs are not the only alternative source of liquidity but they represent the single greatest opportunity for evaluating equity market makers. Given the bilateral nature of the SI, ironically this has achieved the transparency that MiFID II was aiming for. Matthew at Liontrust, via Ben at Jefferies, knows that he is trading with Citadel Securities and he can evaluate us on our merits.

I think people have been surprised at how slow ELP SI growth has been but we are definitely seeing the buy- and sell-side becoming more comfortable interacting with market makers as they are able to access more data. I would point out that there are only four market makers currently reporting their monthly data to Rosenblatt Securities and TABB Group and having this data available supports the evaluation process. Market makers are very different. For example, Citadel Securities specialises in risk-warehousing positions, larger quote sizes, benign market impact and a diverse security universe. Having a robust evaluation framework is important to assessing these factors. 

MM [Liontrust]: On the issue of transparency, if we had decided not to interact with SIs, then I would actually be trading with them on lit exchanges anyway, possibly at worse prices, smaller size and potentially with a larger market impact. That is up for debate, but when I interact bilaterally, I know exactly who I am trading against so that I can hold that venue to account.

HM: What have you found to be the most important factors when evaluating ELP SIs?

MM [Liontrust]: Firstly I need to decide if their model makes fundamental sense and if it is adding liquidity that would be beneficial for me to interact with. I then look at price, size and market impact – those three factors are key. For the buy-side, I think market impact and size has become a lot more important this year. I’m not looking for a twentieth of a tick price improvement, I’d rather have larger size and lower market impact. It’s strange to say it as a trader who is addicted to getting the best price – but the best price is not always best execution for me. If I can get good liquidity and not impact the market, then I am usually a happy bunny. The importance of those two factors has definitely increased over the past couple of years for the buy side in my opinion. Fill rates are another factor to be aware of. I hear of SI fill rates between around 95-99%, but what happens when you don’t trade against them? That’s harder for the buy-side to monitor. One thing is for sure, with the proliferation of execution venues that we have experienced, it is more important than ever to make informed venue selection decisions.

BS [Jefferies]: Jefferies doesn’t have an execution process that tries to minimise the cost to us when doing business for our clients. So for us, the consistency of availability of liquidity is not a crucially important factor, but what is important is the size of liquidity when we need it. We actually don’t consider the marginal price improvements offered to us on the quotes we receive from market makers, and that’s because we are not looking for them to create an ability to synthetically jump to the front of the queue by a tenth of a tick-type price improvement. We completely ignore that. It doesn’t even compute in our system. We are sensitive to the size of liquidity that is being offered to us, and the price impact we will see as a result of that execution.

When we’re talking to the different providers, we are trying to understand factors like their holding periods, strategies and unwind models, and that has helped us to predict the availability of liquidity in size and what that price impact will look like based on what they are describing. By connecting to a variety providers, not ones that are very similar to each other, we also have a diverse range in terms of the universe of coverage. One provider covers more of the small and mid-cap range in continental Europe, an interesting area for us to explore, and other providers have their primary business in cash equities, ETFs or options, and the flow they have in cash is made in the unwind of hedges and those types of trades – but again, it’s a different profile. We’re looking for that complementary nature of the universe that comes together. But ultimately we go to providers and say, “show us more size – I don’t care if you’re not there as often, but show us more size”. Orr show us mid-point liquidity, because then it gets very interesting as we can connect that to a range of additional strategies that are taking advantage of mid-point liquidity elsewhere, from periodic auctions, dark MTFs and so on.

MM [Liontrust]: You have to give yourself liquidity options. We must remember that not all execution venues are suitable for every order type. No one venue type ticks all the boxes. SIs will admit themselves that they are not suitable for every order type, but they are there for when you need them. At every buy-side event I attend, the main problem we all come up with is finding liquidity, so having a variety of good quality liquidity options definitely helps.

JF [Citadel Securities]: The factors that Matt and Ben have covered there broadly fall into three categories: unique liquidity, quantity of liquidity and quality of liquidity. Unique liquidity comes up a lot in terms of what clients are looking for in an ELP SI, and this means offering liquidity across a large and diverse securities universe. This is an easy one to quantify because the information is available on the quote streams. With quantity of liquidity, it is via quote sizes. To Matt’s point, we are not going to be two-way in every single stock all the time in all sizes, but what we will do is offer a quantity of liquidity that matters to the buy-side. It all boils down to those three and making sure that brokers and the buy-side are aware of the different ELP SI models. Citadel Securities obviously only represents one type of ELP SI, but there are other types of SIs out there as well.

Regarding quality of liquidity, measuring the price impact following an SI trade remains the key focal point for many discussions. Ideally, the focus would be as an A-B test per market maker, but realistically this would not be practicable. Focusing on fill level analysis would help the buy side and sell-side determine which market makers unwind positions quickly and which ones risk warehouse positions. One point worth noting is that we are talking here from a Jefferies and Liontrust perspective, but brokers are evaluating these factors very differently depending on their interactions with market makers. It remains difficult for the buy-side to become aware of what a good evaluation and a bad evaluation actually looks like, so again, the more we can talk about it the more we can move into a standardised framework for evaluating these factors.  

HM: What are your thoughts around SI price improvements sub-tick above SMS and the European Commission’s recent take on the tick-size regime for SIs?

BS [Jefferies]: We do not factor marginal improvements in, it doesn’t mean anything for us. We believe it could potentially create the wrong incentive, and I think risks in efficient market structure. In Europe a few years ago when we saw the dawn of fragmentation in lit markets, we saw tick-size competition taking place between primary exchanges and alternative venues, but I think the industry did a very good job of self-policing that and coming to a harmonised tick-size regime. MiFID II of course has a harmonised tick-size requirement for trading venues, so the industry is under regulatory pressure to conform with the regime more widely. I think potentially antagonising the regulator by offering fractional tick price improvements is not very productive.

Matthew McLoughlin, head of trading, Liontrust Asset Management

MM [Liontrust]: From the buy-side’s perspective, a tenth or twentieth of a tick price improvement is not something we are looking for. The regulators have been looking at extending the tick size regime to cover SI flow, so price improvement could soon be a thing of the past. There is a danger that this gets extended to LIS venues and periodic auctions, which would prevent a large amount of mid-point trading. This is definitely not in the best interests of investors. I’m pretty comfortable with the tick size regime being expanded to include SIs, however, because it’s not a driver as to why I’m trading with them in the first place.

BS [Jefferies]: Yes, it’s very important as an industry that we protect being able to trade at mid-point. It’s a very valuable option for a range of different venues that use if it for a wide range of market participants, and is well established as a go-to option for many of the largest asset managers across the Continent.

HM: How do you see relationships between brokers, the buy-side and market makers evolving in future?

JF [Citadel Securities]: I would say the SI regime has achieved one of the key goals of MiFID II, that being increased transparency albeit on a bilateral basis. For the first time, the buy-side and sell-side can isolate, identify and ultimately evaluate each individual market maker on its own merits. Going forward, this provides a sort of three-way feedback mechanism where buy-side can evaluate their brokers and market makers by looking at aggregate SI statistics. This valuable tool will complement TCA and other capabilities for evaluating execution quality in equities and I am genuinely excited to see how this develops.

Over the course of next year, we are likely to see an increase in the number of market makers moving into the SI regime and an increase in SI volumes. Then, maybe towards the end of 2019, I believe we could see a drop-off in the number of market makers because the evaluation framework will be a lot stronger by that point, making it easier to identify and weed out weaker performers.

BS [Jefferies]: I would say that with MiFID II this year, we’ve seen a vast amount of technical and innovation work which will further the gap that exists between different providers. If I think about the sell-side, those with nimble technological architecture that can respond quickly to changes in the liquidity landscape or onboard new venues, are more likely to succeed than those who can’t keep up or their technology is too old and will fall by the wayside. I think that’s likely to continue as a trend over the course of the next few years. We’ve seen clients increasingly applying more quantitative and rigorous tests to their broker selection processes and their trade distribution processes for example.

In terms of the bilateral interactions that exist between the sell-side and the market maker, the transparency is important, but where I’d like to see more transparency is in the tape. The consolidated tape was a much desired aspect we wanted to be included within MiFID II, but as the regulation became more complex that didn’t happen. There’s a role to be played for the industry itself or the regulator to provide a consolidated tape solution, and what I’d like to see as part of that is more granularity around the SI prints that take place. When we trade against an SI we know with which provider the trade was done, and potentially the type of liquidity we have interacted with. We will pass this information back to our clients so they also have that transparency. What we lack though is the ability to identify from the tape generic SI prints when we aren’t involved in the trade. Which venue did they take place on? Is it genuine liquidity or more of a manual or technical trade reporting function? A greater level of granularity would be beneficial in identifying the relative location of liquidity, size of liquidity and the position of the market as a whole.

MM [Liontrust]: From a liquidity perspective, I would love for ‘perfect’ liquidity solutions to land in my lap, but in reality that’s never going to happen. The market structure is constantly evolving with new regulation and execution venues developing constantly. I think that without the full engagement of the buy-side, with the sell-side and the venues themselves, it will be much harder and take a lot longer to drive innovation in the right direction for the industry. Never before have I witnessed the level of collaboration between market participants than over the last couple of years. I only see that developing further in the years to come.

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The bonds were discovered in the regulator’s first assessment of the European bond market for the first quarter of 2018.

ESMA added however, that the data received so far is “not fully complete” for most instruments.

The data “completeness and quality issues” therefore led to a lower number compared to ESMA’s earlier transitional transparency calculations.

The liquidity assessment for bonds relates to those subject to the pre- and post-trade requirements under MiFID II.

ESMA published the list on its website under a Financial Instruments Transparency System (FITRS).

The European watchdog said its liquidity assessment for bonds is based on a quarterly assessment of quantitative liquidity criteria, such as the daily average trading activity and number of days traded per quarter.

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A survey of 100 fund managers carried out by Peel Hunt and Quoted Companies Alliance (QCA) found that 42% have reduced broker lists somewhat, while 19% have reduced their list significantly.

Those surveyed said they believe there will be an overall reduction in the number of broking houses as a result of MiFID II, with 28% stating there will far fewer broking houses and 45% believing there will be slightly fewer.

“I’ve been saying this for years, the market is ‘over-broked’, and the business models have changed,” said one fund manager. “What’s happening at the moment is that MiFID II is coming in and has made the broker try and keep its existing business model, and throw managers, and there’s quite a lot of kick-back on that.

“So, something has to change, and that either means the business models or their underlying brokers have to change, or there’s a bit of a shakeout and there becomes purer but stronger broking houses.”

Steve Fine, CEO of Peel Hunt, also commented he fully expects consolidation in the broking industry as MiFID II puts further pressure on research revenues moving forward.

The survey suggests the impacts of MiFID II overall are far more negative on small and mid-sized quoted companies, in terms of both research coverage and liquidity in their shares.

A majority of 70% of those interviewed said that they believe MiFID II will result in less research being produced on small and mid-caps in the future, with 48% saying they have already witnessed this in the market.

Similarly, 54% of fund managers said that MiFID II will negatively impact liquidity of small and mid-caps with 23% predicting the impact will be very negative.

“I think the most likely expectation is less liquidity initially but that’s not a given,” one fund manager commented. “There are clearly some unintended consequences, we know the research projects will fall by the wayside.

“We know the research costs or the responsibility for research and marketing will fall increasingly on the companies and so there is clearly a risk that there is less research, ergo less knowledge, ergo less liquidity.”

Fine concluded: “The reduction in quality research coverage on these businesses is of most concern, as it’s impacting their visibility in the market and restricting liquidity in their shares, which will ultimately hinder their ability to access capital for future growth.”

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Miles Kumaresan, head of trading and FinTech, Nordea Asset Management

“There is nothing more challenging and relevant now than the aggregation of fragmented liquidity in all asset classes, especially in fixed income,” says Miles Kumaresan, global head of trading and FinTech at Nordea Asset Management. “I’m consumed with this problem.”

Enhancing Nordea’s ability to source liquidity in the fixed-income markets, particularly in the credit space, is the most prominent conundrum facing Kumaresan. Having spent the bulk of his career with investment banks and hedge funds, Kumaresan is now applying his experience with the Copenhagen-based asset manager, having joined the firm in February 2016 with the dual responsibility for Nordea’s trading and technology teams.

“I was never a born trader,” he says. “I was one of these guys who could create tools to help with execution. Everything that we are doing now is to create tools; where they already exist we will use them, but if they don’t exist then we will create specialist tools for the traders, either in liquid or illiquid brackets. This is what we do.”

It is, of course, a futile exercise to implement technology tools without the right teams in place to use them. As well as its 26 traders located in Copenhagen, Bergen and Stockholm, Nordea has invested in a five-person trading research and development team and a five-person IT team focused on trading, a reflection of the company’s recognition that technological innovation is critical to staying competitive.

Building a diverse team

An efficient trading operation requires a diverse set of traders, ranging from classical to quantitative, to enable it to thrive. Kumaresan says that Nordea has a strong base of experienced traders to which it has added three junior traders with strong quantitative and IT skills, brought in last year.

“Everyone in trading has their skills enhanced continuously wherever they are lagging,” he adds. “This is how we were able to retain all of our traders during transition and leverage off their depth of experience. Stacking the desk with only cheaper junior talents was never an option.”

The first thing to take care of in the process is risk rather than reward, according to Kumaresan. Operational mistakes can occur extremely easily with manual repetitive tasks and some of these errors can be very costly. “You need to automate all the operational instructions at every part of the pipeline, starting at the order source, all the way down to it hitting the trading desk,” he says.

Nordea’s trading structure has evolved throughout the two years Kumaresan has been with the firm, the primary of which is the division of teams by instrument liquidity across asset classes first and then by specialisation.

Orders traded in the new cross-asset “Liquid Trading Desk” are suitable for automatic routing to brokers with either zero or very low touch, using what Kumaresan calls a proprietary systematic model that plugs directly into its FlexTrade execution management system. This frees up the high touch trading teams to add value on demanding orders.

The asset manager also has specific teams dealing with high touch trading where specialist knowledge and human involvement can be required. But, even here, traders are given tools in line with the technology-driven focus of the company.

Fixed income traders, for example, use tools that aggregate real-time and historic market data sets to assist with price and liquidity discovery. In equities, the company is developing a model to price liquidity in very large orders to help traders with large blocks.

Technology de jour

Artificial intelligence (AI) is currently the technology de jour for the majority on the buy-side and Nordea is no exception. The firm currently uses AI within its pre-trade workflow automation processes to detect erroneous data and ensure data integrity, particularly useful with these types of problems as AI can capture far more obscure data errors that occur in the pre-trade process.

AI in trading still remains a somewhat slippery entity; while there are some impressive AI systems out there, Kumaresan says that much of this is simply “what used to be called statistics a couple of years ago.” Having spent the greater part of his academic years studying computer sciences and having attained a Master of Philosophy degree in AI and Robotics, Kumaresan doesn’t impress easily when it comes to the AI label that can often be erroneously applied in the FinTech space.

“Having built AI for a long time in other contexts my view is that the majority of the technology with the AI sticker is mere snake oil,” he says. “Therefore, I am a little hesitant in using the word AI.”

And he says that having AI replace humans for trading is “absolutely not” likely in the foreseeable future: “AI can beat chess grand masters because chess has clear states, structure and rules. Trading, on the other hand, requires complex higher level decision making based on vast amounts of mostly noisy and ambiguous information. Therefore, I expect execution to remain an inalienable prerogative of human traders for a long time to come,” he says.

Nordea also has models to normalise trade slippage, to convert raw slippage data into a form that is comparable across metrics in order to conduct accurate comparative analysis. This analysis fuels another real-time statistical decision-making engine that assists in deciding who to trade with and what execution method to employ on orders suitable for zero and low touch trading.

Another project underway at the firm is the development of a complex contingent trading framework across asset classes, which calls on portfolio managers to use structured rules to build up high-level trading instructions.

“It empowers them to specify and obtain more accurate pre-trade cost estimates on complex execution rules. This assists traders with clear trading instructions when working baskets of say multi-day orders contingent on relative price movements,” says Kumaresan.

So with all this technology, how close is the market to solving the original puzzle of liquidity?

The liquidity conundrum

Equities may have its fair share of challenges in aggregating liquidity across lit and dark venues; however, liquidity in equity markets is a relatively predictable phenomenon, mostly due to price transparency. Foreign exchange, meanwhile, still has its antiquated mores—in particular the last-look practice that distorts the true liquidity picture.

The real liquidity problem lies in fixed income. Finding liquidity in the fixed income markets, specifically in credit, has become one of the most enduring puzzles across the buy-side. Credit liquidity is fragmented and discontinuous across both price and time partly due to the infrequent trading property of corporate bonds, explains Kumaresan, which is not helped by the fact there are over ten thousand ISINs in Europe and twice that number in the US.

“Fixed income is still in the dark ages in a technological context,” says Kumaresan. “Before the crisis, banks had all the balance sheet needed to price a wider range of bonds in size. Now you have the same trading structure even though the sell-side can no longer carry big inventory.”

The more advanced segments of the sell-side have been trying to make up for the shortcoming of diminished inventory through technological and quantitative innovation—for example, by automatically pricing a large universe of bonds in order to offer tradable streaming prices. Kumaresan believes this is a “is a big step in the right direction,” with innovations of this kind becoming critical going forward in retaining the role as providers of easy liquidity.

“The new reality of the market structure warrants a new trading paradigm,” says Kumaresan. “Just because we get the majority of our orders done on the first day does not imply that the market is liquid or that the prices we got were good. It is merely the best price given the circumstances. I believe that, particularly in credit, the buy side becoming price makers on the names in which we have a natural interest in, through all-to-all trading, is critical to generate and attract liquidity. This active way of sourcing liquidity could become a real disruptive event in credit.”

All-to-all can’t solve everything

The need to find better ways to trade in fixed income has been addressed by platforms such as MarketAxess, Tradeweb, Liquidnet and Trumid, as well as the many other electronic venues attempting to make all-to-all trading possible. Rather than solving the puzzle, the proliferation of venues has had a very different consequence— namely of greater liquidity fragmentation, says Kumaresan.

As yet there remains no single universal trading protocol that suits all the different types of fixed income order sizes and names. Each venue is currently attempting to solve the order matching problem differently with an emphasis on different segments of the liquidity and size spectrum.

“While the classical RFQ (request- for-quote) trading protocol, used by MarketAxess, is good for somewhat smaller orders and for the more liquid end of the universe it is not suitable for very large orders or illiquid names, because the information leakage is too high with this approach,” says Kumaresan.

“The Liquidnet and Trumid protocols, on the other hand, leak less information but finding a match manually is more difficult. If a protocol is stealthy, then by definition, the low information leakage will also reduce the chances of spotting that liquidity. The key to solving the liquidity puzzle is to embrace all useful trading venues and protocols through a smart liquidity seeking algorithm.”

There is, of course, the argument that buy-side trades are too correlated to enable the all-to-all market to work, because how do you find a seller when everyone else wants to buy too? But Kumaresan disputes the correlation argument.

“While there is a fair level of correlation, the mere fact that sell-side market makers typically turn over most of their books within five days implies that there is sufficient interest on the opposite side of a trade within this small time window,” he says. “Given that the buyside has 95% plus of the liquidity, we are most likely the ones on the opposite side too, helping turn over sell-side books. This would imply that we are not as correlated as we may think.”

Clearly there is still much work to do in order to meet the demand for a new class of technology that can aggregate the vast quantities of data in the fixed income market, while also enhancing workflows in a seamless manner and introducing a smart liquidity-seeking algorithm.

While that is no small task to take on, the pace of technology innovation has undoubtedly spiked in recent years, meaning traders can often be spoilt for choice when it comes to selecting systems – albeit with the caveat that while good systems, they do not provide a seamless workflow. As Kumaresan puts it: “Empowering traders with technology tools is how one gets an edge. It’s like hunting; even if you are a great hunter you still need the tools to get the job done.”

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