European asset managers must diversify their liquidity sources to deliver best outcome to investors, according to a new study called Turbulent Times: How volatility is changing asset managers’ approach to execution. conducted by Acuiti on behalf of global quantitative trading firm Susquehanna,
The study aims to provide insights into asset managers’ changing perceptions of their trading counterparties, ease of access to liquidity, particularly during stressed market conditions, and what requirements they need to meet to ensure efficient portfolio trading activity.
It found that 71% of those that use independent market makers (IMMs) as direct liquidity partners started to do so in the last three years, coinciding with the rise in market stress.
However, only a third of the bloc’s top asset managers currently engage with IMMs directly, suggesting significant room for growth.
It noted that as rising market stress drives some of the traditional liquidity providers to partially withdraw from certain segments of the market, the need for Europe-based asset managers to expand and diversify their liquidity partners’ pipeline becomes increasingly relevant.
And with those using IMMs reporting lower execution costs and fewer issues accessing continuous liquidity during times of volatility, it would seem that having a mix of trading counterparties operating different business models improves pricing in aggregate and ultimately ensures better trading outcomes.
The study also indicates that a divergence in approach to trade execution is emerging across Europe. Over a third or 35% of asset managers are now looking to make changes by increasing or diversifying their trading counterparties, with the biggest driver – cited by 73%- being a desire to execute against firms that specialise in a specific product or market.
As to the type of liquidity provider, independent market-makers were said to perform better on providing liquidity, lowering execution costs, and improving price quality.
Such benefits are particularly relevant during periods of market stress like those experienced in the early stages of the pandemic, Russia’s invasion of Ukraine and the recent gilt market disruption.
A significant proportion of respondents saw no difference in the ability for IMMs and banks to execute in size, although traditional banks were said to cover a wider range of asset classes and offering a broader variety of financial instruments.
The majority also said increasing or changing their counterparties was difficult with internal compliance being the biggest barrier as well as misconceptions around regulatory requirements and fears over information leakage.
“Heightened volatility, the need to reduce costs, the need for liquidity in specialist sectors and constraints on liquidity provision by banks have led the buy side to seek liquidity from other sources, particularly from independent liquidity providers,” said John Keogh, managing director at Susquehanna International Securities.
He added, “Although the survey shows that compliance burdens may be an obstacle to adding liquidity providers, this concern may be overstated as the growth in RFQ based platforms that admit as members both buy-side and market makers directly has greatly decreased the administrative effort to access liquidity directly from market makers. “
William Mitting, founder and managing director at Acuiti said, “Our study shows a clear divergence in the sector with regards to using trading counterparties between those diversifying to respond to a changing environment and those sticking to the status quo. Ultimately, those firms that use IMMs reported better access to liquidity during times of market stress.
In addition, many of those using IMMs said that they offered improved pricing and execution costs. These suggest that asset managers are likely to accelerate engagement with IMMs and the diversification of counterparties.”
