TRADING PLATFORMS ARE CHANGING MARKET STRUCTURE.

Gherardo Lenti Capoduri, Head of Market Hub at Banca IMI explains the promise of electronic trading platforms in the new regulatory world order.

While the industry has been grappling with the fallout of the financial crisis, there has been a plethora of trading platforms looking to capture greater market share with a “one-stop shop” execution model. Although their aims are similar in terms of adding to the liquidity proposition across the trading spectrum, they each have their own brand of innovative technology and trading protocols.

Despite the ensuing fragmentation, these platforms play an important role as part of the ongoing electronification trend of markets as well as being a key component in helping financial services firms meet the incoming MiFID II transparency requirements. For example, it will be more difficult to do voice block trading without impacting the market price. This is likely to accelerate the number of smaller tickets and lead to greater automation as these orders are passed through a trading platform.

This disruptive market structure landscape is not easy for sellside firms who historically have been on the other side of a trade for their core clients. However, the stricter regulatory environment, especially the more stringent Basel III requirements, has elevated inventory management costs and created a re-think of the traditional “client-sales-trader” business model. The sellside, for instance, is reshaping its role towards a more risk-averse agency model that supports the traditional model and provides an array of compliant services as well as a more efficient source of liquidity.

Buyside firms, for their part, are also contemplating their modus operandi particularly against the current bullish market trends and new private capital inflows. As they may no longer be able to count on their sellside colleagues to provide as much liquidity as in the past, they are increasing their overall trading flow as well as becoming multi-asset trading advisors in order to find liquidity and design strategies for their portfolio managers.

Trading platforms are also viable solutions for the never-ending search for liquidity. Key features for the platform to attract liquidity are:

• Stable critical mass of trading flow: it is crucial for a trading platform to be used by as many financial institutions as it can onboard to create critical liquidity flows and an efficient network of counterparties;

• Universal trading model: in order to meet the various needs of sophisticated and technological market participants (e.g. client-to-multi-dealer request for quote, chat, all-to-all, anonymous auction) and the possible combination of B2B2C, D2C and inter-dealer broker approach;

• The participants on the platform should be as varied as possible (liquidity may come from everywhere: asset managers, mutual/hedge funds, investment banks and others);

• “Plug-and-play” solutions for a wide range of client execution management systems (EMS). It should also offer a greater degree of automation and lower latency;

• Data mining and big data: storing and analysis of data with the possibility of building automatic reporting for business solutions and transaction cost analysis (TCA);

• Supporting the financial intermediary’s compliance with regulation: data reporting, evidence of best execution, and bond liquidity among others;

• Opens the door to a wide range of financial instruments.

The next step

There are several different initiatives being developed that will further facilitate the process such as information/data aggregation tools which will help dealers set the deal on the axed instruments, in particular on more illiquid bonds. In addition, all-to-all trading protocols, as well as central limit order books, have been gaining traction. These are particularly popular in Italian markets, which are home to the traditional trading model for regulated markets and MTFs, as well as SOR systems acting as liquidity aggregators in a fragmented markets environment. It enables participants to find latent liquidity in a deeper pool of liquidity.

The trend that we are witnessing in Italy is that trading venues are adding RFQ protocols to their traditional CLOB model, while in other parts of Europe, where the RFQ model has been central for many years, new electronic platforms are building protocols based on an all-to-all model.

The introduction of different waivers across European countries may also affect the choice of future trading solutions. From a trading platform point of view, the European landscape may not have a level playing field and this will create some opportunities.

Conclusion

In this regulatory-laden environment, market participants will have to work twice as hard to comply but trading platforms have started to provide concrete solutions to ease the burden and address market participants’ specific needs. However, these solutions are still quite fragmented and there is no ‘one-stop-shop’ platform yet.

In the foreseeable future, we might witness a merging of ideas and technologies across platforms, which could provide an answer to the fixed income markets’ liquidity pursuit.

©BestExecution 2017

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