SHIFTING SANDS.

Rebecca Healey, global head of market structure & strategy at Liquidnet assesses the leading trends in equities markets and what we might expect in a post-Brexit landscape.

Rebecca Healey is global head of market structure & strategy at Liquidnet and is considered to be one of Europe’s leading industry voices on market structure, regulatory reform, and financial services technology. She joined Liquidnet in July 2016 and is also co-chair of the FIX Trading Community’s EMEA Regulatory Subcommittee. She has held prior roles at TABB Group, Incisus Partners, the British Embassy in Bahrain, Credit Suisse, Goldman Sachs International, and Bankers Trust International.

What do you think the impact of Brexit will be in light of the recent election?

If it is a hard Brexit, then the FCA (Financial Conduct Authority) would no longer be governed by ESMA (European Securities Market Authority), but would still be subject to EU law until the end of 2020 during the transition period. The real question is what direction the new UK government will choose to take – soft Brexit or hard line – however, the political uncertainty surrounding the future relationship between the UK and EU27 is likely to lead to additional legislative changes post 2020. We have already seen a gradual divergence in regulatory approach from both the FCA and the European policymakers.

One area of concern over equivalence pertains to where European and UK shares could be traded in the future. Guidance from ESMA provided clarity on the scope of the EU STO (Share Trading Obligation), which applies to all shares traded on EU27 venues with EU ISIN (International Securities Identification Numbers) only. If there is no equivalence, all UK venues including UK systematic internalisers (SIs) will no longer be eligible for trading by European investment firms for those instruments that are dual-listed. This would have a significant impact on liquidity at a time when ESMA is emphasising the importance of liquidity in light of the suspension of Neil Woodford’s Woodford Income Funds.

How has liquidity changed over the year? What were some of the key findings in your recent report ‘MiFID II Landscape Liquidity Q3 2019’?

The report was very timely given that the MiFID review that is underway will look at the successes and failures of the regulation thus far. We found that in the past two years liquidity has shifted. For example, we saw a substantial 23% rise in the market share of SIs from March to the end of the third quarter 2019. The increase in activity could comfort regulators’ view that in the event of a hard Brexit, the enforcement of STO would push more volumes to European SIs, where the numbers have increased over the past year.

The question though, is whether these would operate according to ESMA Opinion regarding third country branches of SIs, or merely operate as a back-to-back model bringing together third party buying and selling interests across entities and jurisdictions to circumvent the impact of the EU STO. If the policymakers believe the use of SIs is not in the spirit of MiFID II and that they are being used for back-to-back trading, or as a means to match orders across jurisdictions, we could see further scrutiny and potential regulatory tightening.

What about closing auctions?

The report found that closing auctions have grown in the last 18 months reaching 25% of lit market volumes in September 2019. This can be attributed to the growth of index investing and ETFs (exchange traded funds), but participants also feel they get a fairer deal than on continuous lit order books. However, there may also be further regulatory scrutiny here. The French regulator, AMF (Autorité des Marchés Financiers), recently conducted a study that showed the proportion of shares traded at the close rose significantly, reaching 41% of the volume traded on Euronext Paris for CAC 40 stocks in June 2019. The reasons include a wish to avoid high-frequency trading, a rise in algorithmic trading, as well as the increase in best execution obligations under MiFID II to provide end-investors with greater transparency regarding transaction costs and market impact. This was also seen as encouraging more at-close activity.

However, it also notes that any reliance on closing auctions creates operational risks for traders, pointing to a 9% increase in utility company Suez Environment during the closing auction in May 2018 which incurred a trading loss of Ä2.2m.

What were the findings for periodic auctions?

We found that periodic auctions have plateaued in recent months at ~Ä1bn per day, down from the highs of Ä1.3bn in June 2018. The average execution size remained stable for uncapped names at around Ä6,000, while it had risen for capped names in June 2019 to roughly Ä10,000. It is worth noting though that the majority of the activity executed on these venues is now in uncapped names. Conditions could tighten in the future due to the recent ESMA Opinion which aims to limit the conditions under which periodic auctions can operate. For example, where the activity taking place is deemed non-price forming but eligible to operate under the Reference Price Waiver (RPW) – such as the use of pegged orders or systems that lock in prices at the beginning of an auction – it would be subject to the double volume caps (DVCs).

On that note, what impact has the DVC had?

Our report showed that dark activity has stabilised at around 7% of total volumes while LIS (large in scale) trading still accounts for around 33% of the dark market. There is still a conflict over dark trading which needs to be addressed, especially in light of the European Commission’s Capital Markets Union (CMU)* which aims to create more end-investor protection in the hope of generating greater retail activity by 2024. *The overall objective of the CMU is to boost investment flows and economic growth across Europe by removing barriers to fund sales, harmonising rules for covered bonds and ensuring legal certainty in cross-border transactions.

However, there are reasons why asset managers trade in the dark, such as wanting to improve best execution or to protect the end-investor from negative market impact due to unnecessary information leakage. There is no one-size-fits all solution and it depends on the asset managers’ objectives as well as market conditions and types of orders. This explains why there has been a rise in the use of periodic auctions and SIs as alternative methods of sourcing liquidity.

What impact do you think unbundling has had on the market?

The aim was to break the established model and under MiFID II, we have seen that the buyside is paying for research from its own P&L, which has enabled them to choose the best-in-class providers for both research and execution. With the data that firms now have on research procurement, they are able to better establish where to get best value for money. We are also seeing more detailed pre-trade data being fed into the investment process which is improving the timing of an execution as well as uncovering hidden liquidity by analysing previous executions to select the most appropriate venues and minimise unnecessary information leakage.

©BestExecution 2020

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