MiFID II Will Lead to Recalibration of Algos
Mark Pumfrey, head of Europe, Middle East and Africa at the institutional block trading platform Liquidnet, said algorithms will have to be recalibrated as a result of MiFID II.
The impact of the new regulation covering European financial markets from 2018 will include new types of trading venues, double volume caps on activity in individual dark pools and aggregate dark volumes and the buyside talking more responsibility for providing evidence that they have tried to achieve best execution.
Pumfrey told Markets Media: “There is a growing realisation from the industry that MiFID II will lead to a recalibration of the algo market. It is still unknown how the venues available today will exist under MiFID II, what they can offer and which new venues will be launched.”
In 2014 Liquidnet started the Execution and Quantitative Services Group in New York to design, implement, and customize Liquidnet’s suite of execution algorithms and analytics while also providing quantitative research and market microstructure insight to its network of asset managers. The EQS group was expanded into Europe and the firm launched its Next Gen algo suite in the region this year.
In the first quarter of this year Liquidnet EMEA reported records in both principal traded and algos. Total principal traded in the first three months of this year was $39.6bn (€35bn), 6.2% more than the previous record in the fourth quarter of last year. EQS also had a record quarter with principal traded in its liquidity seeking algorithms, Liquidnet Dark and Barracuda, up 330% and 380% year-on-year.
“Our performance in the last nine months has been driven by our algo business and the Liquidnet Dark algo,” said Pumfrey. “The dark aggregator algo has been configured to provide exceptional performance for very large crosses within Liquidnet and external venues, and has come top in TCA analysis which has driven take-up.”
Pumfrey continued that the focus for Liquidet in EMEA is to move away from single dimensional crossing to becoming a multi-dimensional multi-asset class liquidity provider.
Last September Liquidnet launched a fixed income dark pool for asset managers to trade corporate bonds. Five months later Liquidnet said the fixed income dark pool had traded more $1bn in volume and Pumfrey said volume has now reached $1.65bn.
“In EMEA the fixed income pool has $2.2bn of daily liquidity, which has doubled since the start of the year,” he added. “Our pipeline shows that by the end of the year we will have 80 members trading fixed income in EMEA, which is twice the number we had at the beginning of the year. Match rates have doubled since January and should double again by the end of this year.”
The Desk’s Trading Intentions Survey for 2016 found that buyside firms were using 28 fixed income liquidity aggregation platforms this year versus 19 last year, and 14 were being used by at least 9% of respondents. The survey had 70 responses from North American, European and emerging market credit desks spread across 34 investment managers, with an aggregate of €15.4 trillion in assets under management.
The survey said: “The platforms currently most effective at sourcing liquidity are identified as Bloomberg and Marketaxess as a close first and second, followed by Tradeweb, then Algomi and then Liquidnet, B2SCAN and UBS Bond Port in that order.”
It noted that the services provided by Algomi, Neptune and B2SCAN focus on using information to find where to trade – rather than offering a venue for request-for-quote systems, or any auction or order book. For the second year in a row Liquidnet, Algomi and Neptune are first, second and third as platforms that traders plan to use.
“The poor liquidity picture we have seen in Q1 2016 will stretch the burn rate required for running many of these platforms,” added the survey. “Those with other sources of revenue – including long-term investment from financial market operators and participants – will have an advantage. However ultimately this is about pooling liquidity and buy-side traders are clearly identifying certain models that they prefer.”
Pumfrey said: “In order to survive, fixed income platforms need a critical mass of diverse liquidity and an established community. Not many venues will survive unless they are providing something unique to the industry.”
He attended the TradeTech conference in Paris last week and said the two topics discussed most were the seismic impact on the execution market from MiFID II and the recent decision on unbundling research payments.
This month the European Commission published the first in a series of MiFID II delegated acts setting out detailed requirements for the separation of research and execution fees, which have traditionally been combined together. The European Securities and Markets Authority had proposed that fund managers either pay for research out of their own revenues or set up research payment accounts for clients with an agreed budget. The delegated acts appear to allow modified commission sharing arrangements to fund research payment accounts provided they are not linked to trading volumes.
“There was relief that CSAs are still allowed although they have to be linked to RPAs and the research budget which will be onerous for the buyside,” added Pumfrey. “There will be a reduction in the amount available to pay for research and a focus on which providers add value.”
Pumfrey continued that the delegated acts will increase the administrative burden on firms.
“Institutions are currently reviewing their commission management processes to see if their CSA arrangements are robust, as commission management under the new rules they will have to account for every part of their research spend,” he said. “This presents a big opportunity for our award-winning commission management platform which provides an end-to-end solution for institutions under this new regime.”
The changing nature of the equities business was highlighted last week when Japanese bank Nomura said it was closing most of its equities business in Europe, after UK bank Barclays said in January that it would shut its Asian equities business.
“The contraction in investment banking is the start of an industry-wide trend which is the result of innovation, pressure on bank balance sheets, unbundling and increased transparency which makes it harder for those models to do well,” said Pumfrey. “The banks are struggling in all parts of their businesses right now – there are dark clouds over the existing cross-subsidy model.”
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