BLOCK AND TACKLE.
Mark Goodman, head of European quantitative electronic services at Société Générale discusses solutions to navigate a crowded marketplace.
According to recent research from TABB Group, buyside firms have continued to value block trading in equities. However there has been a significant gap between what could trade as a block, the amount the buyside wants to trade in blocks and the actual block numbers – a gap that has persisted despite a number of efforts to “crack the code”, each with inherent limits. Do you agree with this and what other problems do you think there are?
Whilst trading blocks is not the only challenge facing the buyside it is certainly one of the topics we find is raised most frequently. This is partly a function of the changing market structure but it also seems to be self-perpetuating: if everyone else is splitting their trades into smaller and smaller sizes then you are going to follow the crowd rather than post a block.
So whilst the market structure is important there is a behavioural issue here. If what one wants is blocks why do you divide your orders into small sizes, whether explicitly when submitting to dark pools through an ‘aggregator-type’ solution, or implicitly when sending it to a broker’s algorithm?
The overwhelming response was that as the buyside trader does not know who might be trading against them in a particular venue, the right thing to do is to be cautious. In short, the lack of certainty in terms of outcome means people shy away from committing themselves in block size.
The TABB report noted that the industry needs to resolve multiple requirements often at odds with one another, including: enabling trusted counterparties and allowing for anonymity; sourcing liquidity and paying for services; quick-matching engines and seamless workflow integration; and, marrying electronic messaging with traditional sales trading. Does PartnerY provide a solution and how does it address other issues?
The key area we have tried to address in terms of the above is how to enable trusted counterparties yet still allow for anonymity. The issue around an uncertain outcome stems very much from not knowing who is there. PartnerY – by allowing clients to construct a group of counterparties in a pool with whom they wish to interact – ensures that the potential outcome of a cross is much more predictable. However, we retain the notion that at the point of execution the counterparty remains anonymous. Whilst you know who you exposed the order to out of a universe of selected counterparties, you do not know specifically who you crossed your order with at the time of execution. So you retain anonymity at the point of trade.
To some extent this becomes similar to working with a sales trader in order to source a block for you. The sales trader by using their knowledge of your objectives and of the holdings and objectives of potential counterparts will selectively try to match buyers with sellers whilst trying to ensure that anonymity is maintained. PartnerY offers a complementary electronic solution to this more traditional service.
In terms of sourcing liquidity and paying for services we see a very clear approach from the buyside. Even bundled clients will step outside their broker list where a service or provider can really add value in terms of differentiated liquidity.
Some buyside firms have become disillusioned with information leakage and falling order fill sizes in (some) dark pools although they like the anonymity. Do you see PartnerY as a substitute or add on?
We see PartnerY as an addition to the choices already available to the buyside when sourcing liquidity from dark pools. Whilst we do not believe that all liquidity is good all of the time, all liquidity is good some of the time.
If we look at what is already available in the market we would agree that the majority offer trade sizes equivalent to that in ‘lit’ venues and there is clear evidence from our own analysis of information leakage. However, if your order contains significant short-term alpha, and immediacy of execution overrides concerns around signalling risk then you would be happy to interact with these venues.
PartnerY, by nature of the fact that users will limit the number of counterparties they expose their orders to, offers less immediacy. But equally it can offer an environment into which clients feel comfortable in committing large size. And that means it occupies a different end of the spectrum in terms of immediacy versus quality than a traditional dark pool.
In Europe generally market participants trade in small- and mid-cap stocks with the average order size around 55% of average daily volume (ADV) on a given stock. How does that compare with the wider market?
This has very much been the profile of the liquidity that we have seen in PartnerY. It is not something we dictated. It is a result of where the users have positioned PartnerY indicating that a venue, which can handle this type of stock and size, is what they were missing. Typically we have found that the platform is being used much more for small and mid-cap stocks rather than large caps.
What has been the reaction since the November launch and what are your plans for future development?
We feel we have really captured the attention of clients with the concept of passing control from the venue operator to the end user so that they can construct the venue(s) they want. We have a strong pipeline of mainly large long-only asset managers and are currently just north of thirty clients – adding probably around 3 to 4 new parties a month.
Clearly we need to turn this enthusiasm into material cross rates. This is challenging when you are focused on organic growth of participants and natural liquidity. However, fundamentally we do not want to try to accelerate this by adding market-making activity as this would effectively drive PartnerY towards the same scenario as existing offerings in the market, which is simply not differentiated.
This is a more challenging approach and requires patience. Yet we believe the end result is worth it and our existing partners have been very vocal in encouraging us to see this through. So our focus currently is on how to better assist our clients concentrate liquidity to capture crossing opportunities and we will continue to experiment with the offering in order to achieve that.
You say that a unique element of this service is that you are transferring control from the venue operator to the end user. How so?
We allow each participant to select those other partners they want to interact with and allow them to police their list – including or excluding – on demand. Our role is to operate the service and provide data that allows participants to make informed decisions on managing their group. Data reports are provided to clients to allow them to identify partners whose behaviour does not match their desired objectives – including quality indicators around reversion performance as well as frequency/size of trades and average resting time.
Future development is also managed in this way. Whilst we have some ideas we are very active in ensuring that we consult with existing participants and only make changes when we find consensus. Even more encouraging has been that we see examples of participants discussing issues directly with each other then coming to us with joint proposals. This is very much in the spirit of the approach and we believe differs from the more traditional approach of designing finished products and subsequently pushing them out to potential users.
That being the case, what control do you exercise and where is this likely to lead?
Outside of our obligations to manage the platform according to regulatory requirements we do not exercise any control over the type of participants or who should interact with whom. We offer the service to all clients of the firm without prejudice and equally offer all participants the option to interact, or not, at their discretion. We believe this is the best approach to ensuring that the evolution of PartnerY remains in line with the evolution of user needs – rather than short-term market share or revenue wins.
Mark Goodman joined SG CIB in 2010 as head of European Quantitative Electronic Services. He started his career as part of the cash equity team at SBC Warburg in 1997 (later UBS), and began specialising in electronic trading in 2001. Following several years in the London team with particular responsibility for growing the hedge fund business, he moved to the US in 2006 to establish the European service with domestic clients. Goodman returned to London in 2008 as head of European electronic sales before leaving UBS in 2009.