BREAKING NEW GROUND.
RFQs are a familiar sight in fixed income but will they be successful in the equity world? Gill Wadsworth reports.
When the MiFID II rulebook arrived last January, buckling trading desks under its weight, it was hard to believe that anyone would eschew a system or process that promised to make life easier for those operating under the new regime. However, the world under MiFID II, with its onerous reporting requirements and transparency demands, is far from straightforward.
The advent of request for quote (RFQ) platforms for cash equities has taken a while to catch on. While both the buy and sellsides have embraced them for more illiquid asset classes including fixed income and FX, their role in the fast-moving equity trading space has raised eyebrows in certain quarters. The first cash equity RFQ platform – Instinet’s Blockmatch – launched in early 2018 was swiftly followed by Tradeweb’s eBlock and then the London Stock Exchange’s auto RFQ Platform. Immediately the innovations were met with scepticism from a handful of buyside players, with some questioning the need for platforms in such liquid markets.
Tim Cave, research analyst at Tabb Group, says: “Some buyside players did not see RFQ platforms as a natural evolution because they think of RFQ emerging in illiquid markets where it can be hard to find a price.”
These views may be about to change though. To put it crudely, an RFQ platform acts like a dating site for those trying to buy and sell assets. Rather than approaching just a couple of brokers and asking for a price, using an RFQ platform allows the buyside to cast the net wider.
Further they offer automation benefits that meet the high levels of transparency and reporting required post-MiFID II. Regulatory Technology Standard (RTS) 27 demands trading venues provide best execution reports covering the execution of transactions on the venue. Meanwhile, RTS 28 requires firms disclose their top five execution venues or brokers and summarise the level of execution quality achieved. It is geared primarily towards buyside investment firms and means everyone can assess not just how the execution progressed, but where.
“MiFID II places much of best execution emphasis on the buyside investors to comply fully with multiple transparency and disclosure requirements,” says Adriano Pace, managing director and head of equities at Tradeweb. “eBlock has the advantage that everything is audit-trailed millisecond by millisecond, and the details of the trade can be revisited later.”
MiFID II is all about improving outcomes for investors. Since this is inextricably linked to delivering best execution, proponents of RFQ platforms claim that they are well suited to the new regulatory regime since they can include a greater number of potential partners.
Paul Squires, head of EMEA equity trading at Invesco, says pre-MiFID II equity trades were often limited to one or possibly two parties. “It wasn’t the done thing to ask for multiple quotes. That might be for market sensitivity reasons or for etiquette; it wasn’t seen as appropriate to ask for more than one person to trade,” he adds.
Squires says such a model is clearly incompatible with MiFID II since if asset managers happen to “ask a rubbish broker then you get a rubbish quote”, and there is limited transparency to demonstrate the client was front and centre. The RFQ platform, meanwhile, should be able to provide what Squires describes as a “really neat automated workflow”’.
Squires says: “RFQ platforms capture loads of market data which gives a nice easy framework with a simple automated workflow to capture best execution requirements.”
The next argument in favour of the RFQ platform for cash equity trading, also relates to how many more parties get to play.
An expected yet unfortunate consequence for the financial industry post MiFID II has been the squeeze on resources. The cost of complying with ESMA’s 1.4 million paragraphs of directive has been heavily criticised on all sides of the trading process. In fact, Squires says that as the buyside and sellside divert resources towards meeting transparency and disclosure requirements, they have smaller budgets to expend on the trading itself.
“Banks and asset managers are under pressure to reduce fees just as they are having to meet the cost of compliance. Brokers have withdrawn some of the capital they provide to buyside dealers and they do more clinical client profiling,” he adds.
He says that in these cost-conscious times, some brokers are offering only the best service to the biggest asset managers. “If you have £10bn in assets and you are trading light volumes, brokers might not give you such a high touch service,” he adds. “RFQ platforms are a way for smaller desks to get the risk pricing they might not get otherwise, and it allows some brokers to offer risk pricing when they might not usually be considered.”
So far so inclusive, which ironically is where the major challenge to the RFQ platform model arises. It is this inclusivity where the first alarm bells are beginning to ring for the buyside. If players preferred to keep request for quotes limited to just one broker in the past, opening the whole process to any number of platform participants is daunting.
As Graham Sorrell, head of equity, currency & derivatives trading EMEA at State Street, puts it, “Information leakage is the drawback. If you have put three people in competition and you trade, two will lose. The two losing parties may not know your direction – assuming you hid it when quoting – but you’ve given out information to the marketplace.”
However, Tradeweb’s Pace is keen note that the buyside is not foolish when it comes to deciding where to trade. He argues that parties are discerning about what they believe is suitable for an RFQ platform.
“If a buyside user would never dream of telling five brokers about a trade, then why would they use an RFQ platform? Traders have a clear idea of what types of trades they can put through on an RFQ platform and what is best taken to another venue,” Pace says.
Pace adds that platforms can protect all parties from information leakage and has measures in place to monitor participant behaviour, whether the trade is completed or not. “We partner with a third party that synchronises these trades and we compare [leakage] with other venues such as periodic auctions and systematic internalisers. Despite the fact we have typically higher trade sizes, our revision statistics put us in the middle of the pack,” he adds.
Meanwhile Scott Bradley, head of sales and marketing for LSE Cash Secondary Markets, says the exchange acts as a middle ground between parties – in this case they are both sellside – and can manage the information flow.
Cave notes that no trade is ever without some leakage, and he adds that most parties have long-term relationships to protect which would be jeopardised if, it transpired, they had used RFQ platform information inappropriately.
Sorrell agrees, adding, “We favour executing in a more thoughtful way which gives us the best chance of achieving an optimal execution for our clients. At times that maybe putting a trade out for RFQ, but at other times it will not be.”
MiFID II has been a thorn in many sides, but it is leading to much needed change. The idea that comfortable trading relationships had been born out of habit or self-interest rather than what is best for the investor could continue no longer. The RFQ platform is not a panacea – nor is it trying to be. Rather it offers another option for both sides trying to get the deal done in the best way possible.
Agency broker Instinet was the first to launch an RFQ platform in European cash equities with Blockmatch MTF in March 2018. Ben Stephens, head of EMEA business development at Instinet assesses their impact.
Has the buyside warmed to the need for RFQs for cash equities rather than seeing them as suitable only for illiquid asset classes?
The value of the RFQ model has started to make itself clear to buyside users; it offers a level of control over not only the order parameterisation and information footprint, but also for the engagement of counterparties. It serves as a powerful complement to other conditional order types when a trader is looking to execute larger blocks.
This means traders can manage exposure of their intentions in a way that is appropriate for the order. It also provides clients with an opportunity to find a match at a price other than a simple midpoint of the displayed quote. It can serve as an efficient means of price discovery for very large orders, where no quote is available.
Competition is growing and more platforms exist for RFQs for cash equities, what has this meant for your business?
The greater the usage of these new order types, the better for everyone. When we launched our equity RFQ offering, we knew that it would begin a trend and we welcome that level of competition. Competition is very good for the market overall. The critical thing is to offer our clients informed choices – it’s what liquidity aggregation is all about.
Why do RFQ platforms lend themselves well to the post MiFID II world?
One of the key objectives of MiFID II is to bring more trading onto centrally cleared venues. By adding ‘all to all’ RFQ functionality on BlockMatch’s CCP cleared platform, trading interactions that used to be primarily done over-the-counter can now be executed in our regulated venue. We believe this fits well within the spirit of MiFID II and MiFIR share trading obligations, while at the same time giving our clients and members opportunities to benefit from automating the management of their liquidity.
How can clients avail themselves of a variety of platforms to access liquidity, without increasing their risks of information leakage?
Our liquidity aggregation philosophy has been about leveraging Instinet’s broker neutral, agency status as a sort of clearinghouse of liquidity. Our buyside clients can choose to remain anonymous, or be attributed, based on their preference.
We can use our good relationships with Liquidity Providers and SIs to optimise trading opportunities for our clients as the liquidity landscape changes.
Our bilateral liquidity relationships with an array of SIs gives liquidity providers an ability to provide meaningful liquidity to a wider set of counterparties across Europe. This gives a liquidity provider wider “distribution”, if you will, which gives them more innovative ways to reach and benefit end investors.
And by managing our clients’ interaction with many sources of liquidity in an anonymous manner, we can essentially personalise their access to the right counterparties in the most efficient way possible. It’s a win/win – this is good for Instinet’s clients and good for liquidity providers, alike.
What influences will continue to shape the market in the future?
We’ve seen several trends:
- Complexity of rules, and the number and diversity of trading venues has continued to grow. It’s the sellside’s role to smooth this out for their clients, in our view.
- Sources of order flow have shifted away from bulge brackets toward electronic market makers, which have different revenue models. This requires a new set of tools and new ways of interacting with counterparties.
- Execution consulting – i.e., insight that is closer to the live execution time horizon – that is actually part of the trader’s workflow – will really begin to differentiate broker offerings. Clients need to be able to apply the intelligence that big data analytics are making possible in real time.
- Conditional order types will become more ubiquitous – clients need this level of nimbleness and discretion in their automated strategies. The reliance on simple, schedule-based, single-strategy algos is becoming a thing of the past.
- The wider adoption of more complex workflow automation, augmented by machine learning, will happen more quickly than many people currently believe. These capabilities will not make human traders obsolete, but rather, will allow the trader to give these automated solutions increasingly sophisticated tasks, and enable them to take better advantage of the benefits of big data, speed and scale.
- We will see an evolution of the technologies used by the most advanced firms, including platforms such as FPGA, microwave and multi-colocation to gain a technology based trading advantage in a world where efficient information processing, and smart adaptation, is key.
©Best Execution 2019