Lynn Strongin Dodds looks at the current trends in equity markets and the changes needed to make them more efficient.
Covid rattled equity markets in 2020 but it is nothing compared to the Russian invasion of Ukraine. Few predicted the conflict and unsurprisingly, geopolitical risks are now much higher on the agenda for buy and sell side firms as sanctions bite. Navigating markets always requires quality data and the latest tools and protocols but they have never been more important than today.
While it is hard to predict the long-term impact of the conflict, the wide-ranging sanctions will affect liquidity in certain segments of the market. As Alex Tedder, head of global and international equities of Schroders notes, “They will certainly have significant impacts on companies doing business with Russia and the continued impacts on both commodity prices and their availability will have important implications for cost inflation, interest rates and supply chain disruption.”
The US, Canada and Europe are tightening financial restrictions with a new ban that blocks seven Russian banks from using SWIFT, the global messaging system that enables bank transactions. Meanwhile, the clearing houses Euroclear and Clearstream have stopped clearing rouble-denominated securities. In addition, MSCI reclassified Russia as a “standalone” market, from its current emerging-market status while the London Stock Exchange suspended trading in 27 companies with strong links to Russia, including the energy and banking firms Gazprom and Sberbank.
It is no surprise that against this backdrop that equity markets are gyrating and valuations are in a downward trend. “With record fuel prices being recorded in the US, inflation ticked higher, heightening margin pressure for corporates in the real economy,” says Louise Dudley, portfolio manager, global equities, Federated Hermes. “We are experiencing extraordinary volatility in global equities compounded by wavering market sentiment and the risk of recession intensifies on spiralling commodity prices. We expect ongoing swings in the short term as geopolitical uncertainty over Russian crude persists. The potential for further supply shocks across the economy is acute.”
Analysts expect European shares to be among the hardest hit given the region’s close proximity to the conflict but also its exposure to supply disruption and soaring energy prices The eurozone currently imports a quarter of its oil and 40% of its gas from Russia. Although there have been rallies, overall, shares are around 25% cheaper compared to the rest of the world – the biggest discount since the eurozone debt crisis in 2011.
However, Dr Robert Barnes, group head of securities trading & CEO Turquoise, LSEG notes although these sanctions are wide ranging, equity markets have had experience with them before in 2014 and 2018. “While these sanctions are more dynamic and broader in scale, there is an established process for implementing them.”
The other key component in these volatile markets is the need for accurate and quality data, according to Rebecca Healey, managing partner, Redlap Consulting and chair of the FIX Trading Community’s EMEA Regulatory Subcommittee. “There will be a smaller number of equities trading due to the sanctions and it is important to have greater visibility to determine where brokers are trading and what they are doing particularly in times of scarce liquidity.”
There is a hope that the consolidated tape proposed by the European Commission, as part of the Capital Markets Union agenda, will be one step in this direction. “The benefit of a consolidated tape is that it provides a truly aggregated view,” says Ben Stephens, global head of product management at Nomura. “Unless you pay for a service like Bloomberg, you will not get that full picture. That drives competition and gives the end user a better understanding of what is being provided and if they can validate the services they are getting.”
It has been talked about for years but Matthew Coupe, co-chair EMEA Regional Committee & EMEA Regulatory Subcommittee of the FIX Trading Community and director of market structure at Barclays Investment Bank believes that the CMU’s focus on retail investors could bring it over the finishing line.
To date, the proposal on the table is to require the region’s 476 exchanges and trading venues – many of which trade the same securities – to make mandatory contributions to a tape for stocks as well as bonds, derivatives and exchange traded funds in return for “fair remuneration” or “a guaranteed a minimum revenue”. In addition, all market data sources would have to make their offerings standardised and available to market data aggregators.
Although Coupe sees the benefits of greater transparency as well as the ability to flag and identify liquidity as key attributes, he stresses that the data needs not only to be accurate but also relevant to the end investor. “FIX is all about the plumbing and we are working on developing a set of standards and best practices to determine what is just noise and what is important,” he adds.
Not everyone is convinced of the advantages. As Michael Richter, executive director, Transaction Cost Analysis, S&P Global Market Intelligence, notes, in “theory” a consolidated tape has multiple benefits with regard to equity trading, what is there not to like about consolidating fragmented European markets into a single source. However, there are a number of challenges that arise in this concept.
He notes that the liquidity improvement may not necessarily materialise and that market participants would need to be connected to all trading venues and systematic internalisers to be in a position to take advantage of all the liquidity available which in many cases, is not always possible. There is also the latency issue that would need to be addressed. A quote could come available and disappear before an execution could take place.
Also, he says, “In terms of data quality, will the data on the tape be cleansed? The accuracy and reliability of data on the tape would only then be as good as the worst contributor. In terms of the transparency, would the tape consolidate 100% of all data sources such as the fragmented SI’s and the OTC data, if it didn’t, it really won’t be providing improved levels of transparency.”
At the close
There is also debate and discussion around the trading protocols in the market and whether they are useful in a volatile market. For example, closing auctions have gained traction over the past few years, but Richter does not believe that there is a significant benefit to the end investor.
“If you look at it it’s not the total volume in the closing auctions that has increased it is the percentage of total volume that has seen a significant increase,” he adds. “A lot of our clients are providing us feedback that it has become more difficult to trade during the day. The feeling in the industry is that there is a lot less liquidity in the continuous trading hours.”
Richer explains that passive funds are attracted to the closing auctions as for them being able to trade at a closing price suits their investment strategy. “Doing this however, can often cause a particular name to have a price spike and reflect a price or value that hasn’t been consistent with where that name has been trading throughout continuous hours trading, lo and behold the following morning, the stock will find its level again close to the price when continuous trading ceased the day before,” he adds.
“Although electronification will continue to be a hallmark of equities markets, ushering in ever newer and shinier tools and protocols, the human element should also not be forgotten. Equity markets are becoming more and more electronic,” says Chris Jackson, global head, equity strategy & head of equities, EMEA Liquidnet. “However, the role of the sales trader is still extremely important. Difficult trades still need a human touch to find the liquidity. The right business model is a combination of the systematic and human engagement.”
©Markets Media Europe 2022