BLOCK TRADING – WHAT LIES AHEAD.
Robert Cranston, Head Equity Product Management, SIX Swiss Exchange.
The block trading space in Europe has become very active recently. Large changes are underway due to the continuing need for asset managers to move large positions and MiFID II’s proposals for non-displayed trading. The important question investment firms need to answer is, with all the upheaval, how do you continue to service the needs of clients looking to execute large sized trades with minimal market impact?
According to estimates from the latest Rosenblatt Let There Be Light report on dark trading in MTFs and BCNs in Europe, approximately 13% of consolidated turnover was traded in non-display pools in January. In addition, except for Liquidnet, there is a very small proportion of this flow that is actually traded in block sizes (they use a trade value of E200K to approximate block trades).
Only 8% of flow, on average, is traded in blocks on venues measured. This matches other research in the industry that has shown blocks account for a relatively small proportion of all dark trading. All of this is happening as average trade sizes in the lit markets have continued to plummet, making it much more difficult to trade truly large orders without market impact.
Originally, non-displayed trading was presented to the market as a way for traders to move positions with reduced information leakage. For block trades it is a critical trading consideration, although, today it is not only used for blocks. It is important to realise that non-displayed trading is not the same as block trading, and that a relatively small percentage of non-displayed trades in Europe meet the criteria of being a block.
Few venues cater to block trading. This is reflected in the majority of non-display trading venues having average trade sizes that match, or are even smaller than, lit market averages. The other way to measure the acceptability of trading blocks on venues is by looking at information leakage. In the data analysed by Liquidmetrix (see Figure 1), we can see how the different pools perform when looking at price movement after a trade. By either of these measures most of these venues are clearly not serving block size trading. Others, such as Liquidnet show average execution sizes significantly larger than lit markets due to their focus on block execution.
Fortunately, there is no shortage of new markets and order types to fill any gap. Turquoise (Block Discovery), LSE (Dark Mid-Point), Deutsche Börse (Volume Discovery), BATS (Periodic Auctions) and PLATO in Europe as well as the rumours of BIDS or IEX voyaging across the pond are just a few of the options.
Trading participants as well as buyside firms will need to look at all of these options to determine the best strategy, but the inevitable outcome in the immediate future is fragmentation of block liquidity. Hopefully, the long term will see an eventual consolidation as new order book and technology solutions are rolled out to the market and either succeed or fail.
Interestingly, what has happened so far in response to regulation is largely focussed on technical changes around new trading books and models, as well as completely new venues. The natural by-product in the coming years is additional work for all firms looking to interact with these many new ideas for block trading, some of which will thrive, while others will disappear. This is on top of the already large burden of work regulation will cause for firms.
Nearly five years ago SIX Swiss Exchange identified a similar potential need for block trading from their members. At this time the exchange had the choice of either bringing a new facility to the market, or working with an existing pool of liquidity to address members’ needs. Rather than creating their own pool of liquidity from scratch, their answer to the problem was SLS, the SIX Swiss Exchange Liquidnet Service. This service allows all members of the Swiss exchange, and their clients, the ability to route committed orders to Liquidnet which are eligible to match and cross with participating liquidity within the largest block liquidity pool in Europe.
By providing this access, it helped to answer two important questions for the exchange. First, how are we making it easier for our members to trade blocks, and second, how are we actively innovating to help unify the overall market and facilitate block trading in the market whilst maximising the ability to find true natural contra liquidity. SLS is accessed via standard exchange connectivity, using a standard FIX protocol, and is fully supported by our existing interoperable CCPs, making it the only exchange-supported block pool for trading in 11 European markets.
SIX Swiss Exchange Liquidnet Service
- Partnership for Block Trading with Liquidnet, the largest block pool in Europe
- Markets covered: Austria, Belgium, Denmark, Finland, France, Germany, Netherlands, Portugal, Sweden, Switzerland, UK
- Central clearing and CCP interoperability
- Average trade size 2015: Over 300,000 CHF (Double 2014)
- Turnover increased 101% from 2014 to 2015