SHAKY TRADING, TRADERS UNSHAKEN.
Market resilience has been good, even as market returns have been tested. Dan Barnes assesses the current coronavirus state of affairs.
The multiple impacts of coronavirus (COVID-19) isolation policy, a price war over oil, central bank and government reactions has triggered enormous equity market moves and challenging conditions for traders.
John Lonski, chief economist at Moody’s Capital Markets Research, wrote on 19 March, “From the perspective of the US equity market, COVID-19 is the worst natural disaster ever.” For example, US equity markets saw the S&P 500 index drop 30% when it hit a 52-week low of 2,380.94 pts on 16 March 2020, down from a 52-week high of 3,393.52 pts on 19 February 2020. The FTSE 100 hit 4,898.79 pts on 16 March down 36% from its July 2019 highs, and other indices saw similar crashes (see Fig 1).
That has a corresponding impact on asset managers; UBS analyst Michael Werner, in a note dated 10 March, observed that equity market volatility is typically correlated with outflows for buyside firms. As markets sell off and asset managers liquidate positions to give cash to clients, Werner highlighted how this might impact listed fund managers.
“We find that Amundi and DWS are most immune to a 20% equity market decline in terms of the negative impact to their total AUMs (4-6%), given their high exposure to fixed income and multi-asset products,” he wrote. “At the other end, Schroders and Jupiter, which have high exposure to equity AUMs, will see the greatest impact to their AUM bases (8-15%), based on our analysis.”
On the frontline, traders are working hard to minimise the effect that any absence of liquidity or trading fragmentation has on clients’ investments, even in the face of significant outflows and inflows. They face a tough challenge on several fronts.
The first challenge is the operational risk of market access. When travel into offices in major cities has been banned, this requires back-up systems and trading from home.
“Our [buyside] traders have been remotely trading at full-capacity, as have the sell side, in some cases for the last two or three weeks,” says Paul Squires, head of EMEA equity trading and Henley fixed interest at Invesco. “Market volumes are significantly higher than average but we can absorb it. It’s fair to say larger asset managers have become really well equipped in their capacity and structure – even in these particularly challenging circumstances.”
Remote trading has its challenges. Many traders have had to order in extra screens to give them the view of the market they get in the office. Home broadband has improved significantly in capacity but is more susceptible to disruption than institutional trading infrastructure. However, the use of cloud-based trading systems does reduce the impact of traders moving location.
Equally, the markets themselves are under strain with capacity issues. In equities and futures, aggregate market volumes are high; the London Stock Exchange has reported a 23% increase in trading on its main market for February; anecdotally European equity volumes are said to be up by 30% in aggregate over March.
“In Europe exchanges have been working pretty well, handling this increased capacity day-in, day-out,” says Anish Puaar, market structure analyst for Europe at Rosenblatt Securities.” Although in the US there have been concerns about circuit breakers, that has been a debate around their design, not around their functioning which has been as intended.”
Australia has seen volumes driven so high by high-frequency trading (HFT) firms that the Australian Securities and Investments Commission stepped in to limit the number of trades being conducted by specific firms. The Philippines is an outlier in that it has closed its national exchange.
“[A] real positive we have had is market stability,” says Squires. “These are exceptional moves that we have had, in some cases triggering circuit breakers, but the markets are still open and we’ve had a very minor amount of intervention, such as temporary short-selling bans. So, I would have to say that financial markets have been pretty robust throughout.”
Puaar adds, “ If we compare that to 2009 when there were significant outages at some European exchanges, it is a testament to the technology investments that have been made over the last decade.”
The next risk is in the trading itself. With most of the buyside managing outflows, the directional nature of liquidity needs to be overcome, and the volatility of pricing has to be handled. Where liquidity is shallow it makes larger trades harder to execute, or at least more expensive.
“Spreads have blown out 50% in German and UK stocks when you look at the depth of the market, not just the touch prices,” says Mark Montgomery, head of Strategy and Business Development big XYT. “Therefore, liquidity is costing people more. Average trade size in March is down around 10-20% against the previous month.”
Matthew McLoughlin, head of trading at LionTrust, says, “We have not encountered too many issues with liquidity at this stage as large-cap equity volumes have increased dramatically, but we are yet to be fully tested across the entire market cap spectrum.”
The large market moves mean dealers are more cautious about pricing, and so spreads can be wider earlier in the day, tightening up as high-frequency trading (HFT) firms engage and brokers become more confident.
Those banks still willing to offer a risk trade to buyside clients – by taking on a whole position which they must then trade out of – are reducing in number, with buyside firms reporting fill rates for risk trades dropping by between 50% and 75%, in some cases falling to 10%. Dealers are also pulling away from other facilitated trading services such as pairs trading.
At the same time, buyside traders need to focus on getting the price their portfolio managers are aiming for, rather than risk being wrong-footed. “There is less willingness to rest orders in dark pools; as you might expect when prices are moving around a lot you may want certainty of execution over potential price improvement,” notes Puaar.
The sunny uplands of lit markets
Prior to the recent triggers of the sell-off, market regulators in Europe were reviewing infrastructure and trading rules in order to assess any weaknesses. The European Commission (EC) issued a white paper to review MiFID II, including the delivery of a consolidated tape of price data for both equity and non-equity markets.
“Having a single tape of record would definitely be of benefit,” says Chris Jackson, head of execution and quantitative services EMEA for Liquidnet. “There is value in post trade, and the market has found ways to deliver that. But in terms of reconstructing a tape day-by-day from multiple sources, that is much more difficult to achieve if there is no mandate.”
The European and Securities and Markets Authority (ESMA) had also begun a consultation into equity market transparency, which could have serious consequences for the use of dark pools, notably under the systematic internaliser (SI) regime. This allows sellside firms to supply risk pricing to clients without pre-trade transparency on the price. The consultation argues for removing SIs as eligible execution venues under MiFID II’s share trading obligation, and removing the use of waivers for dark trading, based upon the use of reference price or negotiated trading.
Buyside traders have voiced concern about the removal of these as they could impact their ability to minimise market impact by trading in the dark, using the large in scale (LIS) threshold.
“Institutional asset managers are of the view that maintaining the reference price waiver (RPW) and negotiated trading waiver (NTW) … provides an important function in protecting institutional order flow from adverse information leakage,” wrote Rebecca Healey, global head of Markets Strategy & Insight at Liquidnet. “Even large cap household names such as Telefonica and Daimler Chrysler would need to trade 113 and 83 times the average lit order size to reach the pre-trade transparency protection of LIS thresholds.”
The consultation deadline has reportedly been pushed back and traders are using industry groups to voice their concerns.
Montgomery notes that recent data indicates the fear of dark trading may be overplayed, in terms of its impact, as trading fragmentation today has been moving away from risk trading and unlit order books. “For all the concerns of the regulators on the side of the exchanges, volume is going back towards the lit order books in times of crisis because it is the only place where there is certainty of trades,” he says.