UNLOCKING RETAIL LIQUIDITY.
John Owen, COO of Stifel Europe, discusses the post MiFID II market structure and how retail liquidity offers new opportunities to enhance execution quality.
How has the UK equity market structure changed since MiFID II was introduced?
Over recent months, certain aspects of the regulation have challenged the market significantly. In particular the changes to dark trading rules have prompted our clients to require a lot more support to help navigate the new venues and interpret the new restrictions that have been introduced. In particular they need guidance on where to trade their passive, low-impact business.
What specifically has changed around the dark markets?
The UK market was more heavily impacted by the dark pool caps than anticipated – over 350 instruments were suspended as part of the double volume cap regime. Clients have been forced to re-evaluate their trading strategies to take into account new trading methods like periodic auctions. This is as well as navigating a plethora of new venues including bank and external SIs, all of which require the re-engineering of existing algorithms and smart routers.
How have clients adapted to this?
Early trends show that whilst there is evidence that the trading of large orders – sizeable large in scale (LIS) trading – is adapting to the new breed of dark pools, clients are still struggling to find the best ways to execute passive orders in sizes below the minimum threshold for LIS.
Brokers have adapted routing methodology to leverage auctions on existing venues for example, but interesting new opportunities to access previously untapped liquidity are still emerging.
When considering how we might help sellside clients to execute passively, we began to turn our minds to how we might enable them to hook into the unique retail liquidity we see flowing into our systems from wealth managers and retail investor platforms. That led us to develop a completely new platform to bring together our institutional and retail clients called SWIM – Stifel Wealth and Investment Management service.
So how does retail trade size compare to institutional trading venues?
Perhaps counter-intuitively, analysis shows that average trade sizes from retail executions compare very favourably against even dark pool venues. Average trade sizes of over EUR 8000 lend credence to our view of the existence of meaningful execution opportunities within a community that previously wasn’t accessed in this way. The question has been how to access this without significant technical development from the client’s perspective.
How might the market achieve this?
Historically the retail brokers have been served well by routing their retail flow to a specialist group of market makers. We have re-engineered this trading model to allow access from standard algorithms to this flow on an agency basis, bringing two valuable sets of market participants together in a safe and confidential environment. This is fully automated, with parameters from both sides, enabling complete control of trading limits and price improvement.
How does the quality of execution against this liquidity measure up against existing business?
Fortunately, with the availability of more pre- and post-trade transparency, it’s easy to benchmark the results of accessing new types of venues. TCA of our client orders in the first quarter of this year has proved that significant spread capture was achieved by institutional clients accessing retail order flow through our SWIM platform. Pre-trade signalling risk is minimal on the institutional side, and all trades are opaque to our proprietary trading activities. In turn, retail clients have achieved best execution through their existing Stifel Europe trading connections and we’ve worked hard to maximise efficiency gains like trade netting to optimise costs.
What about the instrument coverage. Is retail ownership concentrated in smaller and mid-cap instruments?
No. Whilst retail ownership does vary enormously between instruments across the board, there is no specific trend between large and small-cap stocks. As much as 70% of some FTSE 100 instruments are retail-owned, and trading using this mechanism is suitable to bluechip and mid-cap instruments alike.
How much have you had to consider compliance in such an innovative new model?
Compliance is obviously key. Our priority is to ensure clients are comfortable with new execution policies and agreements we’ve put in place. Close co-operation with the regulator has also been necessary.
Should brokers be looking to build out their retail client base to enable them to take advantage of the significant trading opportunities. Isn’t that fragmented and won’t it take time?
The majority of our clients on the institutional side see SWIM as a neutral retail liquidity pool that’s easily accessible from their existing algorithmic trading suites. We’ve done all the development work for them to enable access with limited technical change and in a cost-effective way. So in that regard, they need not build that community themselves – they can access an established retail base through our existing SELECT (“Stifel’s Electronic Service”) platform.
We don’t see it as building a new pool of individuals – we like to think of it as ‘strength in numbers’.