THE RISE OF RFQ IN EQUITIES TRADING.
Adriano Pace, Head of Equities (Europe) at Tradeweb, explains why the RFQ protocol is a compelling execution mechanism in the cash equities world.
The rise of request for quote (RFQ) in equities trading has been one of the outcomes of MiFID II. Was this expected and what has been the driver?
Although the RFQ mechanism is more deeply rooted in fixed income, it is hardly new in the equity space. In fact, it has existed for a long time on the retail side, where brokers request prices from a network of retail service providers (RSPs), and it is also widely used in ETF (exchange traded funds) trading. However, the advent of MiFID II has significantly changed the cash equities trading landscape for the buyside.
The focus on transparency has led to a search for alternative or additional ways to trade. We’ve seen increased activity on lit exchanges, but also a shift towards Systematic Internalisers (SIs), large-in-scale (LIS) platforms and periodic auctions. In the case of RFQ, it introduces both choice and control to the way buyside firms access liquidity on a trading venue.
Enhanced best execution requirements have been another catalyst, as institutional investors must now be able to demonstrate why a certain broker was chosen to execute an order. One of the key benefits of electronic multi-dealer RFQ platforms is that they provide access to an audit trail of all quotes, helping clients to prove best execution. Ultimately, the implementation of MiFID II has resulted in more choice and flexibility for equities trading desks.
For which market participants is this type of trading most relevant and what are the benefits?
There are different RFQ systems on the market, such as those offered by broker and exchange platforms, and Tradeweb and Plato Partnership’s eBlock. The RFQ model can be used in various ways, predominantly where there is some urgency to trade and there is no natural liquidity available. It is especially powerful in providing the buyside with a transparent means to determine which counterparty can offer them the best price and size on a stock-by-stock basis, by using dynamic and historic quantitative metrics in order to remove any bias from that decision.
Furthermore, RFQ is highly flexible and fits well with other execution methods. It also helps firms comply with MiFID II obligations, from trading on a regulated venue to evidencing best execution. In essence, it combines in a single protocol the benefits of centralised, electronic markets with those of bilateral relationships.
In the past, RFQ was seen as the “last chance saloon” for the buyside when sourcing liquidity due to concerns over information leakage. Has this changed and why?
Initially there was scepticism whether RFQ could work in the equities space. Many buyside traders thought that revealing their trading intentions to more than one broker could lead to information leakage. This idea missed the importance of the fully-disclosed nature of the Tradeweb Plato eBlock protocol. As the client is named, the process is no different to picking up the phone and the dealer adhering to the established confidentiality etiquette. Nonetheless, we decided to work with a third party vendor to analyse the extent of information leakage when using different execution methods, including RFQ. As expected, the initial findings demonstrated the largely non-toxic nature of RFQ on our platform.
Instead, our product gives the buyside trader authority on the negotiation and control of information, particularly when it comes to interaction with market makers or liquidity providers (LPs). When the RFQ is used in a considered manner, which is appropriate to the trade size and liquidity of the stock in question, investors can achieve competitive pricing with minimal information leakage.
What was the genesis of Tradeweb Plato eBlock?
Part of Plato Partnership’s purpose is to simplify market structure and reduce industry costs, and they saw an opportunity in playing a part in the development of cash equity RFQs. So, they invited several firms to tender for the service and we were successful. In the end, they chose us because we were pioneers in launching RFQs for fixed income, but have since added other equity products such as equity futures and options, ETFs and convertible bonds. When we look to expand existing protocols to other asset classes and instruments, we always take into account the individual characteristics of the market and adapt the protocol to suit. Plato also liked the fact that we have collaborated successfully with multiple order and execution management systems over the last two decades.
What does Tradeweb Plato eBlock offer, and how does it differ from other models?
The platform covers all EMEA cash equities, and currently supports above LIS block trades. We provide tools and data to help clients with the decision-making process around execution, and all trading information automatically flows back into buyside and sellside systems.
However, what eBlock brings to the table is the ability to access a constantly growing liquidity pool to efficiently transfer risk in larger sizes. It is fully disclosed, which provides the buyside trader with control over who they go to and the type of indications of interest (IOIs) they interact with. It also means that liquidity providers are fully aware of who their counterparty is, which should give them a lot of comfort.
How do you see this progressing in the future?
There are two key developments we are working on. First, we are expanding our universe to support below LIS orders in addition to above LIS. Second, we will be introducing our Automated Intelligent Execution (AiEX) tool to cash equities, allowing clients to streamline and automate their workflow, identify cost savings opportunities, and free up time to focus on trades which require more focus and expertise. Given AiEX’s success on our European ETF platform, where 53% of tickets were executed via the tool in the first half of 2019, we are very excited about its expansion to single stocks trading in the near future.
In general, when we look at the equity space there has not been a huge amount of innovation, but we do see big changes in liquidity provision with the emergence of the electronic liquidity providers (ELPs). Together with Plato, we will continue to talk to our customers, identify what their challenges are, and then come up with the right solutions.