Yogi Berra, a renowned American baseball player, once said, “In theory there is no difference between theory and practice. In practice there is.” He was right, of course. Similarly, conventional wisdom says that because all lit orderbooks are theoretically identical in functionality, in practice there is no difference in the outcomes they deliver. But in practice, there is…
Natan Tiefenbrun, president for North American and European equities at Cboe Global Markets, and Maria Salamanca Mejia, head of EMEA market structure at Morgan Stanley, unpack the lit order book landscape.
Maria, as a broker what are some of the trends you’re observing in Europe’s lit orderbooks?
Maria Salamanca Mejia
Volumes in European equities have remained subdued in recent years, relative to other regions, and the continuous segment in lit orderbooks has borne the brunt of challenging market conditions as well as changes in liquidity dynamics.
Primary exchange trading as a proportion of lit continuous has fallen from ~70% in 2019 to around 65% today, with participants also embracing other mechanisms including the close, dark venues, frequent batch auctions, and off-venue liquidity. This is reflective of a sharp focus across the board on optimising liquidity capture, minimising impact and reducing costs.
That said, lit books continue to represent an important source of liquidity, and because they are fast moving, it takes sophisticated infrastructure and models to capture liquidity whilst minimising market impact.
From a sell-side perspective, we need to be very attentive to the idiosyncrasies of each offering, and respond to changes very quickly, so of course we need to optimise how we interact.
For this reason, we apply a lot of rigour in how we analyse and access lit continuous orderbooks, taking into consideration variables such as latency, the composition and quality of the liquidity we can interact with, and the structure of liquidity provisions schemes. That allows us to identify the nuances of each order book more clearly.
Natan, how are you helping clients to assess the quality of Cboe’s lit orderbooks?
We definitely see a trend of clients being much more rigorous in how they analyse and access our lit continuous orderbooks. So, we are leaning into that trend with more forensic analysis – not just proving that our orderbooks offer superior certainty of fill, speed to fill, or greater opportunities for price improvement – but going further in two respects:
Natan Tiefenbrun
Firstly – we try to help our participants better understand why our lit orderbooks exhibit these positive characteristics. We do this by sharing more metrics – being careful to select the ones that are relevant to the particular client’s trading objectives – and by being fully transparent with the methodology so that clients can test and replicate our results.
Secondly, we try to help firms improve their trading outcomes by identifying areas in which their trading behaviour – viewed from the perspective of an exchange – is distinctive. Sometimes those distinctions are intentional, other times not, but either way we then try to quantify how those behavioural differences are contributing to a firm’s propensity to capture favourable liquidity on our orderbooks.
Lit orderbooks are a crucial part of the ecosystem – so by helping firms get better outcomes in our lit orderbooks, we hope to strengthen the performance of lit books relative to the alternatives.
Maria, how do these data-driven approaches help you access lit liquidity?
Our approach to venue selection is quite sophisticated, and the research we undertake to optimise our models takes into consideration a comprehensive range of factors.
In our view, it is only additive when venues take an equally robust approach to challenge conventional wisdom and incorporate those insights into the client interaction.
All of those additional datapoints are valuable in the sense they can complement how participants look to optimise their outcomes, and in some cases even contribute to changes in the methodologies underpinning existing approaches to liquidity access.
Natan, how do lit books fit in alongside other market mechanisms, and what are the benefits of operating multiple models contemporaneously?
Clients have different investment and trading strategies, and different liquidity needs. When there are so many ways to trade, we recognise that the best way for an exchange to compete is to offer diverse services that can meet those needs, thereby attracting the maximum possible liquidity into the multilateral exchange ecosystem.
That’s why Cboe has long been a global pioneer in orderbook innovation. Our commitment to innovation and to keeping costs low explains why in Europe we now operate the largest above-LIS block venue, largest dark-midpoint (RPW) book, and largest periodic (frequent batch) auction books. Or in the US market, our innovation means we now operate the leading exchange (EDGX) for passive retail order flow and offer a unique retail price improvement program (BYX) for price-improvement of retail orders.
And we’re always looking for new ways to optimise firms’ access to liquidity – including by making multiple market models easily accessible through a single order type – because this integration of liquidity can benefit all our customers, regardless of what market mechanism they have preferred.
By connecting our orderbooks together we can offer each customer their optimal mix of speed, fill-certainty, size and price improvement. Our most recently introduced “sweep” order allows firms to test first for midpoint liquidity in the RPW book, and then to automatically select either the lit or periodic auction book based on their sensitivities to these factors. We’re seeing some really exciting results from this, with firms who have adopted it doubling their fill-rate at the midpoint – more on that another time!
