What are the key challenges associated with accessing liquidity right now?
Through conversations with buy-side members, we continue to receive feedback that there are two main challenges traders are facing. The first is the continued fragmentation of liquidity across multiple venue types, including some new alternative sources such as direct interaction with market makers.
The second is the lack of orders being worked in significant size during continuous trading and a lack of conviction when opportunities to trade do occur. We’re seeing an increasing need for engagement around the process of finding liquidity and executing those orders.
In our latest Liquidity Landscape report, we highlighted that Q4 2023 saw the lowest ‘on exchange’ notional traded vs. any fourth quarter since 2019, and with only a modest increase on Q3. The closing auction also continues to be a growing area of focus with closing auctions accounting for approximately 27% of the day’s volume. This was the third highest quarterly share since our data began.
While the start of the year has seemed to many slightly busier, the liquidity experience day-to-day can be unpredictable, so the liquidity challenges traders are facing will certainly continue.
What is the top ‘must watch’ area for traders in 2024?
Throughout the last year, there has been a growing focus on the role of risk liquidity, and to a wider extent the position of bi-lateral liquidity relationships in a traders’ liquidity armoury. Increased usage of direct relationships with market makers, who were previously interacting through intermediaries such as broker crossing networks or more latterly as SIs via algos, gives traders different liquidity options. However, these need real understanding as this liquidity is not always available and is not always suitable for certain types of orders or market conditions.
With the technical changes to how SIs can operate in Europe currently being worked on by ESMA, the issue of how risk liquidity is both consumed by buy-side firms, but also distributed by risk desks and market markers, will come into growing focus throughout the second half of the year.
SI liquidity continues to follow its seasonal pattern, with low levels of liquidity seen during Q4. There is also evidence that the average fill size of SI liquidity continues to decrease, confirming the belief to many that this is primarily a source for child-order size liquidity, rather than liquidity that satisfies a trader’s full parent ticket size.
How can market participants navigate rising volatility and trading costs?
Continued pressure on lit trading, and in particular the primary markets, is driven in large part by the desire to reduce impact and lower trading costs. In periods of low liquidity, sourcing liquidity through alternative venue types is key. This is one of the main reasons we continue to see growth in the usage of periodic auctions, with them now accounting for approximately 6% of total volumes. This growth appears to be at the expense of primary market activity as there appears to be a clear correlation between the two.
We continue to see a desire from members to try to trade their parent tickets in larger clips, however doing so is requiring a liquidity discovery process through a service model rather than relying on technical solutions, particularly for the larger executions.
However, through that liquidity discovery process, we have started to see an increase in the number of larger blocks being executed in the market. So far this year, there have been 47 blocks executed on dark MTFs above €20 million in size. This compares to only 10 during the same period last year and it took until the end of May for 47 blocks of that size to trade in 2023.
What role can market participants play in ensuring the trading ecosystem functions optimally?
With more regulatory change on the horizon and liquidity challenges set to continue, it’s going to be more imperative than ever that all market participants work in a collaborative manner. All market participants will need a heightened level of engagement with diverse types of liquidity, different types of firms operating in the market and the numerous industry bodies and regulators we all interact with.
At Liquidnet, we continue to work actively with existing buy- and sell-side firms and are increasingly having conversations with new alternative liquidity providers about how they may contribute to the liquidity network we’ve built, in order to help solve the liquidity challenges we are all facing.