The growth of bilateral trading has caught the attention of many industry participants in the last year, spurring intense debate at many industry conferences. While the concept is by no means a new concept – banks have offered the buy-side bilateral connections to their central risk books (CRB) for years – in the last 12 months, the segment has grown massively and subsequently found itself under the industry’s lens thanks to a few key alternative players championing new ways of directly connecting to the buy-side.
According BMLL Technologies data, bilateral trading accounted for 35% of overall notional traded as of November 2024, including request for quote (RFQ), off-book on-exchange, over the counter (OTC) and SI volumes both above and below the large in scale (LiS) threshold. This marks a 12% increase since January 2021.
Defining what falls into the bilateral sphere is important. Regulators in the last few months have been attempting to clean up reporting flags in a bid to offer greater transparency to participants looking to better understand the landscape.
One of the most notable bilateral growth stories, however, is that of the off-book on-exchange segment. This umbrella term again accounts for a whole host of things including retail flow and high touch agency crosses. Cboe and Aquis’ new VWAP offerings will also print their flow as off-book on-exchange for example.
Central to the growth of the off-book segment and perhaps responsible for ruffling the most feathers is a relatively new workflow whereby non-bank liquidity providers quote directly to the buy-side via their execution management systems (EMS) leveraging actionable indications of interest (IOIs). It’s this new growth among other areas that has attracted notable attention from the industry and sparked new offerings from the more traditional players looking to preserve their market share.
The benefits of streamlined buy-side workflows are clear: offering better price improvement, reduced market impact and time to market and greater flexibility around liquidity access. What’s more, with volumes on the lit market continuing to decline, one can hardly blame traders for exploring alternatives to traditional workflows.
That being said, the bilateral segment is becoming increasingly meaningful with both alternative and now traditional players exploring new workflows, and some participants are now beginning to question whether such a level of bilateral trading exists that could be detrimental to the market’s long term health. Some participants have even begun suggesting that the European equities market could find itself on track to adopting an almost completely off-exchange foreign exchange model in the next few years if it continues on its current path. However, this eventuality is highly unlikely. Said bilateral workflows rely heavily on a reference price from the lit markets. Ironically, the thing that stands to be damaged if too many volumes move off-exchange.
For buy-side traders, the appeal of executing without going out to market is – understandably – hard to resist, but the question as to whose job it is to now moderate the level of bilateral liquidity in the market is now somewhat continuously being asked.
“I can understand the appeal to a buy-side trader thinking ‘I can clear my entire blotter with one click of a button so why don’t I do that and not have to worry about direct market impact?’,” explains T. Rowe Price’s equity trader and market structure analyst, Evan Canwell.
“There’s definitely a place for bilateral liquidity, but it’s incumbent on us as the buy-side to understand what we’re interacting with and think about the balance. It’s like fast food, it might feel good in the short term but there could be unintended consequences for the longer term health of the trading ecosystem.”
Non-bank providers
One of the most spoken about names in this context is, of course, Optiver. While the firm is not solely responsible for the growth of off-book on-exchange, the market maker’s model of connecting directly to the buy-side via EMS has taken the market by a storm. The firm’s model is risk filling but without acting as a systematic internaliser (SI).
“It [bilateral trading for blocks] never really took off as a product whereas the way I look at the more recent developments in bilateral liquidity, it’s for a lower liquidity demand which does feel more sustainable,” says Legal & General Investment Management’s global head of trading, Ed Wicks.
While historical bilateral connections with other alternative providers – namely XTX Markets – have historically been more focused on smaller flow, Optiver’s model offers the opportunity to trade blocks of 5-20% of average daily volume (ADV), The TRADE understands. And it’s this element that has piqued buy-side interest. It’s easy ‘fill or kill’ model means traders don’t have to go out to market in order to execute, simplifying workflows and reducing market impact.
“The liquidity provision workflow can be a useful tool, especially given the recent record lows of lit liquidity. If you can get done and risk filled, there’s an efficiency to that,” says Hayley McDowell, EU equity electronic sales trader and EU market structure Consultant at RBC Capital Markets.
It’s this efficiency that has seen the buy-side continue to use this model of trading to execute flow. According to BMLL Technologies data, as of November 2024, off-book on-exchange constituted 58% of all bilateral trading activity – around €376bn – evidencing how attractive this model is to firms in comparison with multilateral venues and platforms in the lit markets.
“If I see a workflow solution that is potentially saving costs for funds and ultimately delivering good outcomes for clients then we have to evaluate it,” adds Wicks.
“For us, it’s [bilateral] more of an efficiency workflow tool for the lower liquidity demand orders or baskets we have. We consume the feed into our EMS so when an order hits our desk we can see straight away whether the whole order can be fulfilled by the bilateral liquidity. Not having to declare anything is an asymmetric benefit to us because we can see whether that liquidity can be fully filled on a fill or kill basis.
“If we were to go into the secondary markets utilising a liquidity seeking algorithm that would have a cost relative to trading at midpoint on the bilateral feed. For a subset of our flow from a cost perspective and an efficiency perspective it makes a lot of sense to us to utilise that bilateral liquidity.”
In light of the growing bilateral sphere, agency brokers such as BTIG and Redburn Atlantic have also been busy launching services that aggregate and streamline liquidity from alternative and electronic liquidity providers (ELPs) and connect the buy-side with them via an EMS or via a custom algorithmic strategy, all with the aim of easing the strain on the buy-side by channelling liquidity to them via one location.
“Traditional liquidity aggregation is not an option when trading bilaterally, but connecting clients to multiple competing quotes – on a fill-or-kill basis – via a single access point saves them time, limits selection bias and increases overall hit rates,” head of trading and algorithmic solutions at Redburn Atlantic, Phil Risley, tells The TRADE.
“The challenge in optimising the approach to principal liquidity, is to balance the ELP’s need to understand the profile of the flow with which they interact and the requirement to minimise information leakage.
“Ultimately, the goal is to create a virtuous cycle, with high quality flow incentivising larger and more consistent quotes – aligning interests and ensuring everyone wins.”
Redburn’s offering claims to tackle issues around market impact by operating under a fill or kill basis. Each client order is matched immediately in its entirety with a single ELP or not at all. It is directly available to the buy-side with qualifying flow via their EMS as a custom algo strategy. A spokesperson confirmed that the firm is speaking with all of the major non-bank SIs regarding onboarding. The ELP liquidity is not aggregated but available from a single point of access.
BTIG’s offering currently takes in live streams from three ELPs. Based on client preferences, it streams the best quote into the buy-side client’s EMS. A source has confirmed that the number of provider partners used by BTIG is growing.
Said quote can be anything from mid to far point liquidity in different shapes. If the client wants to interact they click to instantly execute or use OMS automation. The client then faces BTIG for settlement so there is no additional onboarding required.
The client has the choice whether to remain anonymous or allow ELP to profile them which may result in tighter pricing. This offering is also available via BTIG algos which for some buy-side clients may fit workflow better with wheels.
Traditional banks strike back
Given the growth of market share seen by these alternatives, the market has also seen a wave of new interest in this area by the traditional banks as they look to maintain their market share and retain commissions.
Major sell-side have offered systematic bilateral liquidity for years now but the practice hasn’t seen mainstream adoption for several reasons. Historically connecting bilaterally to a CRB for example has always been seen as a bit of a blind play as you don’t necessarily know what else is in there. The services for blocks have typically also only been on an ad hoc basis for banks’ larger clients.
“The evolution of IOIs being sent directly to client EMS’ is a net positive and opens up further trading opportunities and importantly enhances workflows, particularly when offered alongside a robust TCA process to help manage the challenges of longer term parent level impact,” explains Goldman Sachs’ managing director and head EMEA electronic and program trading, Alex Harman.
“This year we have been working with the major EMS’ to utilise actionables to deliver liquidity in several products; blocks, IS and close benchmarks. Expect to see a lot more from us here in the future.
“Our systematic GMOC product was the first of its kind and remains a heavily used product as part of our close benchmark offering. More recently we launched our DTC Stealth product, which is a tactic within our SOR that leverages dedicated liquidity from our systemic internaliser, plus other non-displayed liquidity with the aim to fully fill parent orders.”
With alternative players now targeting larger flow, major sell-side are looking to create their own direct connections via EMS providers in order to compete in a second wave of the bilateral evolution.
“I know several [big banks] are building aggregators and liquidity workflows that try and mimic some of the bilateral features. Whether we see a pure bilateral product from the investment bank similar to what we see from the alternatives I still don’t know if that will be the case,” adds Wicks.
“More traditional liquidity providers like the investment banks are now looking at it with some degree of urgency to try and insert themselves into that workflow. I don’t know how many more [bilateral offerings] we would need frankly but we will look at them when they come.”
Fast food?
With both electronic and alternative players cementing their workflows and major sell-side looking to follow suit, the bilateral segment is becoming extremely meaningful for both the buy-side and the wider market. And this meaningfulness is what’s raising some eyebrows. With the proposition now irresistibly attractive to the buy-side, the longer term impacts are now being assessed.
“The issue comes if too much of your flow goes that way,” says McDowell. “It can also impact on-venue liquidity. If has a trader has a large order on the pad, they might go to an ELP first, then maybe an SI, before going to the order book last.”
Given the existing decline of lit, this natural evolution – and it is a natural evolution – has the potential to become a bit of a self-fulling prophecy as spreads and toxicity increase in the lit market.
“Most buy-side firms and a lot of market participants would recognise that it’s in most people’s interests to make sure that lit markets remain a functioning viable part of the market,” concurs Wicks.
Traditional sell-side bring with them whole swathes of other auxiliary services that are bundled with their services across settlement, payments and research to name a few. Electronic and alternative liquidity providers do not provide these extensively and their services are usually limited to the execution side of things.
“Longer term, if we end up with a large part of the market trading bilaterally then we may start seeing impacts elsewhere – for example, will traditional brokers start reducing resources in other areas to focus more on liquidity provision?” Asks Canwell. “Will we see reduced price formation and greater toxicity on-exchange if smaller orders end up in bilateral mechanisms?”
The role of the regulator
The question now being asked by many is: what is the role of the regulator? Some participants are asking whether it is fair that some market makers should be able to risk fill clients without operating as an SI and the associated pre-trade transparency.
Ultimately, given this is the natural evolution of where the market is heading, it’s hard to see an eventuality where regulators would step in to prevent it. Famously, regulators tried to tackle decreasing exchange traded volumes with caps on dark trading in Europe during the Mifid II Review and the multi-year tug-of-war esque saga that achieved an arbitrary result of deleting the 4% and 8% double volume caps (DVCs) in favour of a single cap of 7% has largely been criticised as a waste of time.
“If they [regulators] think too much is being done off-exchange and there’s not enough price formation on-exchange, potentially I could see them stepping in,” says Canwell. “One area where there might be more regulatory scrutiny is around the closing auction because there’s a lot more being done off the primary closing auction in recent years.”
One area regulators should and are looking to change is around transparency. Reporting flags were one such area that was focused on by both UK and European regulators in April in order to simplify the regime and try to understand a bit better where volumes are being executed within the market. The concept of what is addressable and what is not is something now being explored by participants and regulators and could result in further probing from watchdogs.
“Reporting changes had a profound impact on the liquidity landscape. It was confusing before and a lot of the flags didn’t necessarily make sense. There was a lot of repetition and noise,” says McDowell. “Traders are looking for more transparency in the off-book space. Some participants are using “off-book” as a means of printing activity, but peers and clients are unclear about exactly what off-book on-exchange is.”
All roads lead back to the consolidated tape. And there is, of course, the likelihood that we will have a consolidated data source in the next decade (fingers crossed). This will also bring with it extensive transparency that will help both participants and regulators alike to better understand and interpret the market picture around percentages of liquidity accounted for by different segments. Given how participants and regulators alike are turning their attention to the addressability of flow, it may even be a worthwhile venture to do an independent analysis of how stable pricing is in Europe.
“The market structure needs to respond to this change in dynamics and central to this is the delivery of a consolidated tape in both the UK and EU so all market participants can understand what liquidity is available where,” said Eleanor Beasley, EMEA equities COO and head of market structure at Goldman Sachs. “Understanding the different mechanisms leveraged to deploy bilateral liquidity is important as is understanding where this volume is printing.”
The growth of various different trading workflows that fall under the bilateral umbrella is undeniable and certainly something that participants and regulators alike should be keeping tabs on. Whether or not it’s something watchdogs should intervene with is another matter. Bilateral liquidity only works to a certain size. There will always be a portion of the market that requires public markets and going out to find the other side.
The market’s natural evolution is what it is. If these providers are offering buy-side traders an attractive service, who’s to say it is wrong or right? Perhaps as Canwell noted earlier the onus is on the buy-side to steer the market in the “right” direction.
However, when an order hits the pad, it’s rare for a trader to sit back and think about the wider long term market implications instead of whether a workflow will achieve the desired best outcome for their trades and subsequently their clients. On the current trajectory, our markets are likely set to look fairly different in the next five years. Whether that’s wrong is one for the philosophers that walk among us.