The constantly shifting liquidity landscape is characterised by the availability and ease with which assets can be bought and sold without significant changes in price. Particularly in Europe, we are witnessing shifts in this dynamic, as well as increasingly fragmented liquidity within the region.
This landscape has experienced notable evolutions in recent years due to advancements in technology, increased market participation, and regulatory changes. An understanding of the current liquidity landscape allows traders to optimise their strategies, manage risks more effectively, and make informed decisions in both stable and turbulent market environments. The topic of liquidity and its shifting dynamic has been a key theme amongst the industry at various conference held over the last few months.
Speaking to The TRADE about key themes in this space, Mark Montgomery, head of strategy and business development at big xyt, notes “We’ve had the change in the RTS 1 and 2 OTC trade flags. That as a comment sounds dull, but is actually significant beneath the surface; what’s actually happened is with the FIX community getting involved and the regulators listening, they’ve got rid of a lot of the noise that made-up non addressable volumes in the marketplace.
“The big thing about that is the trades that are going on off-book, off-venue, off-exchange and are not contributing to price formation – i.e. it’s noise, it’s synthetic trades or it’s not actionable or addressable – we’ve seen evidence of a big decrease in that and we’ve also seen within that, some more specific and better flagging of trades that have particular characteristics.”
Montgomery went on to add that benchmark trades, which might be a program trade benchmarked to something or a trade that was a bit vague beforehand, are experiencing more specificity around the flagging and the reduction in noise.
“One of the challenges within all of this is you can see percentages swing. Because OTC was so big, it makes the growth in some of the other mechanisms maybe look disproportionately large, but in value terms, we’re going to have to look a little bit deeper and see what it means for the subcategories,” adds Montgomery.
Electronic liquidity providers
Another key theme highlighted by Montgomery is the bilateral liquidity provision being offered by electronic liquidity providers. He notes that these providers “were previously providing liquidity to the markets in a way where they interacted with the exchanges and they were known to certain people in the community, but not everybody. However, today, we see ELPs more active and vocal about their provisions and what they offer.”
Speaking to The TRADE about the evolving nature of ELPs in relation to the buy-side, Anish Puaar, head of European equity market structure at Optiver, adds: “We’re seeing more interaction between buy-side firms and ELPs in equities, be that directly or via SIs. The liquidity on offer from ELPs is another channel that the buy-side can look to use alongside other execution options.” Optiver currently connects directly to the buy-side via execution management systems (EMS).
“As with all participants, we believe it is important for ELPs to be open and transparent about how they provide liquidity. As buy-side-to-ELP interaction grows, it’s important to make sure the nature of these interactions is well understood,” says Puaar.
Reporting
Elsewhere, Montgomery discussed the nature of reporting from ELPs in relation to the SI mechanism. “It seems like ELPs are not necessarily reporting their trades in the way that we expected, which is through the SI mechanism, because it would seem to be systematic and a risk price. But actually, they’re doing it through a waiver through off-book (on-exchange) in certain cases,” he says.
What this means is there’s an interesting shift in risk provision and risk transfer in the marketplace.
“If I’m a buy-side firm and I want to suddenly trade, rather than trading agency through a vanilla VWAP algorithm, I’m suddenly trading on risk,” adds Montgomery. “This could either be in a block or throughout the day with a risk counterparty where I’m giving away a little bit more information to somebody who can do more in terms of price movement, in terms of access to other markets and other venues with that information and with that flow.”
This could ultimately result in a shift which could be taking place away from the bank risk desks and into the ELP risk desks. Montgomery explains that that is “something that the banks will be watching very carefully, and I think it’s something that the ELPs will be looking to see how they manage that risk.”