More than 25% of buy-side firms are currently sending more than 10% of their flow directly to market makers, a recent survey conducted by Optiver in partnership with The TRADE has found.
The burgeoning relationship between the two sides demonstrated by this insight was an almost unheard-of phenomenon a decade ago, prior to the introduction of Mifid II in 2018.
Ben Smith
Speaking to this trend, one global head of trading at a large French asset manager respondent to the survey asserted that this activity represents an initial step in a longer journey: “The trend [of trading directly with market makers] started specifically in the ETF market but our goal is to develop step-by-step in other assets like options, bonds.”
Read more: Buy-side agrees market makers will lead ‘new era’ of liquidity
European equity volumes have been stagnant in recent years. In 2023, traders saw little in the way of improvement of liquidity conditions – the average daily value traded fell 16% from 2022, the lowest in a decade.
With this in mind, Evan Canwell, equity trader and market structure analyst at T. Rowe Price explains: “With lower volumes across Europe, it’s not surprising to see buy-side firms establishing direct bilateral relationships with market makers, especially in the area of systematic, cashflow trades containing no / low investor alpha.”
Broker lists growing
However, the survey also found that despite these low volumes there was also noteworthy, and arguably surprising, developments in the broker space, where 40% of respondents confirmed plans to increase their cash-equity broker lists over the next 12 months.
While 36% of those surveyed responded that they expect their cash-equity broker list to stay the same over the same period, just 24% stated that they foresaw a decrease.
Delving into this, size understandably played a role. While most firms confirmed they keep between 10-20 firms in their broker roster, 30% of the largest buy-side firms trade with more than 50 counterparties.
Following the introduction of Mifid II the market saw a reduction in broker lists, with one study at the time reporting that more than half of UK fund managers reduced the number of brokers they engage with, within just four months of the new regime. However, this approach is demonstrably no longer the state of play.
Read more: MiFID II sees more than 60% of UK-fund managers reduce broker lists
Echoing this in his response to the survey, Ben Smith, head of trading at Independent Franchise Partners, stated: “Thinking back to Mifid II, we expected to shrink our broker list a little once the dust had settled. In truth, that never really happened, and, if anything, the list has grown modestly.
“On the electronic side, we’ve found that brokers have their own niche when it comes to liquidity seeking, dark aggregation, and interacting with the close. In terms of high-touch, liquidity has become so challenging in Europe that having more connections and options is now vital.”
Trading strategies evolving
Elsewhere, The TRADE and Optiver’s report unpacked changing trading strategies in the face of a 35% decline in the volume of trading on displayed markets. As a result, more trading occurred in dark pools, periodic auctions and off-exchange markets, the survey found.
The report explains that lower overall volumes coupled with subdued volatility is likely to have contributed to the decline in lit volumes.
Traders become increasingly concerned around causing market impact by exposing orders to lit venues during quieter market periods, leading many to opt for dark markets or bilateral liquidity sources.
Amidst this landscape, traders identified implementation shortfall (IS) as their preferred benchmark, with two thirds of those surveyed confirming it is used “fairly often” or “most frequently”.
These findings show a clear market preference for IS as it has continued to slowly but surely overtake VWAP as the benchmark of choice. In addition, the close has seen significant growth, due in large part to the increasing number of passive funds that use end-of-day prices as a benchmark.
Among the key buy-side trends explored in the survey conducted by Optiver and The TRADE was the development of more advanced transaction cost analysis (TCA). When asked what impact improved execution analytics would have on the trading desk, 81% stated that it would have ‘some’ or ‘significant’ positive impact.
Read more: A TCA wish list for the buy-side
Specifically, The TRADE’s survey found this especially true when it came to real time TCA, a key industry talking point over the last couple of years. Almost 35% of buy-siders highlighted that real time capabilities would most improve their transaction cost analysis processes, closely followed by almost a third who highlighted the importance of an increase in the number of data points.
Market structure concerns
On the topic of data, there’s of course a lot to unpack across the buy-side, with the survey finding that data fees and consolidated tapes (CT) top the list of market structure concerns.
Specifically, when asked which market structure and regulatory topics would have the most impact on their firms, a third of the buy-siders responded that lower market data costs would be most impactful, followed by almost 50% who highlighted the CT.
There has been a historical lack of a consolidated data source in market, alongside a monopolistic environment when it comes to venues and execution platforms. Owing to this, buy-side firms have regularly been charged high fees for valuable transaction data – to which they have contributed – essentially paying to buy back their own data. One answer to this problem is of course the hotly debated notion of a consolidated tape.
The European Securities and Markets Authority (ESMA) expects to authorise a consolidated tape provider for bonds in 2026, while the UK Financial Conduct Authority (FCA) has effectively met its commitment to have a regime for a CT in place by this year.
The consolidated tape issue, on both sides of the Channel continues to be analysed, however the emerging consensus appears to be that, in the end, together is better.
As Smith explained: “We think that Europe would benefit greatly from a consolidated tape. Foremost, it would serve as baseline and help to democratise access to market data. Importantly, it would make Europe appear more as ‘one market’, hiding away some of the complexity of its market structure that has become anathema to global investors.”
Read more: If you build it, will they come? Does data hold the key to a healthier market?
“The topic around the consolidated tape makes sense for us and we consider that it’d be helpful to enrich any database, to increase transparency and to capitalise on this to deploy more robust AI models around execution,” added a global head of trading at an undisclosed large asset manager.
The TRADE’s European cash equity trading survey included insight from 225 buy-side traders, including a significant number of active asset managers and private banks.