McNiven: Following on the expansion and growth of China Connect for easier foreign investor access to China’s mainland “A share” marketplace, there has been a steady decline of foreign activity in both China Connect and Hong Kong from the peak that we saw in 2021. Hong Kong volumes were down 68% in 2023, compared to 2021. During this time, we’ve also witnessed the beginnings of a large resurgence and keen interest in Japan, attributed to its strong corporate earnings and governance initiatives.

Notably, on 9 January 2024, Japan revived itself to a 34-year high with the N225 Index surpassing the July 2023 peak. Additionally, India in particular over the last two years, along with Korea and Taiwan market turnover has risen. India is largely a growth story with strong prospects and a drastically expanding domestic interest in the equity markets.

Aside from pure market volume and index performance over the last few years, it’s been amazing to see the patterns in ETF inflows and outflows over the same period, particularly in the iShares MSCI Emerging Markets ETFs. Specifically looking at Emerging Market ETFs, you can observe the overall trend of inflows into iShares MSCI Emerging Markets ex China ETF, slowly growing over the last few years. This coupled with a drastic and sharp outflow of the iShares MSCI Emerging Markets ETF, including China, since 2023 through the start of this new year. These are all just a few of the trends that end up creating a dynamic and disperse equity trading landscape.

Within Asia Pacific, where are you observing the most emerging growth and equity expansion? How is this evolving?

Redbourn: As touched upon earlier and showcased below, the emerging market landscape displays a large move away from China by the international MSCI client base, and toward India. In the chart below, you can see the China allocation hit a peak in 2021 at 25% and has since fallen to 17% in 2023. This is nearly the opposite when you look at India’s market weighting, which has been steadily growing and has even doubled in the past few years.

This has further elevated the international client interest that we are seeing in India, especially in the electronic trading space, where we are well-positioned to harness our collaborative Global Execution Services (GES) capabilities onshore and expand our client coverage team. Additionally, our algo development teams have been making enhancements to our underlying platform infrastructure and fine tuning adjustments to ensure that we adapt specifically to the algorithmic challenges and nuances of India and its volume profiles.

McNiven: There are also promising developments taking place in Singapore from a location perspective. We have seen more buy-side growth occurring there with trading desks becoming more regionalised and some traders migrating there under new entities. There are also new Asia Pacific trading desks being launched and staffed as part of brand-new regional office openings. We’ve similarly adopted a larger footprint in Singapore prime to tackle the trend with key members of our leadership based there, including not only Jimmy, our head of electronic trading, but also our head of high touch sales trading (AEJ), along with a senior and growing coverage team.

How has adjusting to this liquidity trend caused shifts among both the buy-side and sell-side?

McNiven: The Asia Pacific equity markets are continuously evolving with each unique market microstructure and the various dynamics of the marketplaces. India in particular has seen changes due to domestic retail and domestic investors, but also with regard to issues surrounding quote to fill times, how blocks are executed, the lack of a closing auction, and exchange sponsored iceberg order types. As mentioned before, all of these aspects invite deep dives into algorithm logic and continuous consulting  engagements with clients. Additionally, for Japan’s rise, which also happens to be a market where dark pools are prevalent, we’ve seen a more granular approach to dark pool executions, counterpart engagements on fills, and fill mark outs, than we had in prior years – and with a wider breadth of participants.

Redbourn: We have seen a shift in a larger breadth of clients on the buy-side becoming more active in the microstructure nature of equity trading, from measuring quote to fill times in markets and algo reactions, to deep analysis of Nomura’s NX dark pool in Japan, and the counterparties and mark outs involved. Thankfully, a lot of these microstructure and minutia areas to equity trading in Asia Pacific are also areas where we thrive in providing value for our clients and we enjoy communicating on these topics to more participants. At Instinet, the quantitative trading services and execution consulting teams are a strong part of the coverage model we have developed to ensure we are providing our client base with what they need.

How do issues around fragmentation of the marketplace in Asia compare with those faced by Europe?

McNiven: The Asia Pacific equity marketplace is more regionalised and country centric than the EMEA region. Each country in Asia Pacific’s marketplace has distinct trading market microstructure characteristics. These characteristics evolve with changing investor sentiment and domestic investor impacts in particular, as we’ve seen over the last four years.

The chart below illustrates two main points. One point, is that the cluster of EMEA markets with consistently low spreads and patterns is aligned, compared with Asia Pacific’s much higher average spread costs across all countries. The other point, is that the spreads in Asia Pacific at a country level are changing over time.

Redbourn: For example, Hong Kong’s cost of trading has increased on the back of higher spreads, lower volatility and volumes. Meanwhile, Korea’s spread has interestingly come down slowly over the course of 2022-2023 as the Regulator has tightened short selling, making the potential for foreign quant clients harder as a participant in the market.

How is Instinet providing clients with the right tools to perform? What is unique about Instinet’s  solutions that differentiates it from other offerings in the market?

McNiven: As diversification at the country and individual stock level continues to rise, having a ridged tier or cluster profile may not always be best, especially as changes can happen on any given day and within individual countries and sectors. As we continue to solve for our clients evolving challenges and help them perform, we leverage our dynamically updated Micro Adaptive Sequencer (MAS) platform that allows us to be highly efficient, nimble, and responsive to client specific needs and requirements. With machine learning capabilities and dynamic optimisation built in, MAS is a model that also runs on a real-time basis. It sits on top of multiple tactics and determines key inputs like scheduling, profiles, and aggressiveness by utilising multiple factors – which can vary from client to client. It’s a framework we’ve built not only to drive performance improvements, but also support responsiveness to client-specific objectives and flows. With MAS, we can organically include historical observations and real-time overlays, using machine learning based models to combine the inputs into a cohesive instruction to an underlying algorithm for our clients.

There are unique values with MAS, some of them being that it considers all trading constraints and components (not just simply price or volume predictions), and it is continuously optimising based on a stock-specific live time component where not only results of fills, but predictions on different factors faired – are set for the next set of trading events. As we mentioned prior, clients have become more interested in understanding volatility and spread pattern changes, and we have spent time bringing more transparency to them on the results, as well as – importantly – simplifying what factors are included in the optimisation, and how the continual process works.

As sourcing quality block liquidity remains one of the most critical challenges for clients trading in Asia Pacific, a significant priority for Instinet is the further expansion in the region of our electronic crossing platform, BlockCross. We successfully launched in Hong Kong and ASEAN last year and will be going live in Japan and Australia shortly. The seamless blotter-integrated access to Instinet and Nomura’s depth of differentiated liquidity inside our dark pools, respectively Instinet BlockMatch and Nomura NX, has driven strong uptake from clients who are keen to execute sizeable blocks, efficiently and anonymously. Next up on the rollout, are the ID markets. Ultimately, all of the tools and innovations we develop at Instinet are focused on delivering value for our clients with quality execution outcomes and performance, wherever they are based or trade.

The post Exploring recent liquidity shifts and the regionalisation of trading in Asia appeared first on The TRADE.

Rodriguez: Looking at the overall market environment, volumes are at multi-decade lows, with the exception of APAC, which drives a strong need for market participants to keep finding new ways to do more with less.  It fuels an ongoing pressure in the marketplace to review and reduce the operational costs of trading.  Both the buy- and sell-side are being impacted, whether it relates to market data, FIX connectivity, or rising exchange fees.  Additionally, with the US move to T+1 happening this May, you have to wonder when that change will be coming across to Europe next, delivering further impacts to global asset managers. Adjusting for that will bring another set of associated costs along with it.

Europe: Record lows

Source: Bloomberg

US: Off a record high hit in 2022. Current turnover is 3X 2013 levels.

Source: Bloomberg

In terms of the trading day, the Close is the most expensive time to trade because the primary exchanges capture the vast majority of this flow and hold the closing price benchmark.  Incredibly, since 2016, the Closing Auction in EMEA has grown, from about 15% of a total day’s volume in the region, to more than 30% currently.

The pricing structure from the incumbents makes it even more expensive. So, the more the Closing Auction grows, the more expensive it is to trade in that way.  In turn, that means participants are thinking about alternatives, where perhaps they can internalise that flow or use other venues.

Proportional Volume on the Close: Developed Europe vs Emerging Europe

Source: MSCI, Instinet

With our microstructure analysis team, we also strive to keep clients closely informed on auction trends and execution costs by generating monthly publications focused on these areas; The Global Auction Monitor and The Global Execution Cost Monitor.

The Global Auction Monitor is a monthly global microstructure analysis report that focuses exclusively on auction trends for each country in the MSCI ACWI index. More simply, it is an interactive tool that helps quantify auction volume trends across global markets. The Global Execution Cost Monitor tracks liquidity, bid/offer spreads, volatility and estimated market impact for each country in MSCI ACWI.

Whelan: If you pull the lens out and think about what the market has been like, for both the sell- and buy-side, you have a higher interest rate environment, you have geopolitical concerns, and you have regulatory hurdles. Those have all hurt revenue streams for the banks, in areas for instance, like M&A.  When revenues are under pressure, it’s natural for businesses to look more closely at their costs.  The equity trading environment is just one area that has been challenging on the revenue side.  We are also seeing firms on the brokerage side being more selective about their own areas of focus and there are signs of retrenchment from some around what capabilities they are able, or willing, to invest in. Ultimately, this can lead to impacts on the innovation space too.

From a vendor perspective, outside of direct regulatory costs, we also see standards increasing around how a business and its technology should operate.  This is most evident in the increasingly formalised process of vendor reviews, where the bar keeps moving higher on the due diligence applied to topics like BCP, disaster recovery, data use, and information security. There are costs that come along with all of that.

How is this impacting technology use/automation levels/algo usage on the buy- and sell-side?

Rodriguez: Cost is a big barrier to entry. It’s multiple tens of millions of dollars yearly to invest in a technology platform, an algo stack, skilled personnel, and quant know how. Against the backdrop of challenging market volumes, you might get to a scenario where smart order routing methodology and logic is adjusted to re-calibrate and account for cheaper options. It makes you think about what that does in terms of impacts on best execution outcomes.  Recently, we have seen more brokers looking at delivering on internalisation, seeing how they can internalise their flow.  It could be through central risk books, or systematic internalisers (SIs), or a crossing mechanism.  Some of the bulge bracket firms facilitate order flow from balance sheets, via their SIs or central risk books. We’re seeing more and more of that and many are going down the path quite aggressively. 

In a best execution environment, there are a lot of algo broker performance evaluations conducted, both on the buy- and sell-side. Therefore, an additional investment requirement has to be made in quantitative staff that can help support that business. Sell-side firms have historically always provided execution consulting and quantitative input and services to clients.  More recently however, the trend has been for buy-side firms to employ their own people that help them evaluate their brokers and the quality of execution provided.  These individuals help in the broker evaluation process, examining how they interact with the market and how they perform. This all brings cost onto the business and the more complex it becomes, the more the requirement grows to have specialists in those fields.

Whelan: With the buy-side, automation is the obvious enabler for doing more with less and keeping costs of the trading desk low.  Over the past ten years or so, the level of sophistication has grown among the bigger buy-side firms, which were first to begin down the automation path. But, we see that smaller and mid-size firms are continuing to adopt automation too, a first time for some.  In terms of cost for the sell-side, we deal with a lot of RFP’s where management is taking stock of the different platforms they have. A lot goes into those conversations, outside of cost, in this environment. In some instances, when a business is doing a broader review of their capabilities and operations it can lead to significant changes in their business model, with that, new technology requirements often follow.  In times of cost saving, we find that businesses are a bit more open to discussions around vendor selection and assessing the wider marketplace. It drives more energy around the review process.

How is it impacting the way the buy- and sell-side interact with one another?

Rodriguez: On the sell-side in particular, “juniorisation” of coverage staff is a factor impacting interactions with the buy-side.  Being able to make new hires is a good thing but it can have some unintended impacts on the existing relationship and interaction too.  Concentration of broker lists is another factor; Is it healthy for the market to only have very similar counterparties? Since there is always discussion about the positive impact diversity has on other aspects of our lives and the general well-being of the ecosystem, perhaps we should therefore apply a similar mentality towards maintaining a diverse landscape in capital markets.

Potentially, rising costs can also have detrimental impacts on innovation and investments in growth.  It could make the difference in whether a firm invests in things like AI or ML. If all a firm can manage to do is satisfy regulatory and risk requirements but not innovate and stay relevant, then they could potentially find themselves becoming obsolete very quickly. That ability to remain relevant is the big challenge. 

How is this driving trends such as outsourcing? In which areas are clients most keen to outsource and why?

Rodriguez: In some scenarios, firms have come to us saying that they need to decide whether or not to invest in building and maintaining a platform or look at third party solutions, which is where a firm like Instinet comes into its own. It’s about having consultative, open and frank conversations with clients and finding out what benefits of scale exist. We’ve been the beneficiary of many of those types of discussions.

It’s challenging for clients because of the costs of maintaining the business. Our Agency Clearing and Settlement Services offering actually came about as we were exploring ways of reducing our own costs as a firm. Now we extend the service to our clients too, as a way to help them reduce their cost, which is a concrete example of the benefits of scale.

Whelan: With regard to outsourcing, frequently when you evaluate the buy versus build trade off, it’s the value-add portions of a business that are more likely to be insourced with technology, whereas the less critical portions of the business and their supporting technologies tend to be outsourced.  For instance, a research provider may outsource their algorithmic platform.  A regional broker dealer may build their own algorithms for their local markets where they have scale and market share, but outsource the rest of the globe.

Preparing for the implementation of T+1 in the US, has posed another great cost for the street. It’s been a catalyst for many of the outsourcing discussions we’re having with clients. We’ve been encouraging firms to use this time to automate any of their manual pre-/post-trade processes that could delay their T+1 settlement.  At Instinet, we already process thousands of transactions daily with T+1, and even T+0, settlement cycles per client requests. Midway, our proprietary middle office system, is geared for it and we are offering it on a white-labelled basis for brokers to manage allocation processes and connections to CTM, FIX, etc. It’s an example of how we are taking the robust tools we use internally to run our own business and making them available outwardly.

The current cost backdrop forces the rationalisation of business models or at the least, some reflection on how you run your business. Some firms might retrench to some extent   For example, if you have previously been expanding into new areas, you might be keeping the focus on your primary markets now. There are some business models where a firm wants to be all things to all people, but I think there are plenty of others out there that say, “We are choosing to be really great, just at these certain things – our bread and butter – and we’ll either outsource or do away with some of the other parts.” More firms are looking to have those sorts of discussions with us and we can provide a broad range of solutions from OMS/EMS through to clearing and settlement, or just the aspects they need.  It’s about providing a broad holistic offering.

Main reasons for outsourcing

Source: The TRADE, 2023 Outsourced Trading Handbook

What role is cost saving having on consolidation and the provider landscape and what impact is this having on competition?

Rodriguez: We’ve seen a lot of consolidation recently, whether it happens because a firm is struggling or because the acquirer sees an opportunity to add to their own toolkit and service offering. The point is, if this continues over time, it could potentially reduce competition and the number of service providers that the investment community can choose from, which is not necessarily a good outcome for the market at large. The question is, what makes certain firms succeed? Those that succeed tend to have scale and diversification of revenue streams. Breaking through is tough so you need to provide high quality execution, service, access to liquidity, find your niche, and all the other things that come with that; those that don’t, will find it harder to breakthrough. It’s the market dynamic, it’s competition, and in essence, it’s the nature of capitalism. You could call it ‘Darwinism in action’.

Whelan: Speaking from the OMS/EMS point of view, clients have a degree of angst around consolidation as it can prove disruptive to the relationship if it affects services levels, commercial expectations, and key personnel.  We have seen consolidation create a catalyst for reviewing the incumbent and opening the door to competition.

Our Instinet Technology Solutions (ITS) business model is about looking in the mirror and saying, “We have a cost base that largely exists to run our global execution business at scale and the costs associated with coming out of the gates every year for it are growing – across regulatory changes, exchange mandated changes, and general R&D so, let’s identify ways we can introduce revenue streams by offering the optimal tools we’ve been using for our own internal consumption to run that business and put them in the hands of our clients to help them perform.”  In that light, we are making meaningful investments year in and year out.

The post Remaining competitive under the pressure of rising costs appeared first on The TRADE.

Rodriguez: We have seen the rate of change in the landscape moving at a faster pace than ever, not just from the product perspective but overall, and getting more complex.  Considering UK versus EU venues, there is a diversification of venues, but within that, there are also variations in how people engage and interact.  When there are two different brokers trying to access the same opportunity, those brokers will choose different methods to get it. The challenge is ensuring that you have the best and latest kit to be able to access the liquidity and succeed. Two of the most important factors in achieving that are broad and efficient access to liquidity, while also having the highest quality of execution. The current market backdrop is challenging in EMEA and exchanges are continuously trying to reinvent themselves with new order types and functionality to try and gain market share. So, we engage with them regularly and they let us know how we can calibrate our interactions to potentially achieve better outcomes.

That said, algo usage is evolving and clients have become much more involved in understanding their order performance.  So, our discussions with clients have become increasingly focused on how we understand their particular workflow, their bespoke universe, and what they want to achieve.  Clients can access execution consultants and quants on the trading desks at the bigger houses for assistance with various selection tools and methodologies but we also think it’s important that they measure, evaluate, and re-calibrate their engagement with brokers around the information they receive.

Laturkar: We see a similar progression in the Americas. Demand is indeed evolving faster than ever, with a steady shift towards electronic execution for the majority of our client base. Over the past several years, we have seen an increase in the level and sophistication of engagement here from our clients on broker algos, their behaviour and performance across multiple types of workflows. And while this is certainly true of our larger clients, we are also seeing increasing adoption across the broader swath of our client base. Algos are being leveraged more as execution focused performance tools, rather than just workflow tools and requirements differ across clients and client types. Trading objectives, workflows, intraday alpha expectations all vary quite widely, so it’s important for us to be able to engineer tailored solutions.

What changes do you see in regard to the average trade size of orders being executed with algorithms?

Rodriguez: Well, because no two clients have the same average order size and what might work for one client, might not work for another, it goes back to why we think having a more bilateral and bespoke approach to algos works best.  In addition to the size aspect, there are a wider set of order flow and order types being executed with algos now as well that have to be considered.

Laturkar: There is certainly a wide variety of order behaviours and sizes coming through algos today.  In the past, clients would only send smaller “easier” order flow through, but as algo platforms have matured and traders have gained an increased level of comfort, they are coming to rely on them for a broader set of workflows now.  So, we do observe clients utilizing them as a key component in achieving effective liquidity capture on their larger orders too, while limiting market impact.  On this point, I’d end by saying it is really not just about the changes in order size because it is also true of several other order flow characteristics including intention, alpha horizon, and order type.

Is customisation the be all and end all?

Rodriguez: Some client engagement is very specific in terms of what a particular client expects of us and our product. In a best execution environment, brokers are evaluated on performance and having the flexibility to customise when required is very important, this relies on close collaboration with clients. The ongoing challenge of maintaining a product that remains competitive is just as important as having something that you can fine tune as you see fit with speed. There is no point saying I can re-calibrate certain behaviours or parameters but that it will take me nine months’ work and effort to deliver it.

Certainly, from a European perspective, we also need to maintain orderly markets and ensure that we are adhering to regulatory expectations. So, as we customise, the level of knowledge that individuals are required to have today versus 10 years ago in that regard, is fundamentally very different. As an electronic house, we are also looking at products more holistically around how we can offer improvement across the stack as opposed to just individual components in silos. The micro data sequence is essential when bringing in that state-of-the-art machine learning component to what we’re doing.

Laturkar: It all depends on how we define customisation, of course – we have certainly seen an evolution in this area. At one point, we were building highly prescriptive customised algos for large firms based on very specific, mostly heuristic-based, instructions. Most of these were meant as replacements for workflow or trader behaviour.  We are not seeing as many of these requests from clients today.  From our perspective, we also found a proliferation of those highly bespoke strategies made it harder to maintain their code, measure their performance, or apply learnings to and or from the broader platform to those custom algos.

Currently, while we still have tremendous client interaction and engagement, there is a different focus.  Clients have a desire to use what the broker algos have to offer, which allows for pushing the envelope on improvements in execution quality, which also involves collaborating on customisations for their specific type of flow.  So, we find the key is intelligently using what we have and working closely with our clients to adjust and cater to the unique requirements or characteristics of their trades.  It follows that we would want to have a platform that allows us to be efficient, nimble, and responsive to client specific customisation, and this led us to the launch of our Micro Adaptive Sequencer (MAS). You can think of it as a dynamically updated optimisation platform that allows for embedding multiple models, inputs and factors to inform execution profiles. With machine learning capabilities and dynamic optimisation built in, MAS is a model that also runs on a real-time basis.

It sits on top of multiple tactics and determines key inputs like scheduling, profiles, and aggressiveness by utilising multiple factors – which allows for these to be variable from client to client. This is a framework we’ve built to not only effect performance improvements, but also to support responsiveness to client-specific objectives and flows. With MAS, we can organically include historical observations and real-time overlays, using machine learning based models to combine the inputs into a cohesive instruction to the underlying algorithm for clients.

What other innovations is Instinet working on?

Rodriguez: As a neutral agency broker, every innovation we make is about helping our clients perform better. Because we don’t trade our own book, every order we generate and each of the capabilities we develop, are for the sole benefit of our clients. Our MAS innovation is a very key part of that while we also focus continuously on offering new markets, new functionality, and the ability to deliver seamless and quick solutions.  

With regard to new markets, we actually just became the first non-member international broker to smart order route in South Africa across Johannesburg Stock Exchange (JSE) and A2X.  As a complementary alternative to the primary exchange, A2X is playing an integral part in the progression of South Africa’s marketplace, providing market participants with an efficient and cost-effective trading venue to post-secondary listings and trade shares.  We arranged the Instinet connection to A2X through our local executing brokers and we’re quite excited to have access to this venue for clients.  There has been a strong uptake in A2X among industry participants, as seen by the growth in listings and market share. 

Source: A2X

At the end of the day, trading venues and liquidity sources are of the most value when they are carefully chosen and engaged based on each order’s particular characteristics, market conditions, and the trader’s objectives. It’s important not to think categorically, such as “should I interact with venue X?”, but rather to develop a continually evolving strategy for “when and how to optimally interact with venue X”.

Globally, the concentration of volume around the close is yet another area demanding a set of specialised tools.  Emphasising this trend, global volume on the close rose again almost 2% in September, with an increase in every region. 

Source: Instinet, MSCI

In Developed Europe, the September surge resulted in a record high proportional volume on the close.

Source: Instinet, MSCI

Laturkar:  Referring to Sal’s point about making sure clients have optimal tools designed for the close, our quantitative teams conducted extensive research and analysis on the dynamics of exchange closing auctions, examining their impact on liquidity and market movements. As a result, we engineered a set of precise Close Overlay micro tactics to address the ongoing volume trend and the opportunities that presents.  They aid performance because they allow you to trade opportunistically in various ways, as the close approaches and we designed them in such a way that they can be set to work one after the other to complete unfilled orders, irrespective of the specific algo or strategy in use. 

Longer-term, Instinet continues to invest across the entire algo stack.  Last October, we acquired FIS execution systems along with their robust signal and routing technology, which we are in the process of integrating within the overall platform.  As well, there has been a large amount of investment at Instinet to significantly upgrade our market data and market access technology which are, of course, both critical components in achieving optimal execution for our clients.

Do you foresee a consolidation of algo providers? 

Rodriguez: We have seen a lot of M&A recently in the market. The thing to remember is that flow is allocated on performance – clients are quick to find out who is good and who is not.  This will lead to more consolidation amongst fewer algo providers. You need to continually invest to remain relevant. If some providers are underinvested that flow will move elsewhere. The more flow you get the more benefits you get from a cross perspective. Incumbent firms like us on the brokerage side need to make sure that we not only get as much business with our clients but also do as much business with the relevant venues. We’ve seen an increase in conversations with some houses around outsourcing for those that have perhaps under invested or those that are seeing the rising cost of being in this business. We’ve been a beneficiary of those situations.

Laturkar:  I would say we are already seeing some level of consolidation occurring across the broker landscape. Part of it is driven by the points made earlier, regarding increasing levels of bilateral engagement between clients and brokers. In order to sustain a meaningful level of engagement, clients have had to focus on deepening relationships with key counterparties. On the flip side, however, given the focus is on execution performance, that allows for continuous innovation and there is increasing competition among new entrants in this space.  We are always welcoming of more solutions for the industry.

The post Staying ahead in the evolving world of algorithmic trading appeared first on The TRADE.

The war in Ukraine has delivered unfortunate social and economic damage across the region and beyond, and together with inflation and the subsequent hiking of interest rates in the UK and elsewhere, this has caused European markets to recover from the pandemic at a slower pace relative to other regions. All three are large volatility events across differing but broad time horizons but the Covid pandemic outsized all other volatility events by a wide margin, as demonstrated by the S&P 500 VIX Index, trading at record highs in March 2020. In the chart below, you can see the FTSE (UKX) & EuroStoxx (SXXP) lagging behind the US Index (S&P).

Historical VIX Volatility in Comparison to Major Indices

Source: Bloomberg

While the positive correlation between volumes and volatility is often spoken about, when it comes to block volumes, we actually tend to see an inverse correlation. However, there has been an increased demand for our dark trading options, as well as, in the dark book within our BlockMatch MTF. Since our launch at the end of 2022, dark and RFQ volumes in BlockMatch EU have been exceeding our growth targets. Over the course of Q1 2023, BlockMatch dark market share increased by 57% and this past March, BlockMatch Europe and BlockMatch UK outperformed other European MTFs up 33% MoM combined, with our average block trade size moving +69% higher MoM as well. 

Since European block venues are prioritised by size over time, it leaves investors preferring to maximise size to ensure they have the best queue position possible. As a result, we have seen an increase in demand from both the buy-side and sell-side in their conditional interaction with BlockMatch, by opting orders into Instinet BlockCross for the buy-side, or typically in the case of sell-side, DEA access to the venue.  We give enormous credit to our team of technologists because we also see this as a testament to the sophisticated systems and scale they have built for us.

Market volumes show that European liquidity is becoming increasingly sparse and one-directional, which leaves investors competing against one another for the same limited liquidity. In the end, whatever the prevailing market conditions may be, our clients rightly expect innovation and a close partnership approach to assist with liquidity discovery.

How does trading in the dark affect impact in the lit and vice versa?

The concept of dark trading is to effectively enter or exit sometimes large positions, with little to no market impact. Over time, the number of dark venues in Europe has increased at the same pace that algorithms have become more advanced at reading signals, meaning that generally the trading footprint has become slightly more visible across many dark pools. Our role as a global agency broker, aligns perfectly with maintaining BlockMatch as a highly regarded dark venue, ensuring that all flow present in the pool, is client driven. 

Regulation has also had an impact on dark trading. With the removal of double volume caps for UK stocks, dark trading has grown at a faster rate in the UK than mainland Europe securities, which lag behind as shown in the chart below.

Europe & UK Dark Market Share

Source: big xyt

Instinet also has a tailored and proactive execution consultancy relationship with clients.  Trading in the dark is easy in itself, but trading in the dark at the right time is harder to manage. To this end, we apply various mechanisms to ensure the best possible outcome for clients and are always glad to guide with a robust quantitative approach.  

There are multiple types of platforms available for block trading, (dark books, RFQ, SI, quote driven, and auction MTF).  How do you clarify their roles?

The liquidity challenge, has for decades, been driven by a mixture of macroeconomic factors and regulatory reforms that have in turn accelerated the innovation and creation of various liquidity solutions designed to help investors, however the result has been an increasingly fragmented marketplace. This has evolved in parallel with new opportunities and growth within Block liquidity, especially hard-to-find mid and small cap securities, and other non-addressable liquidity; interaction with retail liquidity is also increasingly a focus for many.

Ultimately, the choice of how to trade depends on a client’s specific objective. For a buy-side firm, the trading options are not limited to traditional multilateral venues like dark pools operating within central limit order books (CLOBs). Bilateral protocols such as SIs and requests-for-quote (RFQs), as well as the use of conditional trading via indications of interest (IOIs), are now at the forefront of the block trading marketplace.

The chart below offers a clear and simple way to view the main differences between the types of platforms that are available.

As a hybrid-venue, Instinet BlockMatch is designed to be conducive to natural block-sized liquidity and user control, providing the option to advertise willingness to trade through IOIs and RFQs.  Users can send RFQs or respond with quotes and can use limit prices, bid, offer, or midpoint pegs. Control remains with the order originator regarding which counterparties to include. They can also elect to automate the RFQ process by way of a smart order router (SOR) or custom algorithm.

Here is a look at how the RFQ process works.

Instinet recently introduced expansions to its BlockMatch venue, tell us more about that and any plans to grow further.

Sourcing and aggregating different types of liquidity, while minimising the risks of information leakage, is our fundamental role as a broker, and the key to better and more consistent execution quality for our clients. That’s been the driver in launching BlockMatch in multiple regions around the world.

The fully regulated venues that we have established to date are; BlockMatch Europe, BlockMatch UK, and BlockMatch Asia. We have carefully engineered each one to support clients with the objectives, strategies, order types and nuances of their respective markets. BlockMatch Europe is our newest addition offering access to dark and displayed liquidity in pan-European equities. Additionally, BlockMatch offers IOI functionality which allows users to advertise and interact with conditional orders within the MTF. Clients are finding more and more value in our unique functionality, combined with the ability to seek out natural block liquidity.

In March of this year, our BlockMatch Asia venue expanded securities coverage within our dark pool in Hong Kong to include securities from Indonesia, Malaysia and Philippines. We plan on expanding securities coverage even further to other APAC markets in the near future. Since markets in APAC can have higher frictional costs of trading, wider spreads at BBO, and higher market impact in comparison to other regions, dark mechanisms especially can provide impact cost savings and spread savings there.

When we first launched BlockMatch Asia with Hong Kong securities in February 2022, one of the main features was the addition of a conditional book for the submission and management of conditional orders, There has definitely been an increase in client interest and awareness of conditional order types in APAC, over the past two years in particular, and we think that trajectory will only continue.

In addition to expanding BlockMatch Asia’s securities coverage, we launched BlockCross in Asia at the same time. BlockCross is our conditional order management platform that helps clients manage their large-in-size orders in a controlled environment. The launch there follows on the success we’ve had with BlockCross in the US and the growth trajectory that’s underway for the platform in Canada and Europe.

With greater fragmentation across European markets and methods of trading, and as continuous liquidity becomes harder to uncover, how do you think client needs are evolving?

There’s definitely a need for brokers to be omnipresent across all venues, while maintaining a level of “quality control” to ensure that clients are capturing the optimal level of dark liquidity, whilst minimising signaling to the broader market. Instinet’s algorithm platform offers multiple  levels of “style” which can control near/far touch positioning and more importantly venue selection.

In the last year, Instinet’s dark allocations have seen a shift from our most commonly adopted “aggressive” style into our “normal” style, arguably in part as a response to declining market liquidity which sees a more concise venue selection. This shift has been driven by both our clients and research by our quantitative strategy team. Following this shift, our clients have seen a similar dark participation rate, but most importantly an improvement in performance versus an unadjusted arrival benchmark.

Normal vs Aggressive Volumes

Additionally, we see some of our clients asking for more control and have responded in a number of ways. Firstly, our BlockMatch RFQ venue allows for a counterparty selection filter, which enables a client to specifically target a particular type of liquidity as they look to execute (i.e retail, professional or market maker). Secondly, the global release of our BlockCross application provides clients with the ability to selectively “opt-in” individual orders into our BlockMatch dark book , giving the control back to the trader meaning that when a live opportunity arises, they can react real-time to block opportunities. BlockCross has been live for over three years in Europe now, and over that time the client base has grown to more than 120 buy-side clients, with more to come.

Another major need we find clients looking to satisfy, is better clarity and quality of analytical data, so that they can make more informed decisions throughout the lifecycle of their orders . What we are seeing through our interactions with our clients, is that the demand for data remains high with advanced analytical tools now considered essential for modern trading desks. Traders  require a really clear picture of the marketplace, which means having the best real time analytics and data to generate actionable insights and make decisions. Further, in regard to our Instinet Newport EMS, we also see a greater demand for embedded analytics and hosted solutions. As a global agency broker and technology provider, Instinet is in a unique position to assist clients because we deliver bespoke, customised technology and high quality execution, a combination which allows us to be close to our clients’ needs, while also maintaining a high quality of data and output.

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What has driven volumes to the close globally in recent years and why is this phenomenon so important for market participants?

Volume patterns have changed drastically over the last decade, particularly around the rush leading up to and into the market close of each day. Increasingly, the trend observed is that the greatest amount of a trading day’s volume and value is exchanged in merely the final minutes or even seconds of the Closing bell. The volume has been growing aggressively in quarterly cycles, as well. In 2016, the 20-day moving average of Closing Volume was only 6% of daily volume, but reached a record high of almost 16% in December 2019.

Developed Europe is the region with the most proportional volume on the close—about 2X the global average.  Closing auction volumes in Developed Europe have been trending aggressively higher over the last four years—even more than other regions–ranging from a moving average of 13% in February 2016 to a new record high of 28% in December 2019.  

Emerging Europe has been quite stable when compared with other regions, generally trading in a band between 7% and 10%.  Closing auction volumes in the US have been rising gradually over the last four years, hitting a new high in December 2019 of almost 14%, based on the 20-day moving average. Similar to other regions, closing auction volumes in Japan have been trending higher, spanning from a low of 5.5% in February 2016 to a high of 18% in December 2019. Asia Ex Japan has also been quite stable within a band ranging generally from 8% to 10% from 2016-2018.

Why is this happening? 

We think there are a few factors to consider. The close is being used as a strategy. It is the only time of the trading day when such a huge culmination of diverse market participants with varying strategies and benchmarks come together for a single point in time with such uniform urgency. Intraday, market participants choose to trade at many different venues but at the close they all gather at the same place. The majority are likely there seeking to avoid market impact, exchanging and seizing massive liquidity without leaving time for the market to react.  On top of this, there is also incremental volume from imbalance offset opportunities that cause even more trading.

With regard to pricing, by the end of the day, there are more transparent opportunities to be found with increased clarity on where the price is going in the time left.  All of these factors add up to a frenzy of liquidity that has created a kinetic energy drawing in both people and algorithms to be part of a cycle that self-perpetuates and is reinforced each day.

What is Instinet’s Global Auction Monitor and has it uncovered any noteworthy trends so far?

The Global Auction Monitor is a monthly global microstructure analysis report that focuses exclusively on auction trends for each country in the MSCI ACWI index. More simply, it is an interactive tool that helps investors quantify auction volume trends across global markets.

To arrive at calculations, we first break down the world using MSCI indices to define each market. We then calculate a volume profile for each day based on total shares executed on a minute by minute basis. The profiles themselves are interesting and valuable, but for the purpose of the Global Auction Monitor we focus only on proportional volume of the morning open auction, the afternoon closing auction and the last 30 minutes of the day. Details on all calculations are provided each month in the appendix of the report and the FAQ worksheet that accompanies the report’s interactive spreadsheet. 

Since closing auction volume can vary significantly with scheduled events such as index rebalances, we offer three separate time series in the interactive application: ‘All’ Trade Days, which includes all data, ‘Normal’ Trade Days which encompasses closing auction proportional volume less than a 2 standard deviation diversion from the 20- day rolling average, and ‘Extreme’ Trade Days which covers closing auction proportional volume more than a 2 standard deviation diversion from the 20-day rolling average. In the Global Auction Monitor, we present the ‘Normal’ Trade Day data unless otherwise noted.

One of the most interesting insights we have gained from the product is to observe a quarterly seasonality effect from which we see an increase in proportional closing auction volume in the third month of each quarter – even after removing the skewing influence of index rebalances.  The effect is consistent through time and seems to be global in nature – impacting virtually all countries in our study.  We attribute this pick up in closing auction volume in March, June, September and December to quarter-end asset allocation shifts to passive instruments i.e., ETFs/index funds.  This theory is further supported by the fact that the effect is most powerful in December, which suggests that in addition to a quarter-end asset allocation effect there is also an end-of-year passive asset allocation effect that is having a microstructure impact.

How did the COVID-19 pandemic impact the close and continuous trading regionally?

March 2020 was an exceptional month in many ways for the global economy and microstructure metrics. Closing auction proportional volume was unusually low amid the volatility of March 2020 and that brought closing auction volumes back to 2018 levels. Despite some retreat seen in the August 2021 Global Auction Monitor, global closing auction volumes are gradually climbing back to pre-COVID levels. While closing auction volumes have rebounded in other regions, in Asia Ex Japan we are not seeing a return to pre-COVID levels yet.

Breaking the recovery down by region, Developed Europe has now fully recovered and even surpassed pre-COVID highs in recent months. Closing auction volumes have rebounded faster in Developed Europe than any other region. Last month, it was the only region to observe an increase in closing auction volumes. Over a long-term view, closing auction volumes in Emerging Europe have been quite stable relative to other regions. In July 2021, the series hit a new record high and has come back a little in August.

Similar to other regions, Japan saw the closing auction proportional volume fall in March 2020 but closing auction volumes in Japan have been trending higher and have also rebounded to pre-COVID levels. Asia Ex Japan saw a rebound in July and August but overall levels are far from pre-COVID levels. In March 2020, we observed closing auction proportional volume falling to the lowest level in about two years.

The US closing auction was unusually low in March 2020—breaking traditional seasonality patterns-resulting in three-year lows for closing auction volumes. Since that time, however, the volumes have been recovering.

How did market participants adapt trading processes to the changes, and in what ways can venues/order types help traders optimise their engagement with liquidity at the close? 

The continued migration of volume to closing auctions, and the last minutes of continuous trading, makes it that much more important to engage with the various liquidity sources and tools at and around the close. There are great opportunities for tactical liquidity seeking in the last two minutes – but the price improvement profile changes. Displayed quote sizes can be very large – sometimes sizable portions of the ADV.

A well-tuned trading system can optimise liquidity. Instinet uses a specialised “Close Overlay” to opportunistically trade in various ways in and around the close.  Modern execution algos should incorporate imbalance and indicative size feeds, use order types such as imbalance offsets, and integrate TAL and other alternative close venues, to minimise impact and maximise liquidity in closing auctions. Algorithms should also account for market dynamics going before the close too, where liquidity can be highly concentrated and impact and spread costs minimal. The algorithms that account intelligently for these various effects can perform notably better.

Trading near the close can be very unlike trading during the rest of the day, providing a unique set of opportunities. Having the right tools, innovations and data that can help make the most of it is critical. It is worth understanding the information that comes out of the close and brokers should be held accountable for providing it.

What could go wrong with such big market events bunching up at the end of the day? What if Level 3 circuit breakers fail?

Rather than wonder if exchange A can backup exchange B at the close, as an industry we should wonder if an improved/extended competitive framework is needed to improve the closing auction so that organically, by market forces, there are alternatives on the sidelines. Even with a perfect backup system, traders and institutions have to be ready with their strategies and technologies in the right place to respond and react if something fails during the close. There is a long way to go to make instantaneous backup as robust as the industry already has for intraday trading.

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