Enabling transparency in an increasingly fragmented market : Addressing EMEA challenges with a more consolidated view

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By Artur Fischer
In this article, Equiduct Trading’s Joint CEO Artur Fischer argues that in times of extreme structural and economic change, there is an even greater requirement for transparency. He believes that in an increasingly fragmented market, there’s an even greater risk that organisations will need even more help if they are to avoid effectively trading in the dark with no clear consolidated view of market pricing. Here he identifies the growing requirement for a new generation of virtual order book that can consolidate all the visible pre-trade information generated from significant relevant markets, effectively delivering transparency and providing firms with access to a single, unbiased source of pan-European equity price data.
The European equity markets have undergone a period of rapid and unprecedented change over the past two years. While some of these shifts have been mainly related to the still-evolving current global economic situation – leading to the disappearance or restructuring of some of the biggest names in finance – others have centred around newlyintroduced regulation, with the arrival of new types of execution venues and cross border clearing venues being among the most obvious and significant.
These changes have created some huge challenges (and it should be said equally huge opportunities) for market participants, whether they be the large broker dealers having to connect to all the new trading venues in search of liquidity, or a pension fund simply trying to understand what the “Best Execution” he has been promised actually means.
Each of the incumbent Exchanges, the new Multilateral Trading Facilities (MTF), and the growing number of Dark Pools or Crossing Networks provides an alternative USP for execution of equity orders, and each operates with a slightly different business model – both pre and post trade. This has understandably stimulated competition for order flow liquidity, introducing alternatives in the post trade space, and leading to a major shake up in fees. Not surprisingly, this has also irreversibly fragmented liquidity. However, this fragmentation is an evolving process; the picture is far from complete or even stable, and can be expected to go through several consolidation and subsequent fragmentation phases before the next “Big Bang”.
Opening up the European equity markets
With new entrants into the execution space, Europe’s equity market is opening up for investors from across the world. FIX-compliant technology is enabling easier connectivity to the new venues and providing an opportunity for a wider range of firms to get access to venues over and above the incumbent. In Vol 2 Issue 8 December 2008 of FIXGlobal, John Palazzo of Cheuvreux stated “FIX affords every broker the ability to get into these markets at an unprecedented pace” – at Equiduct we certainly agree, but there are still some considerable challenges.

How, for example, do “sell-side” firms determine whether they should connect to these new venues? How do they then prioritise which to connect to? How do they choose where to actually send their order? Also, how do “buy-side” investors understand which venues their brokers should be connected to, if they are to ensure them the mythical Best Execution? What price should they be using to markto- market at the end of each day and for intraday position risk purposes?
At Equiduct, we’re hoping to provide some of the answers to these important questions. We hope to be able to shed some light on the situation and show how to achieve best execution on the various available platforms with a range of analytical tools. Uniquely, the toolset includes a Pan-European aggregated feed.
Ensuring execution on the most appropriate platform
Firms across the trading spectrum, whether small or large, are increasingly using sophisticated smart-order-routing solutions and algorithmic trading systems to “slice” orders and to determine where they should distribute the pieces across the Dark Pools, MTF and Exchanges. However, in order for these systems and indeed an individual trader to start to effectively predict the future, it is important to understand the present and the past. Information providers such as Markit or Fidessa with their Fragmentation Index can confirm the common knowledge that liquidity fragmentation is a reality once a trade has been executed. However they do not have the ability to see how the market should have performed by examining the pre-trade order and price information that was available at the time of trade.

At Equiduct we have been collating all visible pre-trade information (Level II data) for the top 700 shares across Belgium, France, Germany, The Netherlands and the UK from the major European venues (BATS, Chi-X, NYSE Euronext, London Stock Exchange, Nasdaq OMX, Turquoise, Xetra) since April 2008. Yes, a significant percentage of order flow has moved away from the incumbent exchanges but what is not such common knowledge is that trades are still not always executed on the most appropriate platform. Indeed our analysis shows that in April 2009 a significant proportion of trades executed on the incumbent exchanges should have been transacted on an alternative venue, and approximately 35% of executed trades are still not transacted on the best price venue. Significant price improvement could have been achieved if this had happened. (See Diagram 1)

To give the market a view into what is actually happening, Equiduct has created a range of products that provide both real time and historical data analysis, including a powerful tick-by-tick Level II data store that can be used in real time, or as a market reconstruction facility. This allows the user to simply select either a precise time point (with millisecond granularity) or an individual trade to see the corresponding consolidated book display at that very moment, and to “quality check” the execution quality. The tool is also able to regenerate the graphical market fragmentation and liquidity picture over different time periods, or the optimal split for a trade given the prevailing market conditions at the point of actual or theoretical execution.
Remember ‘best price’ doesn’t always mean lowest cost
Another significant challenge for European market participants searching for best execution is that the best price does not necessarily correspond to lowest cost (when trading fees and clearing and settlement charges are included).

Equally, when looking to assess open position risk or calculate a “mark-to-market” price, the accepted method of using the FTSE or DAX intra-day and closing prices is not necessarily most appropriate in today’s markets. Looking at the post trade data, only 20-30% of the total volume of transactions are executed at the incumbent exchanges (from where the index information is generally derived), meaning the index price being used is – at best – a guide. Adding multiple currencies into the equation for many stocks simply confuses the issue further. Unfortunately, unlike the United States, European markets currently have no single consolidated price and no single benchmark method for determining one.
Creating a “virtual book” for greater market transparency
For firms who have purchased real time data from the Exchanges, Equiduct sees it as important to have a clear view of the individual venue market depths, the consolidated virtual book and optimal fragmentation. But what about the firms who do not have all this information available? Since April 2008, Equiduct has also been consolidating the visible pre-trade information gathered from the significant relevant markets into a “virtual book”, providing access to a single source of equity price data. The resulting benchmark, (we call OrangeVBBO) has been calculated from this book and the price has shown the consolidated true best price, mathematically derived from the full depth of the market for each instrument.

Equiduct has now decided to “step up to the plate” and create a Pan-European aggregated feed (by price), i.e. a consolidated tape. This provides market by-price real-time data feed without the venues names, pre and post-trade. All the orders with the same price are aggregated on a single line without the venues names displayed. This feed contains all the visible liquidity for any single stock, and addresses all the information-related needs of traders, compliance & risk departments and back or middle offices. This anonymous data feed is a derived data feed, and is therefore not subject to real time Exchange fees.
The last few years have been tumultuous for the financial markets, and this situation is unlikely to change for the next few years. Participants will continue to come and go, moving in and out of different markets, and adding new and ever more complex strategies to their trading capabilities. But with more new entrants into the execution venue space on the horizon, the requirement for a single consolidated tape will become more and more pressing for both the “sellside” and “buy-side”. I am looking forward to seeing how the various challenges being faced will be addressed, but believe strongly that a consolidated tape will become the European real-time liquid equities benchmark that is so often asked for and is so clearly needed.