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Buy Side Defends Off-Exchange EU Trading

MiFID II aimed to increase trading on lit venues in the European Union but fund managers argue that systematic internalisers, dark venues and periodic auctions have saved money for end-investors and there are other ways to increase transparency, such as introducing a consolidated tape.

The European Securities and Markets Authority last week published the responses on certain aspects of the regulation.

Richard Worrell, head of EMEA equity trading for Janus Henderson, said in the asset manager’s response that the industry’s responsibility is to save clients’ money by encouraging innovation.

“Therefore, I do not believe restricting venues, removing mid point or price improvement is sensible at all,” he added. “Systematic internalisers, dark venues and periodic auctions are examples of innovation that saves clients money and they should be encouraged.”

Norges Bank Investment Management, responsible for investing the country’s sovereign wealth fund, said in its response that large-in-scale venues efficiently facilitate block trading between institutional investors. The venues offer a good balance between order size and fill rate and their mid-point execution feature is important in contributing to fair pricing.

“Although these venues are exempted from pre-trade transparency requirements, they do contribute to price discovery through timely post-trade reporting,” added NBIM. “We have welcomed innovation in this space as it offers tailored solutions to the needs of current market participants, especially in light of the increased institutionalisation of asset management in recent years.”

NBIM continued that any disruption of LIS mid-point execution would harm market liquidity making European markets less attractive to large institutional investors.

BlackRock also said in its response that it is wrong to assume that all trading that takes place off-exchange detracts from price formation or market quality.

“Concerns that ‘dark’ venues detract from transparency and price formation would be best addressed by having a real-time tape of record that consolidates the information from all venues operating in the marketplace – ‘dark’ or otherwise,” added the fund manager. “The same is true for pre-trade transparency, which is best addressed by developing a European Best Bid or Offer.”

The European Fund and Asset Management Association added there is no need to artificially incentivise lit trading versus other execution methods.

“This will not result in a positive outcome for investors and will remove optionality for firms and result in a detrimental impact on end-user objectives and strategies,” wrote EFAMA.

The association continued that the quality of lit markets could be enhanced by reducing the number of order types that a venue may offer to four types of orders, as most of these order types only exist to facilitate latency arbitrage. “We consider that this will enhance the quality of the execution of transactions and reporting,” said EFAMA.

Consolidated tape

Esma has recommended a real-time consolidated tape for equity markets in Europe. There is no consolidated tape in the region to provide an overall view of the market so investors have to rely on data from third-party vendors which increases the cost of trading.

BlackRock said in its response that a successfully governed European consolidated tape would be transformative for markets and for investors.

“It would bring clear benefits; increasing transparency and strengthening best execution, while simultaneously improving competitiveness of European capital markets and contributing to the delivery of Capital Markets Union,” added BlackRock.

In addition, BlackRock said Esma should eventually extend the tape to pre-trade information, creating a consolidated European Best Bid or Offer. “The EBBO would be equally important to enhance market quality and to open-up best execution data to all investors, large and small,” added the fund manager.

Invesco agreed that an EU consolidated tape, including for exchange-traded funds, would incentivise lit trading.

The response said: “Invesco believes that the provision of an EU consolidated tape is a utility to the market and therefore is unlikely to emerge without some regulatory intervention to support it.”

Systematic internalisers

MiFID II banned broker crossing networks and required broker-dealers to set up systematic internalisers in order to provide principal liquidity to clients. The Esma consultation asked if SIs should stop being eligible execution venues.

BlackRock said systematic internalisers should remain as eligible execution venues as they are an important execution channel for investors seeking principal liquidity from broker-dealers for block trades, but should be tailored more specifically to the provision of risk capital.

“There is understandable concern around the volume of trades taking place on SIs, and whether they are appropriate to the venues,” added BlackRock. “This debate would be better informed by the data and transparency provided by a consolidated tape.”

Janus Henderson agreed that SIs, particularly for large in scale blocks, are a crucial part of the trading landscape. The fund manager gave the example of recently trading approximately three days volume of a German stock at a 2% discount which would have taken five to six days to execute without an SI.

“Instead, less than two days, after we traded, the stock was down more than 5%.Therefore we helped preserve significant alpha of ~3% for our clients,” added the investment manager. “As importantly, we used the proceeds to reinvest in existing European names and a new idea, so the market is still seeing the volume.”

Invesco added that the MiFID II best execution obligations are often met by trading on SIs, rather than exchanges or other authorised venues.

“As such, given that Esma’s analysis does not present a holistic view of the use of SIs, and concentrates only on the volume of trading which takes place on SIs, we cannot be convinced of the proposal to remove SIs as eligible execution places for the purposes of the MiFIR share trading obligation,” said Invesco.

NBIM said a level-playing field for SI activity is required and further analysis on their contribution to price and liquidity discovery is needed.

“Ensuring banks/brokers’ intermediation activity is not hindered remains important for the less liquid segment of the market, since there may not be other feasible liquidity sources, added NBIM. “Reducing available liquidity from these banks/brokers would be to the detriment of these listed firms and to the market more broadly.”

Double volume caps

MiFID II introduced caps on trading in dark pools with the aim of shifting volumes onto lit markets. Esma asked in the consultation whether they should be extended to  cover illiquid markets.

“We believe there are fundamental questions about the effectiveness of the double volume caps that should be addressed before considering smaller changes or refinements,” added BlackRock. “Regardless, we do not believe that the DVC should be extended to cover illiquid markets.”

Janus Henderson said the double volume caps have not worked so continuing to use them “let alone extending them without evidence seems slightly mystifying.” The fund manager continued that exchanges need to innovate to increase volumes, for example, by offering a midpoint, hidden order type.

The European Fund and Asset Management Association also asked for the removal of the caps. “The mechanism does not result in positive outcomes for end-users and contributes to complexity in European market structure,” added EFAMA.


Regulators have expressed concerns about the increased volume of trading in the closing auction as intraday volumes have decreased.

BlackRock said the trend was driven by regulations making broker-dealer risk taking more costly, causing them to unwind more of their positions in the close; technology making it easier to access closing auction liquidity; index funds referencing the market close price as a benchmark and the ETF create/redeem mechanism.

“Ultimately, it is at this point unclear whether an increase in closing auction volume has any impact – positive or negative – on volatility and on price formation,” added BlackRock. “As such, it is too early for regulatory intervention, although initiatives like shortening market hours could help concentrate more liquidity into intraday trading.”

Venues have also introduced intraday frequent batch auctions which Janus Henderson said had been a success.

“They are an innovation which offers mid point liquidity and therefore should be encouraged, said Janus Henderson. “Some measures could be put in place to simplify the system and make all work in the same way. For example, we do not believe it is fair to fix the price at the start of the auction.”

Janus Henderson noted that frequent batch auctions are still only around 3% of total volume and so not really worthy of further scrutiny. “Let’s not stifle innovation that helps price formation and also save investor’s money,” the fund manager added.

NBIM said closing auction liquidity needs to remain accessible to all market participants, with an appropriate level of transparency.

“Innovations linked to closing auctions, such as market-on-close crossing mechanisms offered outside of the primary exchange, should be assessed for potential unintended consequences, including the risk of further market fragmentation,” NBIM added.

The Norwegian fund manager continued that frequent batch auctions are promising venues for sourcing natural liquidity and have the potential to improve execution quality for long-term investors as they take place in parallel with continuous trading.

State Street Global Advisors added that closing auctions are a valuable source of liquidity but highlighted the monopoly pricing power exerted by the exchanges.

“While we agree with Esma’s statement that “liquidity attracts liquidity”, we observe that the cost of transacting at the closing auction is increasing, which will ultimately be to the detriment of the investor,” added SSGA. “We encourage Esma to continue to monitor these developments closely.”