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Global Equities 2010 : The Liquidity FIX

What key features do successful exchanges share that encourage liquidity; how automated trading drives growth and why markets will attract incremental liquidity with the advent of global CSAs. Robert Barnes, Managing Director, Equities of UBS Investment Bank explains.
The execution arms race continues. The prize is order flow that concentrates to those most capable, particularly in navigating market structures.
Market structures comprise the rules and institutions that determine competition and the framework of interaction, including Exchange fees, which ultimately shape order execution strategies. The focus includes external factors that impact business and operating models, driving opportunities to grow revenues and reduce costs.
Exchanges rebuilding liquidity is a priority market-wide theme in 2010 in the context of competition, transparency, and investor choice at trading and clearing layers. From a User perspective, we wish to work in a spirit of partnership with Exchanges and Regulators to promote liquidity and new business, and we thank the Authorities as they provide a framework within which we can behave as entrepreneurs.
Macro trends include rising number of trades, coincident with automated electronic trading. Regulation promotes competition, transparency, investor protection. This leads to a better result for clients via competitive execution policies. Competition, thus fragmentation, makes the world more complex. Not all brokers, however, can keep up with the technological arms race. Direct Execution models of electronic trading are evolving to address this. Latency reduction increasingly is sought for competitive advantage.
There is increasing awareness of a positive dynamic involving non-displayed pools and high frequency trading. The key insights are that markets allowing discretionary non-displayed broker crossing processes and non-discretionary dark pools effectively speed net liquidity onto order books. The benefits are lower market impact, greater efficiency, and a better result for end investors.
These benefits multiply if statistical traders are active. When orderbook liquidity increases, so too does the proportion of trading opportunities; and these stimulate further orders to the orderbook from automated strategies. This incremental liquidity, aggressive and passive, narrows spreads.
The world’s markets are split into those that support and benefit from high levels of automation, and those with the opportunity to encourage more. Investors’ current focus include global macro trends and emerging markets which means that moving toward more consistent electronic access models will help markets to take advantage of this burgeoning liquidity. A good start is to implement and enhance FIX specifications to offer advanced electronic flexibility. This adoption of standardisation can aid emerging markets in growing their scale of business.
One of the more “seismic” changes to Equity markets in recent years is the proliferation of commission unbundling and Commission Sharing Agreements, “CSAs”, or Client Commission Agreements,“CCAs”, in the USA. Initiated by UK regulators in 2006, this commission unbundling initiative spread across Europe (at the end of 2007) with the arrival of the Markets in Financial Instruments Directive, or “MiFID.” Global clients, preferring one consistent process world-wide, have led the demand for CSAs to become a market convention. With many CSAs established on a global basis, it can be easier than ever before for a newly automated market joining a broker’s network to attract liquidity.
Successful markets world-wide share key features and best practices that encourage efficiency and liquidity growth. These include :

• Electronic Trading
Clients want faster execution and access to more liquidity, so they increasingly employ Electronic Trading Services such as “DMA”(Direct Market Access) and algorithmic trading strategies that lead to better alignment of execution with client objectives, more ownership over the traded price and therefore more influence over best execution. Automation speeds the process, trading is safer with system-embedded checks.
Clients want the ability to trade with a spectrum of Algorithms as well as DMA, and Algorithms are more effective with a meaningful range of order types and the facility to quickly enter, modify and cancel orders.
• Anonymity of Broker identifiers :
Offering anonymity of Broker identifiers is a key to greater market liquidity and investor fairness.
• Auctions
and support for complementary liquidity pools: Many investors benchmark a market’s close; they appreciate a robust mechanism that also serves as a concentrated liquidity point.

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