Off-Exchange Trading Evolves
With Mehmet Kinak, Global Head of Systematic Trading and Market Structure, T. Rowe Price
For buy-side investment firms, what are the challenges/opportunities of increased off-exchange volume?
First, it’s important to note that not all off-exchange trading is the same. Trading for an asset manager with $1.6 trillion in AUM, we are always seeking opportunities to interact with unique liquidity and that means engaging with a multitude of different venues and platforms. The recent rise of off-exchange volume is attributable to retail trading and the biggest challenge we’ve encountered with this increased volume is a lack of transparency, specifically related to real-time attribution of off-exchange venues. From an institutional perspective, retail liquidity is often classified as inaccessible, but having greater transparency of volumes, real-time, would help buy-side firms more accurately manage their activity in the marketplace.
How do you navigate off-exchange segmentation?
Segmentation can be useful because it helps us identify the counterparty; that’s one of the benefits of off-exchange trading. We spend a lot of time trying to better understand and classify the counterparty with whom we are engaging. For example, if we’re trading on a block crossing system, the counterparty is most likely another institution. If it’s a Central Risk Book (CRB) or Single-dealer platform (SDP), the counterparty is clearly defined. Our goal is to interact with counterparties that have similar interest in keeping the prevailing best price stable and are comfortable trading in larger size.
In terms of retail activity, the segmentation of that order flow is extremely helpful to wholesalers and allows them to provide the current structure that’s in place today. Many market participants would agree that retail investors have never had a better experience. Interest from non-wholesalers to interact with retail orders isn’t surprising, but practically speaking this isn’t always reasonable as retail activity often doesn’t align well with institutional behavior.
What are your thoughts on new order types?
It should come as no surprise that buyside firms will never be the fastest market participants. In fact, most times we aren’t even interested in running the race. Order types that are intended to slow things down or help institutions avoid adverse selection have helped “level the playing field”. Once again, we’re looking to interact with someone that’s like-minded in preserving the existing quote and specific order types that are designed to do just that have been very beneficial for us.
How do you feel about innovation, and when is innovation not helpful?
The first question I ask myself is, what is this new innovation trying to solve? Everyone in the market has their own commercial interests and I understand that I have to consider whether any new initiative is simply a commercial benefit to a specific firm or if there is a genuine market issue/need that’s driving it. We are not supportive of initiatives that introduce operational and practical complexity without either solving a distinct problem or improving the overall experience of market participants.
As an example, Nasdaq’s recent “Extended Trading Close (ETC)” proposal looks to address the issue of closing volume that’s migrating to off-exchange venues. But ETC would provide an opportunity to access-liquidity only after the conclusion of the closing cross. In our opinion, ETC adds operational complexity without actually addressing the stated problem. The real issue appears to be the efficiency of the closing auction itself. A more thoughtful innovation, and one likely welcomed by most buy-side firms, would be to create a distinctive closing cross by separating the closing auction from the continuous market.
How important is it to have global consistency in market structure?
Although I appreciate the nuances that exist in varying markets, having global consistency in certain aspects of market structure would reduce trading complexity for global asset managers. How we engage in specific markets varies by the different rules that govern each region and country. One area that we continue to advocate for with regulators is defining best execution obligations which differ across the globe. Separately, while we aren’t supportive of excessive fragmentation, single venue markets sometimes lack innovation, and we embrace new entrants into markets where competition is deficient.
There are new equity exchanges in the US and apparently more on the way. How many is too many?
I don’t know what the right number of exchanges is, but I think we may have already crossed that point of having too many. We’re certainly not fans of continued fragmentation without real innovation/differentiation from new entrants. And again, we have to question whether their differentiation is actually solving a problem or addressing a need. Do we need a market that’s open 24/7, another inverted venue, or more protected quotes? If we’re going to allow for new exchanges, then in my opinion it makes sense to revisit the Order Protection Rule (OPR). Without OPR new exchanges would need to stand on the merit of their innovation or uniqueness.