As the first year of MiFID II draws to a close, liquidity in Europe’s equity market has begun to assume a bit of a holding pattern and we can start to make some observations about the regulation’s impact. TABB Group analyst Tim Cave examines four key emerging trends.
As the first year of MIFID II draws to a close, we can begin to make some observations about its impact on liquidity in Europe’s equity market.
Overall, November saw a dip in European equity volumes, with average daily notional falling 9%, to €79.4 billion, as markets calmed following the turmoil during “Red October.” Month over month, the market exhibited a holding pattern in terms of the market share of major execution channels.
Nevertheless, some clearer trends are beginning to emerge. Here we take a look at four key issues.
1. Bank SIs – Limited Growth During 2018
Bank systematic internaliser (SI) activity, the regulatory channel for principal trading, has been the source of much conjecture to date, but largely devoid of hard facts. It has been difficult to decipher much from the RTS27 execution quality reports banks have had to produce on a quarterly basis under MiFID II. Publicly, aside from comments in quarterly earning calls, most bulge-bracket banks have been keeping their powder dry over the impact of MiFID II on equity trading. Anecdotally, buy-side traders report varying levels of performance among the large houses; some have adapted well, offering access to a range of new liquidity sources and deploying more risk, while others, less so. We know that MiFID II’s promotion of risk-based trading, principally via the enhanced SI regime, has led many banks to invest in central risk books (CRBs); but these appear to be at differing stages of development.
This mixed performance appears to be borne out in the data (see Exhibit 1, below).
Exhibit 1 – SI Activity in EU Equities Under MiFID II
Source: TABB Group and big xyt
Assuming that much of the addressable SI activity undertaken by banks is above the large-in-scale thresholds (LIS), then – while this accounted for much of the initial increase in SI activity at the outset of MiFID II as banks re-categorized their OTC activity – it has not increased much this year. There has been some fluctuation in the past year, but daily notional remains at around 5 billion euros.
On the other hand, there has been steady increase in addressable SI activity below the LIS thresholds, with average daily volume increasing from 1.9 billion euros to 2.9 billion euros between January and November. Much of this growth seems to have been driven by electronic liquidity provider (ELP) SI activity (i.e., non-bank firms).
2. ELP SIs – Picking Up Steam
Most practitioners have been surprised at the relatively slow uptake of SI activity undertaken by ELPs at the outset of MiFID II. This has had as much to do with the brokers offering access to ELP SIs as it does the SIs themselves. The divergence in broker performance is evident in this area also: While some brokers are offering direct access to all these sources of liquidity, others have been able to connect directly with only a few, or, for some, none at all.
Nonetheless, activity through ELP SIs has steadily increased, with average daily notional increasing from €243 million in January to €963 million in November, according to TABB Group estimates. The majority of this activity is being undertaken by five ELPs – Tower Research Capital, Jane Street, Citadel Securities, Hudson River Trading and Virtu Financial – and these are volumes that are being tracked by TABB Group in its monthly European Equities LiqudityMatrix. More ELP SIs are just getting going, notably by major market-maker XTX Markets, so expect volumes to rise more in 2019.
ELP SIs appear to have been the main driver of growth in SI volumes below the LIS thresholds. We know anecdotally – and from disclosures in RTS27 reports – that the bulk of ELP SI activity is below LIS. ELP SIs accounted for 33% of below-LIS SI activity in November, compared with 12% in January.
The buy side is getting more comfortable executing against ELP SIs and is seeing low levels of market impact with certain SI operators.