Changing of the Guard
In this new marketplace, the role of
participants such as high-frequency traders
and market making firms will change and their
importance as intermediaries will become
more apparent. These proprietary trading firms
commit their own capital to supply liquidity
using sophisticated algorithmic techniques,
providing automated pricing in thousandths of
a second, while also delivering semi-automated
pricing on less-liquid instruments such as
small-cap stocks and ETFs.
Today some of these firms are authorised by
the FCA as systematic internalisers (SIs), but
in the future all OTC liquidity providers for
equities will need to be authorised as such.
For the more technologically advanced firms,
this represents a real opportunity, but MiFID
II also signals the end of the broker crossing
network (BCN) regime, which has evolved
in Europe and Asia largely as a result of the
absence of regulation around trading venues.
The relative lack of regulation has meant
that application of best execution rules has
sometimes been opaque, and while BCNs
have tried to distinguish themselves based on
the access to liquidity and protection against
‘toxicity’, the differentiation between many
venues has been unclear.
In the future, a multilateral trading venue
must be authorised as an ATS in the US, a
PTS in Japan, a multilateral trading facility
(MTF) or an organised trading facility (OTF)
in Europe—creating a more transparent model
and making it easier to measure toxicity and
opportunity cost.
SYSTEMATIC INTERNALISERS (SI)
VERSUS THE BROKER CROSSING NETWORK (BCN).
Potential Advantages Potential Disadvantages
• Unlike a BCN, an SI will offer
pre-trade transparency • Information is provided to the SI
• Tailored liquidity—less toxic
business means better quotes • Orders are no longer
multilateral, so clients cannot
cross directly
• No incentives—an SI cannot
rebate for trading, otherwise it
would be subjected to payment
for order flow constraints • No benefit to resting orders
against an SI (Principal
Trading book)
• Transparency of counterparty
—you don’t know who you are
trading with in a BCN • Sls have the ability to ‘last-look’
—can choose whether to fill an
order or not
• Expectation SIs will offer
multiple quotes in price and size • Sls are not obliged to trade
• Quotes above SMS are private
4
Autumn 2017
THE IMPACTS OF A NEW LIQUIDITY PARADIGM
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