Equity markets: The factors hurting best execution in 2020

Published on 8 December 2020

Anish Puaar, equity market structure analyst at Rosenblatt Securities, looks at several factors that are affecting best execution in Q4 2020 – including operational failures at major exchange. A review of the data reported under MiFID II has found that few of the reports deliver value – although there is some gold hidden within.

We assess how buy-side equity traders are able to navigate regulation and market structure in order to deliver better execution for investors.

Dan Barnes Welcome to Trader TV, I’m Dan Barnes. Today we’re going to give a quarterly update on equity market structure. Joining me is Anish Puaar, market structure analyst for Europe at Rosenblatt Securities. Anish, welcome to the show.

Anish Puaar Hi Dan, thanks for having me back on again.

Dan Barnes We’re nearly two years into the MiFID II regime now. Can you tell us how has it helped best execution?

Anish Puaar The FCA did a big, dramatic review in 2017, which is before MiFID II came into force, looking at the years failings and certain firms’ best execution policies. Since then, you haven’t really heard much from the UK perspective from the FCA, and I don’t think there’s been much else from other European regulators in terms of how they’re monitoring best execution. And I certainly haven’t seen any firms being fined for failings in best execution. Part of that could just be the approach that Europe takes towards best execution, which is a principles-based approach.

Dan Barnes What useful data have you actually found from the RTS reports, which were designed to monitor best execution?

Anish Puaar MiFID II introduced these RTS 27 and 28 reports. The RTS 27 reports look at venue execution quality and include a number of metrics that venues have to report there. The RTS 28 reports are broker- and buy-side reports that list, on the broker side it’s the top five venues used by that broker over the past year, and the top five brokers used by the buy-side over the last year. It’s important to say that these best execution reports have been of, maybe limited usefulness across the industry. There are a number of differences in the way that firms choose to report the data, and that’s due to format or just how they think something should be defined as the reporting itself. So even something as simple as a top five list of the trading venues you use over the last year, is open to interpretation. In our look at the RTS 28 reports, we compared many routes and trends among 28 banks and brokers. 15 of those 28 self-routed orders to their own SI, or MTF in some cases. It’s also interesting to note the use of lit venues fell year-on-year, while the number of dark MTF and periodic auction mentions increased year-on-year.

Dan Barnes Talking about market structure level, we’ve seen a few operational failures recently on exchanges, on Euronext and The Australian Stock Exchange. How do outages impact execution quality?

Anish Puaar We’ve had a lot of outages in recent months. Obviously you’ve mentioned Australia and Euronext, we’ve also had New Zealand and Tokyo, and also problems with stocks. For instance, they had a problem with the stock 600 calculations a couple of weeks ago. They’ve been for a number of different reasons, whether it’s kind of hardware failures, and cyber attacks in the case of New Zealand. In Europe, we’ve had the situation for a long time that MiFID fragmented equity trading and brought in competition to the primary exchanges, but during a listing market outage, we don’t see trading shift over to MTFs like CBOE Europe, Turquoise and Aquis. Trading just seems to stop altogether, and there’s a number of reasons for that. You’re looking at best execution, which I mentioned earlier in Europe, is principles-based rather than price-based. Well, principles-based means that a broker can choose whether or not to connect to alternative venues, so the mix of participants on a listing exchange is probably going to be a lot more varied than a MTF. There might just be some firms that haven’t connected to a MTF and therefore they just won’t be able to trade when the market goes down. If you’ve got a best execution rule based on price, like in the US, you’re obligated to connect to all the exchanges so you can easily carry on trading if there’s an outage. In Europe, there’s a lot of reliance on the primary as a source of liquidity. The primary exchange still accounts for 60-70% of liquidity in continuous trading, and that feeds into broker algorithms, market maker, risk limit systems and controls, etc.. So, when 60-70% of the liquidity automatically disappears, then the market just seems to seize up and freeze and trading doesn’t continue. And also, sometimes you’re unclear as to whether the market’s going to be down for five minutes or five hours. When you’re in that situation, part of you might think, ‘maybe I should just wait, because if it’s just a short duration outage, I can just carry on trading in five minutes, and I don’t need to take the risk of moving my trading to another venue.’

Dan Barnes The time of day when an outage occurs is also very important, isn’t it?

Anish Puaar Yes, so in the afternoon, perhaps when there are US market participants starting to trade European stocks, that could have a bigger impact, and you are also looking at the closing auctions, so one of the notable things about the Euronext outage was that the closing auction didn’t run. And obviously the close is becoming a much more important liquidity event during the day, because of factors such as the rise of ETF trading and passive trading strategies.

Dan Barnes Definitely. Anish, that’s been great. Thank you very much.

Anish Puaar Thanks a lot, Dan.

Dan Barnes I’d like to thank Anish for his insights today, and of course you for watching. To catch up on our other shows or to subscribe to our newsletter, go to TraderTV.NET, or ETF.NET.