Bringing Back the Block
The utopia of equity trading – the natural block – is becoming the essential modus operandi for many. In terms of execution, 67% of buy-side participants now place more importance on finding natural blocks than choice of venue, broker or strategy. Yet only a third are actively moving from schedule-based trading back to blocks. While many may claim to want to trade blocks, block trading remains elusive, more often a problem of perception versus reality.
While European regulators have indicated their intention to protect institution-sized business by excluding large-in-size orders from volume caps on dark trading, this alone is not enough to guarantee an increase in block activity. Liquidity may pool but it still needs to move, and the ability to facilitate trades in the post-MiFID II world is the elephant in the room. If MiFID II regulation prevents brokers from matching riskless principal trades going forward, block liquidity risks becoming intransigent and the negotiation of trades potentially harder to achieve.
The market will of course adapt. Technology is already improving information flows to locate natural liquidity and fast-moving sell-side firms have spotted the gap in the market. Dedicated block desks are springing up at sell-side firms which have firm-wide access to internal books across the floor. To protect client trading intentions being leaked in the usual manner, these block desks are also ring fenced internally.
There is also a change in approach by the buy-side. Asset managers are no longer sitting by passively waiting for information flows. Holding the majority of the assets means the buy-side holds the liquidity, and as such is choosing to become the instigator of blocks. Improved order management system technology and greater automation of processes enables firms to trawl asset managers’ current, past and intended portfolios to find potential opportunities to trade. While much of the information once remained in the hands of the sell-side, the shift of this information flow to the buy-side creates a new dynamic. The question remains whether broking will continue to be mission critical to bringing back the block, or if technology will eventually facilitate full buy-side to buy-side negotiation of blocks. The recent success of block crossing offerings illustrates how venues and brokers are adapting to new opportunities to create block trading. New entrants, such as Luminex and Plato as well as Turquoise, look set to reshape the traditional buy-side and sell-side relationships still further.
However, ultimately, any increase in block trading depends on the level of urgency to complete the trade. Trading blocks does not suit all strategies. The growing regulatory importance of a firm’s ability to demonstrate best execution – on the buy-side as well as the sell-side – will ensure firms need to optimise all opportunities available to meet regulatory obligations. The trend towards more patient execution depends on the investment process. Where there is significant order imbalance or high market momentum, trading in smaller sizes over the day may deliver better execution. As market volatility increases, buy-side firms will need to capitalise on opportunities as and when they become available. This will require greater information flows, and improved accuracy and standardisation of this data.
To investigate these challenges, TABB Group conducted research with 43 global heads of trading in August 2015 to establish how firms plan to adjust to MiFID II in light of the current market structure, and whether current proposals will succeed in bringing back the block.
- European Equities