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TabbFORUM: Forecast 2021: Electronic Trading & Market Structure Outlook, Part 2

Forecast 2021

Erin Kelly

Erin Kelly

What were the trends in market structure and electronic trading this past year, and where are they headed? This edition of Forecast 2021 introduces movers and shakers in the market structure and trading space who offer their outlook for what’s next for the industry, written by Sam Belden & staff at Forefront Communications.

The year 2020 has been unlike any other, and the capital markets and institutional fintech space were forced to adapt. In our Forecast 2021 series, we bring you reflections and predictions from prominent firms and thought leaders from the industry. Today, we’re highlighting perspectives from the world of market structure and electronic trading, with thought leaders providing their perspectives on the spikes in volumes and volatility, the key trends that define electronic trading and the most consequential market structure changes looming on the horizon. This is the second installment of the feature on Electronic Trading and Market Structure.

Rosenblatt Securities

A NY-based research and investment banking boutique and agency-only institutional brokerage firm

Justin Schack, Managing Director

2020 saw major spikes in volumes and volatility. What was your experience during this period and what have been the long-term effects?

On the whole, equity markets have handled the volatility and volume spikes very well — particularly during the first pandemic waves in late February and early spring, as the industry adjusted to remote work. That could bolster the case for remote and hybrid becoming more prevalent post-pandemic. More recently there have been some hiccups, particularly for retail brokers and non-US exchanges, that could bring more emphasis on systems integrity and backup plans.

What are the most important trends in electronic trading to keep an eye on in 2021?

The retail trading explosion, which is driving record off-exchange activity. During the pandemic, off-board market share has been in the low-to-mid 40% range, up from the mid-30s for many years. In the last week of November alone, we hit three daily records, peaking at 47.13% on November 27. Some actively traded names routinely exceed 50-60%. Institutions and other non-retail traders must adjust tactics accordingly. And with so much marketable flow executed bilaterally off-exchange, price discovery could be degraded. Should this continue in 2021, a new regime at the SEC may want to take note.

What’s the most consequential market structure change you’d like to see made in the coming years?

I’m usually the guy who says “it ain’t broke, so don’t try to fix it.” And even though markets continue to get more complex — with three exchanges and an unprecedented new order type debuting since September — I still believe that. It may be worth exploring intelligent tick sizes, which could address some of the weirdness that results from $1,000 and $1 stocks being forced into the same penny-increment regime. Longer term, I’d consider harmonizing the two-tier system that regulates exchanges and off-exchange trading differently, despite them competing for the same order flow. That underlies a lot of the complexity that many critics find objectionable.

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Security Traders Association

A grassroots organization representing individuals employed in the financial services industry

Jim Toes, President and CEO

2020 saw major spikes in volumes and volatility. What was your experience during this period and what have been the long-term effects?

The major takeaway from 2020 is that U.S. markets demonstrated incredible resilience. While the record volumes and volatility in March and April were a live stress test, operations were overwhelmingly smooth and major buy-side firms and individual investors alike have continued to invest with confidence. The shutdown of physical trading floors and the rise of remote work added a degree of difficulty to this period. It has been a difficult year, but the silver lining for our industry is that we now have a roadmap for navigating challenges like these while protecting investors.

What are the most important trends in electronic trading to keep an eye on in 2021?

The advancement of trading technology continued its march in 2020, allowing more entities to connect and trade with increasing sophistication. We saw this dynamic play out in 2020 with the rise of retail investors, and it will be interesting to see where it goes in 2021. Another one is increasing regulatory scrutiny – in particular around post-trade surveillance – which has ratcheted up cost pressures on both sides of the Street and caused firms to look at their processes and systems with a more discerning eye.

What’s the most consequential market structure change you’d like to see made in the coming years?

We’d like to highlight a potential change to our market structure that we would not like to see. In October, New Jersey lawmakers proposed a financial transaction tax (FTT), a move in line with certain election-season rhetoric. This tax might sound minuscule, but the impact would be enormous – the sheer volume of activity in our industry adds up. Already, major exchanges have engaged in conversations about a potential move to Texas. In addition, an FTT would tax the savings of individual investors, making it more difficult to fund education, save for retirement and the like. Make no mistake: this would be watershed legislation that is being sold as a temporary two-year only tax to help a state experiencing a major budget shortfall. We at STA are committed to advocating against it to protect the long-term health of our industry and the economy at large.

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Themis Trading

An institutional agency brokerage firm

Joe Saluzzi, Partner & Co-Founder and Sal Arnuk, Partner & Co-Founder

2020 saw major spikes in volumes and volatility. How do you think most firms handled it, and what do you think the long-term effects will be?

Market participants mostly handled the volume and volatility spikes very well during 2020. The exchanges provided orderly platforms without significant outages, and they are to be commended. Major market makers have likewise performed well. The only participants that seemed to struggle have been newer market entrants focused on retail – one notable online broker encountered significant outages, where their clients could not get their trades done in a timely fashion.

What are the most important trends in electronic trading to keep an eye on in 2021?

Consolidation has been a driving theme in recent years. Market participants have become more concentrated – institutional brokers, data providers, market makers. Will this stifle real innovation and choice? Is it desirable for there to be only a few very large market makers? Is it desirable for the only substantial innovation to be in pricing schemes and latency reduction?

One trend we don’t particularly like is liquidity migrating increasingly to the dark (approaching 50%) – specifically not to dark pools in the traditional sense, but to liquidity providers in somewhat captured relationships. We believed this is not desirable for price discovery and transparency. Orders that are increasingly segmented and cherry picked in the dark will increasingly lead to displayed liquidity being less diverse and more toxic.

What’s the most consequential market structure change you’d like to see made in the coming years?

We remain today of the same opinion we had a decade ago – that payment for order flow is a perversion that increasingly degrades price discovery and fairness. Investors should not have to worry about intermediary incentives designed to be at odds with simple best execution principles.

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Tourmaline Partners

An outsourced trading solutions firm

Aaron Hantman, CEO

2020 saw major spikes in volumes and volatility. What was your experience during this period and what have been the long-term effects?

While our business has grown substantially in 2020, this result was not solely driven by the pandemic or the changes it brought in market conditions – rather, it was part of the ongoing larger growth story of outsourced and supplemental trading. That being said, the events of the past year did underscore our value to clients who used us in ways they previously had not. For example, many of our clients struggled to find liquidity during peak volatility. Our vast sell-side reach was put to the test and ultimately benefitted existing and new clients alike. In fact, these market conditions served to strengthen relationships between the buy and sell sides, especially for those who are highly connected, as there has been a significant uptick in high-touch trading. The pandemic has also highlighted the value of outsourced trading from a business continuity standpoint and made clear that remote trading can be a valuable resource when structured properly.

What are the most important trends in electronic trading to keep an eye on in 2021?

If this period of volatility persists, the conversation will focus on what is not trading electronically. With less liquidity, there has been more trading occurring off electronic venues and in a high-touch capacity. In this environment, there is no substitute for experience, expertise and deep sell-side relationships. Looking at electronic trading itself, heightened fragmentation has led to a growing realization that scale and reach are paramount. A growing number of buy-side firms are coming to understand these realities and the outsourced trading space has grown accordingly.

What’s the most consequential market structure change you’d like to see made in the coming years?

The closing auction in the U.S. is antiquated compared to other regions. It could be far more modern and electronic, allowing people to move their bids and offers much closer to the market close itself. This may require action from exchanges and regulators, both of whom can look to European markets as a model.

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Wells Fargo Securities
A provider of banking, capital markets and advisory solutions 
Rob Newhouse, Director, Quantitative Execution Desk

2020 saw major spikes in volumes and volatility. How do you think most firms handled it, and what do you think the long-term effects will be?

2020 was unique for a number of reasons – the ability for firms to handle the increased volumes and volatility in the public markets key among them.  Most firms in the institutional segment handled the increased volumes quite well – and in hindsight perhaps even better than expected – considering the need to distribute that data to resources spread across disparate, remote working environments.  Most bulge bracket sell-side entities handled the volumes and volatility well and to their own benefit, servicing customers without interruption throughout the volatile times of late Q1 and early Q2.  Anecdotally, it seems the retail trading space suffered perhaps a greater degree of instability than their institutional counterparts, due likely in large part to the difference in maturity levels of respective institutional platforms versus their retail analogs. Whereas institutional trading platforms have had previous historical events (e.g., 2008 Financial Crisis) as well as ongoing growth in order volumes/market data messages to help guide technology maturation, many formative retail platforms have had relatively fewer historical experiences to draw from, perhaps leading to some of the issues reported in the media regarding the stability of retail trading platforms throughout 2020.

What are the most important trends in electronic trading to keep an eye on in 2021?

I think there are two trends that seem to be gaining momentum within 2021. The first is whether newly introduced NMS venues can have any effect on the cost of colocation and exchange data feeds available from each venue directly; as they enter the market, new exchanges’ pressure on costs may lead to other exchanges following suit with decreased pricing structures, creating a catalyst for additional growth in near-venue colocation and low-latency distributed Smart Order Routing. Secondly, the maturity of data science and the focus on the space over the last 2-3 years seems to be providing real value in terms of algo feedback loops, where nascent data collection, reviewing and analysis efforts are bearing fruit in terms of algo performance optimization. Whereas ‘latency’ was the arms race of the past decade when speaking about electronic trading, the next decade may look at data-driven feedback loops as a more important competitive differentiator.

What’s the most consequential market structure change you’d like to see made in the coming years?

We’d greatly welcome a discussion around the newly formed NMS plan regarding Consolidated Market Data, and whether it might serve as a replacement for the existing CTA/UTP regimes. Such a plan is pivotal to the industry’s long-term growth, insofar as that access to market data is central not only to investors, but to financial technology firms that are designing and building new platforms within the capital markets system. Whereas one can argue whether the current plan serves its constituents well and even warrants replacing, a discussion around the plan, who it is meant to service and how it can best do so, is long overdue and should be welcomed by all participants.

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