Following a recent FCA platform market study, which explored best execution and the role of market makers, Wealth Adviser took the opportunity of setting up a question and answer interview with Ben Jowett (pictured), head of business development & client sales at Winterflood Securities…”
How does market making in securities work on retail service provider networks?
A broker or asset manager looking to trade via the retail service provider (RSP) network on behalf of their client, sends a quote request electronically to several market-makers. All market-makers on that respective firms’ selected panel, and who deal in that stock, then submit their best price available for the requested size within a few milliseconds. Typically, the best price wins the order.
According to the FCA Investment Platforms Market Study Report, the RSP network has shown to return prices better than those published on lit exchanges approximately 80-85 per cent of the time. At Winterflood, independent analysis of our trades show prices are better than or equal to the lit exchanges 93 per cent of the time.
What securities are the market-makers commonly trading?
While other market-makers may choose to focus on their house stocks or sectors where they consider themselves experts, Winterflood Securities makes a market in virtually all stocks in the UK. We also support investors in trading broader instruments, including North American equities together with investment trusts, exchange traded products, exchange traded commodities, gilts and bonds. Winterflood is dedicated to providing continuous liquidity and committing capital in all the markets it operates in.
How has MiFID II affected this trading?
MiFID II has seen to it that order flow should migrate to available liquidity – the ‘contra-trade’. Firms tasked with the execution of orders are duty bound to ensure their clients have ‘good outcomes’ and must take ‘all sufficient steps’ to see their clients achieve best execution under the regulation. We have seen flow converge to execution specialists and move away from houses that were more focussed on research for example.
The EU regulation rightly insists on transparency from all industry participants, and one such requirement is that investment firms must publish annual reports which detail their top five trading venues. These reports offer unique insight into the venue choices of investment firms and provide a suggestion of the liquidity and execution quality available at these chosen venues, which include market-making firms. The reports highlight the important role market-makers play within financial markets, especially with regards to retail flow.
Genuine, client-centric market-makers have always had a key role in delivering on the spirit of MiFID II by generating value for investors when facilitating their business, typically at improved prices. Achieving best-execution means assessing several factors, not least price improvement. Investors benefit from high quality execution performance due to the market-maker’s ability to frequently improve on the benchmark price through capital commitment and diverse distribution channels.
What affects pricing for a market-maker?
There are various factors that affect pricing and spreads, including news flow, results announcements, sector sentiment, political events, macro-economic data and currency fluctuations. The frequency with which a stock is traded is usually a key indicator as to how tight a spread might be and how much ‘size’ that price is made in. There is a finite quantity of shares available at any given price point and this is the size the quote is made in. The size available is also related to the same factors that affect price as above. However, any size can be requested by the client and price quotes will reflect that available liquidity accordingly. The market-maker is obliged to not exceed a maximum spread within a set size as specified by the exchange.
What should asset managers look for when choosing market-makers?
A true market-maker supports the market throughout the trading day, come hell or high water. Whenever investors face an elevated period of event-driven volatility, such as Brexit, the speed and consistency with which market-makers create two-way liquid markets, by continuously quoting bid and offer prices, is often overlooked.
Asset managers should choose market-makers which best serve their clients’ needs. They must ask themselves: what would be the best outcome for my client? Best price, liquidity available, likelihood of settlement and speed of execution are four examples that need to be considered. Asset managers should look for Indications of Interest displayed by market-makers to see what order flow the market-maker may be working with, and should also access trade adverts showing which market-makers have been recently active in which stocks.
Asset managers also need to adapt to tech transformation in this time of unprecedented change. A good market-maker should harness technology to continually evolve its contribution. Being able to provide high quality functionality, often with bespoke solutions is important if a market-maker is to excel with its service offering. Powerful technology coupled with the expertise of experienced traders is the optimal blend for a quality market-maker to offer excellent client service.
What effect has recent volatility had on market making?
In our experience, the average retail trade size is approximately GBP6-7,000. Despite increases in volatility from time to time, good market-makers quote two-way prices in sufficient size throughout these periods. Arguably, volatility can be better for liquidity than a stagnant market. A high quality market-maker should have a comprehensive mix of liquidity from a diverse range of sources.
Institutional businesses, corporate programmes (often via registrars), retail order flow, platforms, hedge funds, family offices, dark pools and other trading venues, in addition to the market-makers’ own capital commitment, combine to provide the depth of liquidity required for an effective market dynamic and hence good outcomes for its clients.
What makes one market-maker better than another in this context?
As volatility returns to the market and macro fears loom, the depth of liquidity is more important than ever. A good market-maker will be there in all market conditions – not just in fair weather. Consistency of pricing and provision of liquidity that can be relied on from a range of sources, coupled with dependable settlement, is what can set a good market-maker out from the crowd.
