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Whose Liquidity Is it Anyway?

Two events this week crystallised the need for better pre- and post-trade information.

Firstly, BATS joined ranks with Chi-X to question the LSE’s decision to set its market to auction mode during its recent outage.

In a related white paper on the subject BATS also claims that “it is questionable whether the market was orderly on the LSE given publication of data which did not represent legitimate trading interest or available liquidity”. It would be interesting to find out, therefore, why the LSE decided to put its market into auction this time rather than suspending it altogether (as it has when it has suffered previous outages). But, whatever the LSE’s motivations were, you only have to look at the widening gulf in fragmentation between the LSE and other European primaries to see how critical the battle for liquidity in London has now become.

The crucial issue, however, is agreeing a mechanism to provide the market with a pre-trade tape of prices that has an agreed “market outage protocol”, an agreed standard for deciding on fungibility, and a means of determining which venues to include or exclude from the tape. Without this it would seem that effective price formation when a primary market is down is still some way off. This is especially the case when there is uncertainty over if or when the primary market will reopen (a point that is acknowledged in the BATS white paper). Anyway, rather than deliberate on this, the guys at Fidessa Towers and I thought we would take the “ask the audience” option and allow you to make your views known to the trading community at large.

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The second development was the announcement that Nomura is going to reclassify its dark pool (NX) as an MTF and adopt a more transparent approach to publishing post-trade information by publishing its trades to Markit BOAT. Whilst Nomura is to be applauded for playing the game, it’s still only a partial solution to the problem. Other broker dark pools, such as BlockMatch from Instinet, have taken the MTF high ground, too, but still report in a different way (BlockMatch trades are printed to the Chi-X OTC tape, for example). The net result is that it is still pretty hard for the chaps back at Fidessa labs to assign all these dark trades to the right categories. This point was highlighted by CESR chairman Eddy Wymeersch who commented in the FT Trading Room article “we have very contradictory figures with regard to dark pools”. Maybe I’ll ask Santa to put a Fragulator in his Christmas stocking.

A point that all venues (primaries, independent MTFs and broker dark pools) need to remember, however, is that it’s not actually their liquidity in the first place. Markets have always been about trying to bring together willing buyers and sellers in order to meet the needs of both. So, in reality, liquidity belongs to them and not to the venues. What we need, then, is a clear set of rules for both pre-trade price dispersal and post-trade reporting. Only then will the real liquidity owners (market traders) be able to get a fair deal out of MiFID.

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