Link10 Nov 2018 17:41
Healthy competition
Mifid II has achieved a greater focus on the quality of trade execution, which is welcomed by platforms where this is an area in which they are competitive. Hargreaves Lansdown uses 32 market makers to get the best quotes for clients and Barclays Smart Investor scans up to 20 market makers on any one trade – a process they say helped improve prices on 90 per cent of trades in the 2017-18 financial year.
Where there is competition and liquidity on the order book, private investors aren’t getting a bad deal. The LSE rules on market maker obligations have been updated since Mifid II and there are obligations placed on registered market makers to honour the quoted spread in order-driven markets at the normal market size (NMS), which is calculated at 2.5 per cent of a security’s average daily turnover over the previous 12 months and reviewed quarterly.
Technological innovations at the LSE also help private investors, with safeguards against irregular trading activity including active market surveillance and algorithms monitoring order flow. Some innovations are designed to make the exchange more attractive as a listing destination and some participants have questioned whether they confer any benefits to investors. For example, the quote-driven market maker intra-day auctions that occur on SETSqx, the LSE’s order book for small-cap shares, have been described by one institutional-facing market maker as having no added benefit above and beyond trading on the order book. This feature does offer a degree of flexibility for quote-driven pricing that helps differentiate the LSE from competitor exchanges such as the Chicago Board of Exchange (CBOE), which may suit some companies looking to raise capital.
The advantage of a quote-driven auction is that all orders will get filled – but it’s literally a seller’s market. In an order-driven market, the market makers are obliged to fill the NMS, but if a flood of orders bids up the price then a new equilibrium must be found. If investors have placed a limit order (put a ceiling on what they’ll pay) with their buy-side broker, then their order won’t get filled. The auction may be needed to flush out more sellers to increase supply of an illiquid stock – but, clearly, this won’t be at the same price that private investors initially saw quoted.
Brokers are cutting down their research teams, and fewer companies – especially in the small-cap space – are getting coverage
Regulation has benefited small-cap investors, but there is a downside
In the past, there were complaints that some retail brokers were all too often offering execution at prices outside of quoted spreads. There has always been an obligation to offer best execution, but now, thanks to Mifid II, the scrutiny brokers are under – especially with RTS 28 requiring transparency on how orders are routed – means there is a lot less s
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