TABB Group

The Rise of Conditional Orders Post-MiFID II

The International Equity Trading benchmark research study for 2019, conducted by TABB Group, found that 79 percent of firms are using conditional orders to source liquidity for their clients. The trend is expected to accelerate further as more than 30 percent of these traders plan to increase usage in 2020.

Campbell Peters, US Equity Market Structure Analyst at TABB Group, commented:

“When looking at the response weighted by each firm’s US Equity Average Daily Volume, the response grows to a very impressive 95% of firms using conditional orders. Further, no one said they planned to decrease their use, proving that while there has been tremendous adoption of conditional orders among buy-side traders, we will continue to see buy-side growth.

Peters, who authored ‘Conditional Orders in Equity Trading’, added that this use of conditional orders to aggregate systematic internalizer (SI) liquidity could have implications outside Europe: “If the MiFID II rules around dark trading and SIs expand to the US, there will be an even greater demand to aggregate dark liquidity among various venues.”

MiFID II restricting rules on dark pool trading were designed to bring the majority of trading across Europe “on-venue” to either an existing Regulated Market or MTF or alternatively onto a new venue type, an OTF. Steven Maijoor, Chair of ESMA, explain the pro-transparency regulation aims to provide the right amount of transparency that contributes to efficient price formation and to a level-playing field between the different types of trading venues while avoiding adverse market impact.

In December 2018, the Commodity Futures Trading Commission (CFTC) issued an amended order that exempted four United Kingdom-based MTFs – Creditex Brokerage LLP, Currenex, FX Connect, and Thomson Reuters – from SEF registration. By the end of 2018, there were 20 EU-authorized trading venues, MTFs or OTFs. The CFTC grants an exemption from SEF registration if it determines that a foreign facility is subject to comparable supervision and regulation by the appropriate governmental authorities in the facility’s home country.

Portfolio managers use conditional orders to search for hidden block liquidity without fully committing to trade, as they allow the trader to represent larger orders in multiple venues without the risk of being simultaneously executed in multiple trading venues.

Advanced algorithmic interaction between liquidity-seeking broker algos and Alternative Trading Systems (ATS) has given rise to conditional orders, which are routed in two variants: simultaneous venue routing and sequential venue routing.

The research study found that venues are increasingly looking to use conditional orders with volume weighted average price (VWAP) execution algorithms, which result in smaller conditional print sizes.

Conditional orders started out as mechanisms to trade blocks and are now becoming a trend in non-block size trading (100-1,000 shares) among more sophisticated portfolio managers who use liquidity-seeking algorithms for moving considerable size.

These type of orders have pivoted to be the de facto method for aggregating liquidity in a decentralized marketplace: “Marketplace fragmentation isn’t going away, as SI volume has grown to nearly 10% of the total off book volume in Europe since MiFID II was implemented”, Peters added. “By addressing the needs of the buy side and beyond, conditional orders have demonstrated their value, which is why we expect they’ll become ubiquitous on institutional equity trading floors.”

Under the MiFID II framework, no mechanism is provided to determine the SI status. This generally becomes a problem for asset managers and hedge funds who have not built the infrastructure needed to support reporting and rely on their SI counterparties for performing those functions.

Companies following the MiFID II SI regime tend to offer a comprehensive suite of SI services which include real-time public quoting, network access, bilateral trade matching and real-time trade reporting, standardized market data and order entry interfaces, which reduces connectivity costs and provides interaction via a technology provider considered to be trusted and reliable.

In 2018, FlexTrade Systems integrated SmartStream RDU with FlexTRADER Execution Management System (EMS) to allow mutual clients the ability to embed SmartStream RDU’s Systematic Internaliser (SI) Registry information directly into the send order ticket.

The same year, SSW, an innovative pan-European liquidity provider in a very broad universe of instruments, started its Systematic Internaliser (SI) business by utilizing Cboe Europe’s SI connectivity and bilateral facilitation service.

Also in 2018, Imperative Execution launched a dark pool to actively solve the problem of minimizing market impact. Nasdaq Stock Market introduced a new order type to help institutions gather more liquidity. Luminex Trading & Analytics is running a buy-side only block execution facility, which has gained traction over the past three years.