By Stuart Thompson, Head of Execution and Quantitative Services APAC, Liquidnet
What are conditional commands and what problems do they solve?
Stuart Thompson, Liquidnet
Conditional orders are orders that allow a trader on the buy or sell side to maximize their chance of crossing a block. It does this by posting an effectively executeable indication of interest (IOI) in places that may support it. The simplified thought behind this is: The more venues there are, the greater the chance of encountering counter-liquidity.
When a contra is detected, a corresponding freeze request is sent to the trading venue, converting the conditional order into a firm order ready for execution.
Conditional orders allow traders to place their parent order on different trading venues at the same time. For example, if a trader holds an order for one million shares of HSBC, that one million shares could be represented in as many pools that support conditional order types and in the entirety of the order without having to split it into fixed sections.
This conditional ordering approach offers a number of advantages:
-Increased opportunities to execute a block by using different sources of liquidity in fragmented markets;
-Allows traders to execute an order in lighted markets And never miss a block opportunity (not even in the dark);
-No interruption of the planning of an algorithm;
-Reducing market impact by minimizing information leakage and potentially shortening the order time horizon – thereby reducing market risk due to block size; And
-Smoothing inefficiencies when publishing firm orders.
CONDITIONAL ORDERS TO ASIA PACIFIC REGIONS
Conditional orders in Asia are still in the early stages. Outside of APAC, they have been integrated into dealer workflows across Europe and America for some time. Regulation has been a key driver of adoption in Europe as market structure reforms such as MiFID II have placed increased focus on innovation in venues/exchanges and brokers to meet best execution expectations.
Banks and other brokers have historically had their own iterations of conditionals, sometimes referred to as “shadow posting” among other things. The forthcoming further market entries in APAC have acted as a catalyst for a greater interest of all participants (buy and sell side) in stronger interconnectivity of the brokers.
New venues (and exchanges) serve to further accept conditional venues. Overnight and cross-border traders are also more aware of and more open to adopting other regional order types.
CONNECTION TO CONDITIONAL VENUES
Depending on the workflow, there are several ways to connect. Dark pool aggregators such as Liquidnet’s dark strategy would provide conditional access to their ‘in-house’ liquidity pool as well as to other trading venues, effectively stitching together the evolving liquidity landscape.
Broker algorithms can access conditions and optimize the way liquidity is accessed depending on the benchmark being looked for. Blotter scraping and block venues allow conditional access to the pool of front-end applications as well as the ability to negotiate a trade.
THE CONDITIONAL CHALLENGE: MEASURE QUALITY
A key challenge will be to adjust the perception of portfolio managers and investors to trading blocks “at a price”. Conditional orders trade at a price in a region where 40% to 50% of orders on a given day, in this case APAC, trade at the volume weighted average price (VWAP). For conditional (and dark) orders to be successful, benchmarks and trading strategies need to be changed or adjusted.
Measuring conditional performance and communicating it to buy-side buyers and their portfolio managers can be done through impact models that show “basis point savings” in real monetary terms. Another useful tool is reputation scorecards – how are companies actually performing and ranking in venue booking? With the application of market impact analysis, reversals, and venue toxicity, determining which conditional venues outperform others becomes even more complex.
A fixed 70% up-rate is expected across Liquidnet’s European pool, which will be actively monitored over time, while other pools of competitors have much stricter intra-day criteria.
OPTIMIZE CONDITIONS
Based on Liquidnet’s experience in the established EMEA and US markets, we can conclude the following:
-It is crucial that all market participants enter the market in a staggered manner, preferably when first routing to the market. This comes in handy when an order goes out of limit and back into limit, reducing the negative impact on fixed rates across venues (especially as more venues offer conditional opportunities).
-When selecting the stagger order (i.e. which markets we visit in which order), we prioritize our Liquidnet pool based on performance and return, then randomize the order of the other venues broadcast. It is evident that this logic works well in a mature conditional landscape. As the APAC landscape has only just reached early adoption, the approach will be better aligned to assess new venues on entry, performance in terms of occupancy rates and impact on the market. This flexibility will determine whether adjustments are needed for a more stringent prioritization mechanism.
-When there are multiple companies for the same order from different locations, Liquidnet will currently accept the first firm order that is received.
As the search for liquidity with conditional orders continues, expect greater broker interconnectivity, further innovation around Market-on-Close (MOC) and VWAP, and the addition of more pools.
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The information provided by Liquidnet does not constitute investment advice, nor is it intended as a recommendation to buy, sell or hold any of the instruments mentioned. The analyzes provided are not sufficient to make an investment decision. A recipient should consider its own financial situation and investment objectives and, if necessary, seek independent advice before making any investment. While the statements provided by Liquidnet are believed to be accurate, they have not been verified and should not be relied upon in considering the merits of any particular investment. All data shown may be subject to minor deviations.
The information provided by Liquidnet is for use by institutional investors and is intended only for the recipient. Any disclosure, reproduction, distribution or other use of the message or the information generated by the product by any person or entity other than the intended recipients is prohibited. For more information on the information and analysis provided here, please contact your Liquidnet representative.
© 2022 Liquidnet Holdings, Inc. and its subsidiaries. Liquidnet, Inc. is a member of FINRA/SIPC. Liquidnet Europe Limited is authorized and regulated by the Financial Conduct Authority in the UK, licensed by the Financial Sector Conduct Authority in South Africa and is a member of the London Stock Exchange and a remote member of the SIX Swiss Exchange. Liquidnet EU Limited is authorized and regulated by the Central Bank of Ireland and is a remote member of the Warsaw Stock Exchange. Liquidnet Canada Inc. is a member of the Investment Industry Regulatory Organization of Canada and a member of the Canadian Investor Protection Fund. Liquidnet Asia Limited is regulated by the Hong Kong Securities and Futures Commission for Type 1 and Type 7 regulated activities and is regulated by the Monetary Authority of Singapore as an Approved Market Operator. Liquidnet Japan Inc. is regulated by the Financial Services Agency of Japan and is a member of JSDA/JIPF. Liquidnet Australia Pty Ltd. is registered with the Australian Securities and Investment Commission as an Australian financial services licensee under AFSL number 312525 and is entered on the New Zealand Financial Service Providers Register (FSPR number FSP3781). Liquidnet Singapore Private Limited is regulated by the Monetary Authority of Singapore as a Capital Markets Services Licensee, CMSL number CMS 100757-1. Liquidnet Holdings, Inc. and its subsidiaries are part of TP ICAP Group plc.
This article first appeared in the Q4 2022 issue of GlobalTrading, a publication of Markets Media Group.
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