Trading Technology

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Simmy Grewal, Aite Group Analyst
Simmy Grewal, Aite Group Analyst

How Electronic Can Europe Get?

While the U.S. has led the world in the adoption of electronic trading, Europe is quickly catching up, driven by MiFID and the subsequent explosion in fragmentation.

Over the last few years, electronic trading within equities has become commonplace in Europe. Since the widespread adoption of the FIX (Financial Information eXchange) Protocol, organizations have been developing algorithms to automate the execution phase of the trading process. The introduction of the Markets in Financial Instruments Directive (MiFID) in November 2007 only spurred clients’ reliance on brokers providing algorithms and smart order routers due to an increasingly fragmented European landscape.

While the United States has led the world in the adoption of electronic trading, with nearly 70 percent of its equity order flow being executed via algorithms and direct market access (DMA), Europe is quickly catching up, driven by MiFID and the subsequent explosion in fragmentation.

In the last two and a half years, multiple European execution venues have emerged as a direct result of MiFID, including MTFs and dark pools. With faster systems and infrastructure, these new destinations have led to a proliferation of technology-savvy, latency-sensitive high-frequency traders.

As these new types of clients emerge and traditional clients become more sophisticated, brokers have had to amend and adapt their offerings to suit the individual and unique needs of their diverse client traders. Brokers have expanded their traditional, simple benchmark strategies into strategies that incorporate dynamic, real-time variables, customization, and low latency infrastructure.

In today’s market, we can see a clear difference in algorithm adoption rates from client to client. It would be tough to find any high-frequency traders in Europe that do not use algorithms — whether their own in-house algorithms or broker solutions — and DMA. A much smaller percentage of traditional long-only institutional equity flow regularly utilizes this resource.

Traditional institutional firms have a wider standard deviation of algorithmic adoption than high frequency trading firms; some institutional funds execute nearly 45 percent of their flow via algorithms and DMA, while others execute merely 15 percent of their flow this way. Aite Group estimates that slightly more than half of European equity volume is executed via algorithms and DMA. This estimate takes into account the interaction of buy-side traders with their sell-side brokers, but excludes any client trades that a sell-side broker may receive via a sales trader and then place in an internal algorithm.

As traditional clients become more accustomed to the fluctuating European landscape and adapt to the evolving technologies available, we will see a significant uptick in the volume executed via algorithms and DMA. In addition, as liquidity returns to European markets and frictional costs are removed, we can expect an expansion of high-frequency players.

Over the years, as clients have become more knowledgeable and comfortable using algorithms, distinct visible trends have appeared as to the types of algorithms they utilize. With the marked increase in volatility over the last year, clients are steering away from traditional strategies in which a trading schedule is determined using historical volume data. These types of algorithms have become less and less reliable in fragmented, fluctuating markets, which currently favor more dynamic strategies that adapt to current market conditions.

In response to this natural evolution, brokers are hard at work designing less historically dependent algorithms and focusing on strategies that incorporate real-time variables and that adjust trading strategies dynamically. However, there are a multitude of algorithms available to buy-side traders in today’s market, often with creative names that don’t make it easy to establish what exactly these algorithms do.

In recent years, customization has become very popular with clients, making it necessary for sell-side firms to offer this service. Client traders adapt sell-side algorithms to mimic their own trading behavior and style, and may also use them as a means to evaluate sell-side offerings. By providing each of their brokers with a list of functionality and parameters for customized algorithms and then comparing how each customized broker algorithm performs, clients are able to compare apples with apples.

About the Author

Simmy Grewal is London-based analyst with Aite Group focusing on European market structure. Her latest report, “The European Equity Electronic Trading Market: How Deep Is Your Pool?” gives a comprehensive overview of equities electronic trading in European, detailing nuances particular to the European market, and providing Europe-centric profiles of brokers that provide equity electronic trading.

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