Report Questions Depth Of UK Liquidity
Wednesday, January 26, 2011

New research published by TABB Group shows that only 65% of turnover in the UK, Europe’s largest equity market, is actually "meaningful and executable liquidity" with 35% consisting of “noise,” or reprints of already already-conducted trades.

Tabb Group's study also shows that cash trading is further diluted by a plethora of execution channels as well as alternative products, such as Contracts-for-Difference, and the true size of the investor market is masked by high-frequency trading.

“This new data demonstrates the true size of the market,” say Will Rhode and Miranda Mizen, co-authors of the TABB Group Pinpoint study, entitled 'Breaking Down the UK Equity Market: Executable Liquidity, Dark Trading, High Frequency and Swaps.'

According to Rhode, “this research should form the basis for considering regulatory change.”

The 20-page study was undertaken to shed light on the composition of liquidity in the UK equity market. To reach their estimates, the two TABB analysts took a "top-down/bottom-up approach" and used a wide variety of inputs, including public trade data, non-published data, TABB Group studies, and interviews with a range of market participants including brokers, trading venues, retail brokers, hedge funds, and institutional investors.

“We selected the UK market since it is the largest in Europe,” says Rhode. “It has a wide variation of order flow and channel usage, as well as the largest use of swap activity. We broke down turnover by execution channel, market participant and by cash equity/swap activity.”

The study sought to achieve five objectives: demonstrate how much of the daily traded turnover is made up of meaningful, executable liquidity and what is just ‘noise’; shed light on the make-up of the opaque, over-the-counter (OTC) market and help clarify the debate about this large part of the market; determine how much of the UK market is conducted in the electronic dark market; show the levels of activity amongst different market participants and establish how much turnover is attributable to high-frequency trading (HFT); and size the contracts-for-difference (CFD) market by determining how much UK equity trading is done on swaps versus cash and, therefore, how much equity trading is not subject to stamp duty.

As a result, TABB estimates that while OTC-reported turnover accounts for 45% of the market, less than a quarter of it is executable. The balance, says Mizen, is in fact comprised of reprints of already-traded turnover with 72% of executable liquidity being traded on the lit order book of an exchange or multilateral trading facility (MTF). Meanwhile, dark trading accounted for 11% of executable turnover.

High-frequency trading, the study found, accounts for 35% of the total turnover yet this activity is focused on the continuous markets – venues where trades can occur in a continuous, electronic fashion such as the lit- and dark-order books. While investors hold the balance in terms of market participation in the overall market, liquidity providers dominate the continuous markets with 77% of the flow, leaving just 23% made up of natural order flow. This, Mizen says, “highlights the need for investors to have alternative execution strategies to achieve best execution.”

The study also showed that EUR1.3 trillion of the UK turnover is CFD-related, representing 31% of total equity turnover, or half of the executable market in the UK.

“The combined effort of all these elements,” says Rhode, “is that the UK equity market is not nearly as deep as it may have at first appeared once you extract non-executable liquidity, or noise, and high-frequency trading from the picture.”