The Latest on European Equity Market Structure Part I

PETER HAYNES: Welcome to TD Cowen's podcast series Bid Out, a market structure perspective from North of 49. My name is Peter Haynes, and today we will cross the pond for the first of a two-part series covering the latest on European market structure. Helping us understand these dynamics are two long-standing experts on market structure in the region. James Baugh from TD Cowen's London office and Dermot Dunphy from global investment manager M&G.

In this episode, number 60 in our ongoing series, we cover changes in the anatomy of a trade from when Dermot started his career at M&G in 2001 versus 2024, the threats to the LSE's dominant position as a capital markets hub, and a one-on-one on some market conventions and sources of liquidity that are unique to Europe and the UK.

In Part II, Dermot and James discuss the arrival of Robinhood to Europe, accessibility of end-of-day auction volume, the move to T+1 and a renewed push to shorten the trading day, and finally, the possibility of a central regulator for Europe and in a perfect world one central listings venue for all EU countries. We hope you enjoy the discussion. Coming at you right now is episode 60, Part I of this two-part series. James, Dermot, thanks for coming on the podcast.

JAMES BAUGH: Thanks, Peter, and really good to get involved.

PETER HAYNES: Well, I know you two are sitting in the same room, which I think might be a little dangerous, given that the Six Nations Rugby Tournament just completed. And on the one hand, England beat Ireland in the matches. But on the other hand, Ireland won the overall table. So Dermot, what's more important, winning the table or beating England?

DERMOT DUNPHY: I think winning the table, definitely winning the table. We'd much rather have got the grand slam on the run. But yeah, definitely winning.

PETER HAYNES: And James?

JAMES BAUGH: Yeah, I think-- yeah, look, I was going to say I think Ireland were running out of steam, one more game and that, but in the end. And I think given that England did beat Ireland, I think you might start to see Ireland on the ropes next time out.

PETER HAYNES: I'll look forward to that ongoing debate between the two of you, and I know both of you are passionate about rugby, and as am I. So congrats on a great tournament. And as we were saying before we started, the scores were so close. And of course, England managed to blow it on the weekend against France. So let's move on here.

And just before we get started, though, I would like to ask each of you to provide just a bit of a background on your careers. James, I'll start with you, and then we'll pass it over to Dermot.

JAMES BAUGH: Yeah, sure. Thank you, Peter. So I guess we're going back a few years, but I started out my career from university as a commodity analyst. I did a short stint at Dow Jones, running their Power Index business before I flipped over to equities. And yeah, I guess most of my growing up, if you like, most of my career, particularly in respect to market structure, was at the London Stock Exchange.

And yeah, I suppose my timing there was interesting to say the least, in terms of being part of what was significant regulatory change in Europe with MiFID, MiFID I, removal of the concentration rule, introduction and competition in secondary markets and equity trading. And latterly, I was running the secondary market, the trading business there. And I was also responsible for the turquoise business.

So hopefully, that kind of lends itself to my next stint, which took place at Citibank. I was there for nearly five years. And I kind of moved specifically then into a market structure role, particularly focused on MiFID II. And that was an absolute, again, dream opportunity to be part of a business, and thinking about, I guess, how you commercialize regulatory change, how you ready your business, if you like, all of those impacts.

And then, yeah, I was lucky enough to come over to Cowen. As you said at the outset there, I'm now part of Toronto-Dominion Bank and do, I suppose, a not dissimilar job, focusing on market structure. But what's super interesting here at TD Cowen is that very much like yourself, Peter, market structure being at the center of all of the equity business, particularly the electronic low touch business, how we think about our liquidity strategy, how we get in front of others.

So again, great opportunity. And hopefully, it lend itself to some interesting chat on the podcast.

PETER HAYNES: And Dermot?

DERMOT DUNPHY: For me, it started 25, 26 years ago. I was working at Robert Fleming, one of the old British merchant banks. I started off in settlements and progressed through onto the dealing desk as a junior. And then I moved over to M&G 23 years ago in 2001, started on the centralized equity dealing desk there, specifically starting in smaller companies, trading smaller companies for the fund managers in Europe and the UK.

And then we started to also trade some convertible bonds on the back of that. So it was an interesting and new challenge for us. A few years into that, the desk changed again slightly, and we all as a desk started to trade globally. So we were trading full spectrum of market caps, from large to the micro small caps. And we were trading everything, from Japan, New Zealand, all the way over to the US and Canada.

And I've been there ever since. It's progressed, it's changed. The infrastructure we use has changed. The people we speak to have changed, although we still speak to a few of the same old faces from way back in the day. But the way we do our business has changed an awful lot, and the way we communicate with our brokers has changed an awful lot.

And the way we think about the market and people like James and Jen in New York and their knowledge of the market microstructure really does help us. And that's something that we take on board an awful lot, helps us with questions that we then go and ask other people.

PETER HAYNES: Now, James, I find it really interesting that the catalyst for your career to move to the sell-side was MiFID. It was a catalyst event, and it was an event that required the sell-side to have dialogue with the buy-side on market microstructure issues. We had a similar, really seminal event in North America, which obviously cascaded to Europe, too, but it was the Flash Boys book back in 2014.

I'm sure Jenny would say the same thing that that was when buy-side desks really dug in on the microstructure and the plumbing of the market. Whether you liked what was in that book or not, it was a catalyst, I think, to have everybody sort of focus more on these issues as they become more important and as trading becomes more complicated. And so with that, Dermot, why don't we start 23 years ago when you were at M&G in 2001?

And I want a really simple example to just talk about how the business has changed from the chair you sat in then versus now. So I'm going to use an example. In 2001, your portfolio manager wants to buy 500,000 shares of what was then known as Shell, which is now known as Royal Dutch Shell, which is an LSE listed component of the FTSE 100. How would you have handled that order in 2001 versus now?

DERMOT DUNPHY: Back in 2001, on the basis that we do all the usual checks that we still do now, have a chat with the fund manager, have an idea as to what the fund manager wants us to do with the order, their view on stock, their view on the market, and any events such as index changes or any big economic data, it's all just a plain vanilla day.

Back then, look on the IOIs, see who's out there. If there's an obvious call, pick the telephone up and just place the order with them. Can I get risk? Can I get a market maker to fill me in the whole piece? If not, we can't do that. There's no actual IOI. There's no way to work it. Then we just leave it on a third of the volume, third of the volume, 30%.

That was deemed a safe strategy back then because everybody else was doing it. That was pretty much the way it worked back then. And obviously, at the end of the order, you then get a telephone call to say, this is how many you bought. And you put it into your order management system and process it. Whereas now, today, I'll pick the order up. I'll be looking at the ADV of the order, how much of the percentage of the ADV is that going to be for me today.

In Europe, I'll be trying to look at my consolidated tape as best as I can, as I kind of put that together on Bloomberg, depending on how much we spend to get all the different fees of all the different venues. And I'll look at that, I'll think about what I want to do, how do I want to approach it. Again, I'll look at the IOIs. Is there an actual IOI that I can go to, that I can possibly do it in one click? If not, then I go into the waterfall of choices.

So I'll probably look at the dark pool and the matches, and I'll see if I can get any matches with natural on the other side and get the order done that way. If not, then I'll start looking at the risk IOI. So I'll look at which brokers are putting risk up. And the risk dynamic has changed very much from 2001 to current days. I think the size that we would be able to get risk in has definitely diminished over the years.

So it would be unlikely I'd be able to get the whole order done in one click at the current moment. I then have a think about, if I want that risk and where I work with the risk, if I'm going to have to sit and wait for a central risk worker or for a market maker to get out of their risk first without delaying me. I may then decide, well, actually, do I want to work with myself or just put it into an algo?

And again, I'll be looking at the algos. I'll be thinking about my strategy. Do I want to have it in a dark-only strategy, that will sit under the radar slightly, that will only just go to various sort of pools? Or do I want to be slightly more aggressive with that strategy and open it up to a few of the other lit volume? And then also, do I want to expose it to the Systematic Internalisers at banks or the ELP SI? I decide which one of these strategies, how much I want to go with it and I want to do.

Then I'll make my decision. I'll put it in the market. I'll have it working. And maybe I'll go with a high-touch broker, such as [INAUDIBLE] and I'll leave it with the high-touch broker. I'll discuss with my contact here what I want to do, how we want to do it. We'll start working it. And then I'll sit there, and I'll look at every single fill that comes in. The fill comes in, it'll have my FIX tag 30.

I can see the markets, the venues that the smart order router that you guys use is going to. I can start to look at where we're getting fills. And then I can have a discussion with the sales trader and maybe try to amend our strategy, speed it up, slow it down, and discuss whether or not we want to put more of a focus on the dark pools or how we want to manage the order. So, yeah, quite a big difference the way it used to be.

PETER HAYNES: It leads to a couple of interesting follow-ups. But the first one I want to ask, though, is are there nuances about how you'd manage that order if it was, say, Vivendi in France versus a FTSE name or a Dutch name? Like, do each of these individual countries within Europe have their own nuances with respect to how you would handle that type of order?

DERMOT DUNPHY: There's minor differences. But generally, it would be a similar process between a French large cap and a UK large cap. Pretty similar.

PETER HAYNES: OK, and then the other follow-up question I have, which you mentioned risk is way down relative to your start of your career in 2001. My experience is risk has been cyclical. And then maybe that's a made in Canada issue in terms of when the banks are willing to be risk on or have willingness to commit capital. Have you found it cyclical over that 23-year period? Or is it linear straight down, meaning it's just been continuously reduced amounts of risk that brokers are willing to commit to your orders?

DERMOT DUNPHY: I would say it's been slowly decreasing over the years. There will be-- as you say, there will be certain points where people may be a bit more encouraged to try and provide some risk to you. But generally, I think the risk appetite has gone down. I think the overriding risk suppliers have changed in Europe, particularly in the last 5 to 10 years.

I think with the amount of risk that we get, where it comes from the balance sheets that's supporting the risk has definitely changed. And it's a very, very different ethos to our risk providers than there was.

JAMES BAUGH: So fair to say it's got concentrated to maybe a fewer larger firms. Is that correct?

DERMOT DUNPHY: I think a fewer larger firms and also the way the risk is managed at the firms, it's very, very different. Going back to when I first started, if you walked onto the trading floor of most of the bulge banks as such, you'd see a plethora of market makers. If you looked at the oil trade, the oil sector, you'd probably have two, maybe even three market makers just making prices in oil. Whereas these days, I think if you went and sat with market makers, it would be very, very different picture. There'd be a lot less.

And the way that the books or the position our books are allowed to take and the positions they're allowed to hold have decreased, I suspect, in value. It feels like when we look at it.

PETER HAYNES: We're going to dig in on some of the changes to the specific liquidity providers a little later on in the podcast. James, you mentioned that you spent a significant part of your career working for the LSE. Today, the LSE faces an existential threat from primary UK listings that are migrating to the US market in search of higher valuations. I'll just list a few.

In the last year, we've seen CRH move to the US. Ferguson and then Smurfit also did a merger, which I think was in part due to the fact that the merged entity would have to be US-based and have a higher valuation. And then more recently, you had the very high profile IPO of ARM Technologies, which was an LSE-- or excuse me, a UK company that went straight to the US as a deposit receipt.

So make no mistake, the threat of the US, essentially, gravitational pull of its market towards any other jurisdiction is a threat to every domestic market that's not known as the US. And that includes Canada, although we have our own issues here in Canada that are a bit different. So the UK government's involved in working with the LSE, and there were some developments on this file, as recently as last week, with Chancellor Hunt's budget.

What are the steps being taken locally to offset this, as I say, gravitational pull of the US market to keep some of the UK's primary listings and potentially future IPO staying local?

JAMES BAUGH: Yeah. I mean, I think it's great that the government and quite a number of folks in the industry are very much focused on this now. It seems that we've been backpedaling for a period of time, and it was somewhat concerning that we were seeing all of this business, as you say, migrate to the US and in the secondary markets. We're still very much challenged by this kind of liquidity shortfall, which as you say, we can touch on in a bit.

But yeah, so I think there were a number of things that came out of the budget, which I think we should all be positive on here in the UK, at least. And some of this was echoing the comments that we heard I think at the backend of 2022 as part of the Edinburgh Reforms. But let me just kind of highlight a few here and in no particular order. And there's a few acronyms, so I have written it down.

If it sounds like I'm reading it out, it's because I probably am. But first of all, there was the announcement of this initiative called PISCES. And it's an acronym, so it stands for Private Intermittent Securities and Capital Exchange System. So this is a proposed sort of centralized platform sandbox, if you like, to trade existing shares of private companies through intermittent trading windows.

Now, obviously, the devil is always in the detail, but essentially the idea here is to give broader access to investment pre-IPO. So when these firms do come to market, ideally, they'll be looking at London as their destination of choice. So that's one initiative. Second initiative I've got down here, which I think is quite interesting, is focusing on UK pension funds. The concern here is that the allocation to UK stocks should be, could be much, much higher.

And therefore, there's a consultation which will look into providing greater transparency and disclosure of country holdings. And we may see some level of enforcement, whether that's a percentage threshold or otherwise, for UK pension funds to invest in UK stocks. Third one on my list here focus on retail. There's various discussions, interest on retail. And again, I'm sure we'll touch on that in a second.

But one proposal is what has been referred to as a British Isa. So today, there is a certain amount of money you can put into a savings program, so the stocks and shares savings account, which is essentially tax-efficient. What they're talking about here is adding another amount of money you can invest into UK names, which again seems eminently sensible to me to kickstart a bit more interest, retail interest in UK names.

So that is sort of the three focus areas for the government. There's various other bits and pieces around the periphery, if you like, trying to encourage more turnover, more interest in perhaps retail-driven names, particularly in small and mid-cap names. So here I'm thinking about the repeal of the research unbundling rules. And I'm not sure whether it will get to it, but we can all, I guess, discuss the pros and cons of that particular initiative.

But nonetheless, it could be an opportunity to provide some free research into retail to generate a little bit more interest there. So, yeah, really good to see some I think fairly, say, obvious initiatives that are only obvious in retrospect. But nonetheless, good to see some focus there.

PETER HAYNES: Yeah, the pension issue is one that we're facing here in Canada, pressure on the Canadian pension funds to own more Canadian stocks with a massive amount of pushback. And that is something that's very high profile and government-driven. A couple of follow-ups for you, James. Nowhere in there did you mention the repeal of the stamp tax. What is the potential latest on that?

Obviously, there are workarounds with CFDs and other things, but it's a nuisance. And then secondarily, more of a subjective comment, how much of this LSE migration issue do you blame on Brexit, if any?

JAMES BAUGH: OK, so let me answer the first question. There is no mention of stamp that I'm aware of. And it is-- I wouldn't quite say the elephant in the room, but it's certainly something that gets debated and discussed in various public forums way back. I was part involved in some of the conversations in focusing on getting stamp removed from the growth stocks in the AIM market. And that took forever and a day as well.

And regardless of that, I'm not sure the Chancellor is looking to take stamp off the table right now. In terms of Brexit, I mean, again, I think it's somewhat subjective and a matter of opinion. I don't really see that it's had a direct impact on this sort of flight of issuance to the US. There's no doubt that from a secondary market perspective, it's not particularly helpful when we start looking at convergence and divergence of regulation.

I know when speaking to colleagues in North America, when they look to Europe, it looks a very complicated landscape. I mean, not just in terms-- as to what terms is described in how he looks to execute his business. But when you layer on top of that regulatory fragmentation divergence, it does become even more of a challenge. So not helpful, but I think, really, it's the macro conditions. It's the, let's say, value versus growth story here in Europe, in the UK, which I think is what's leading to that flight of business away from these shores.

PETER HAYNES: And I feel like we have to admit, outside of the United States, that they're winning. And it's not healthy for any domestic market to lose large cap names or even any names to the US. And we'll see whether or not this trend can be reversed. I worry about it for sure. So Dermot, let's carry on from our earlier talking point about how you've evolved your execution strategies over time.

Most of our listeners are familiar with North American conventions in Europe. There's some different terminology. So I'll ask you just to provide a little bit of perspective on how buy-side investors find contra liquidity in multilateral trade facilities, MTFs, that some cases use periodic auctions, and then also through the bilateral liquidity provision, excuse me, on facilities known as, quote, "Systematic Internalisers." Can you explain to our listeners how MTFs listed venues and Systematic Internalisers all fit together to help you achieve best execution?

DERMOT DUNPHY: Yes. Well, I mean, the MTF is pretty much the same as the ATF in the US. So that's an easy one to kind of grasp. The Systematic Internalisers are similar to risk, but it's slightly-- it's a lot more electronic and as the name suggests, Systematic process in which you interact with them. So they'll be providing quotes continuously to brokers generally. Occasionally, we do have a few where they'll provide the quotes directly to the buy-side, and we can interact with them directly.

But generally, with most of these, it's through our brokers that we look at this lens. And all the different choices, whether it be the Systematic Internalisers, the periodic auctions, the listed venues or the MTFs, we rely very heavily on the brokers. We rely on the broker's smart order router. And then we also rely on being educated, so we spend time speaking to the Systematic Internalisers.

They'll come and meet with us and talk to us about what they do or spend time with the exchanges, whether they be the primary ones, such as the LSE or Euronext, or whether they be the other main exchanges, such as [INAUDIBLE] or Aquis. We spend time talking to them about the products that they provide to the brokers, who ultimately take care of our orders for us. And we educate ourselves. We learn more. We learn how the system operates.

And we spend a great amount of time with people such as James. He helps us to be better. He helps us to know a lot more about the details of what's going on. He gives us the questions to ask, so we will then spend time speaking to other brokers and making sure that they have that depth of knowledge and they have that understanding. And he gives us questions to quiz them about with their smart order routers, to make sure that we are getting the best possible outcomes that we can, so that we can challenge the venue usage, we can challenge the way that our orders interact with the market.

We've used it very, very well with program trading. We spent a lot of time with the brokers that we do program trades with and change the way that we interact with the market with those guys. We've had thoughtful discussions with them. And we've seen a positive outcome for that, which is a positive outcome for our clients, so that we're not signaling as much when we go to market, that we've got a good process in place to make sure that the orders are being executed well and cared for well.

PETER HAYNES: How many bulge bracket dealers have their own Systematic Internalisers? And is that publicly known which firms offer that, alongside the liquidity providers that we are hearing a lot about here in North America?

DERMOT DUNPHY: Yeah, I'd say the majority do, and we get all the details back on the FIX tag 30, which is something we look at and we spend a bit of time, making sure our FIX tag 30 data is correct internally as well. So we can look at whichever banks all of the banks I've got providing a size. We can look into that, and we can look at the performance that we're getting.

And it could be that some of our brokers work better than other brokers with the Systematic Internalisers. And we can review that data. We can go and challenge the brokers on how they're interacting with the SIs and how their smart order routers, how they're piecemealing the child orders. There's a lot of questions that we now have the knowledge to go and have the discussions about all of this. We're very, very aware.

And we see the changes in behavior as well with the SIs, whether it be the ELP SIs or the bank SIs. We can see that different banks and different ELP SIs have changing performances and how that can move up and down, and then how our brokers also react to that and the changes that they make to make sure that we get a better outcome.

JAMES BAUGH: I think what's super interesting here is the fact that liquidity is not commoditized as some might have you believe. And equally, the broker services, the execution platforms that are not commoditized. And therefore, it really is understanding what liquidity is available and when, but also what's the quality of that liquidity that's available and how does that fit in with the strategy that the likes of Dermot are looking to use and the outcomes they're looking to achieve.

PETER HAYNES: Yeah, obviously, the data is what matters and the analysis of that data. Dermot, we completed a two-part study-- or excuse me, a two-part podcast series with Jenny Hadiaris, who is our algo/market structure expert in the US. And we talked a lot about algo wheels. I'm curious if algo wheels have become popular in Europe, whether or not you have an algo wheel that you utilize. And maybe you can break down for us the percentage of your flow that would be electronic versus block desk.

DERMOT DUNPHY: Yeah, the algo wheel is becoming more popular in Europe. It's being discussed a lot when I'm at conferences. We don't use an algo wheel at M&G. it doesn't suit the type of orders that we get. So the orders that come over from the fund managers, we spend a bit more time discussing with them the market and what's going on. And the size of the orders they tend to send us doesn't suit for us at the moment, going into an algo wheel. So we don't use that.

And in terms of percentages of orders that we use, on the global basis, we have desk in London and we have a desk in Singapore. The desk in London trades everything that's in Europe and everything that's in the US. Over the two desks, our algo usage is around 20% to 30% of all the orders that we see. And it's probably higher-- it's higher in the US compared with Asia and in Europe. It's slightly lower than Asia as well.

The reason for that is, I think, maybe slightly market dynamics. The US lends itself slightly better to us for using algos there. I think, as you say, the data, the data that goes into building the algos and the algos are able to react to is more readily available in the US than it is in the other regions. In Asia, generally, we tend not to have too many secondary markets. It tends to just be the primary exchange, generally, that we go to.

And then in Europe, obviously, we have a broad range of venues that you can go to. But our European orders, it suits the type of order that we get as well, the size of order, it suits us now to where we are, I think, at the moment for that kind of 20-ish percent flow going through the outflows. But we continue to evolve. We continue to look at it. We continue to spend time talking to our brokers, looking at the market dynamics and making sure that we're in the right place. So we're continuously learning.

PETER HAYNES: That is all for Part I of our two-part series. Thank you, Dermot and James. And I look forward to carrying on this discussion in Part II.

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