The Latest on European Equity Market Structure Part II

PETER HAYNES: Welcome to episode 61 of our TD Cowen market structure podcast series Bid Out. My name is Peter Haynes, and I'm your host for this episode, which is the second in a two-part series on European market structure with our guests James Baugh, Head of European Market Structure at TD Cowen, and Dermot Dunphy, Head of Trading at investment manager M&G.

In this episode, we cover the impact of Robinhood's arrival in 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 the perfect world, one central listings venue for all EU countries. Here we go with episode 61 of our market structure podcast series.

So James, I've read that Robinhood is on its way to Europe. And actually, I'm hearing it's coming to Canada as well. And it made me curious to know how significant retail flow is in your jurisdiction, Europe and the UK? And does retail execution work similar to the US using bilateral systematic internalizer arrangements? Or they're known as wholesalers in the US. How does that work?

JAMES BAUGH: Yeah, so interesting that, as you mentioned there, Robinhood coming to the UK. I think this might be their second attempt. I think also, if I'm not mistaken, they're looking at a crypto initiative into Europe as well.

I think that retail in the main is somewhat nuanced across the different markets, the different regions in Europe. So Italy, Scandinavia tend to be a little bit more kind of retail-heavy, retail-sophisticated, if I could put it that way. And you see a lot more on book activity. Your average retail investor will understand what a limit order is, will expect to see their order on the screen, on the terminal.

In the UK, though, it's very different. It's what we call the RSP model, the Retail Service Provider model, which in essence, is sort of a request for quote platform, which is dominated, or certainly traditionally dominated by market makers interacting with retail brokers. But if we sort of fast forward a little bit to where we are now-- and I think the direction of travel-- it probably is more in line with the US wholesale model, where we're starting to see those ELPs that Dermot referred to previously, those Electronic Liquidity Providers, those more sophisticated market makers that are also now interacting with retail directly on RSP in the UK.

But also, on other platforms in Europe, like Equiduct, and/or providing direct price feeds to retail brokers. So yeah, similar, but not similar, if that makes sense, Peter.

PETER HAYNES: Well, it does. And it actually is a point of frustration for me when I hear Chair Gensler at the SEC who refers to PFOF, or Payment For Order Flow being banned in both the UK and Canada. And when I hear that about Canada, I say that it's BS, because the reality is Canadian retail firms can achieve similar PFOF economics through executions on marketplaces that pay rebates to takers of liquidity.

So I want to understand this, James. Is PFOF actually banned in the UK? Or are there workarounds that achieve the same outcome, kind of like Canada? And what's the latest on the discussion about banning PFOF continent-wide in Europe?

JAMES BAUGH: Yeah, so PFOF in the UK was banned, I think, back in 2012. So that's a definite red line, and maybe just to kind of round that out for Europe. So Europe, we kind of all thought that it was banned, and then it seems that there were different interpretations from different member states. And holes were found in the existing rules and regulations.

So that has been addressed in the current round of regulatory change. And the drop dead date for those that are offering some form of Payment For Order Flow-- that has to stop by the end of June 2026. If it's not banned already, it soon will be.

Maybe it's sort of addressing then your second point around, does it really matter? Does it make a difference? Is it similar here to what you see in Canada? To a certain extent, yes. I mean, we don't have those rebates for taking liquidity on venue. It's very much more about passive rebates, so about placing passive orders into the market, and that's the rebate.

And, in fact, the regulator, the European regulator has been quite specific, stating that on venue rebates for passive flow is completely separate and independent to the discussion around PFOF. But that said-- and this goes back to my previous life at Citi Bank, where I was involved in their wholesale execution business and I was competing for some of this flow-- those ELPs, those liquidity providers, those that are engaged with retail business, they will do this at zero cost anyway, making it very difficult-- or certainly, did make it very difficult for me to compete for that business.

And their business model is clearly about taking their own, sort of their haircut in the spread. And arguably, whether you ban PFOF or not, there is still the ability for those firms to step in front of other execution agency brokers, perhaps, as I say, in respect to the business I was operating at my previous company.

PETER HAYNES: So I can see how this play is going to play out too. Robinhood's going to show up in Europe and its peers, and they're going to look for ways to replicate the economics they have in the US. And they're going to find little holes in the rules that you referred to earlier, and they're going to exploit them or push for change. And they'll obviously have their ELPs on the other side of that argument arguing for the same thing.

And meanwhile, the Dermots of the world and the James Baughs of the world will be pushing to allow that retail flow to interact directly with institutions like M&G. Right now, Dermot, are you able to trade directly with retail on these RSPs? Or is that just a bilateral facility that market makers are on against retail?

DERMOT DUNPHY: We do have that ability with the use of some brokers who are able to interact with that. And as you say, we're quite keen to do that. The retail, it's good, especially if we can deal in the middle of the spread, then it's good for the retail investor then not having to cross over to the other side of the spread, even if they're just inside of it. And it's good for us as well, because we can be there and also deal in the middle.

I think roughly, in the UK, the retail accounts for about 10% of the volume that goes through. So that's quite a lot of-- that's quite a lot of volume that can get involved in if you can do that. And if you can do that in the middle of the spread, that'd be wonderful.

But again, it's the-- I think I kind of come back to it. It's the knowledge of the brokers that we use. It's their ability to interact and to see the market dynamics and the market structure and be able to provide a good liquidity option for the retail side of the bargain that are coming in.

So yeah, we are able to, and we're keen to. Very much depends on the brokers that we're speaking to and their knowledge and skill set.

PETER HAYNES: Well, that will be an evolving topic, as I say, when the high profile US firms show up and start to run lots of advertisements and grow their market share. So Dermot, just talking about liquidity and where trading takes place, we've done some research here in Canada recently that shows literally 40% to 45% of large cap equity volume in Canada now happens in the last 15 minutes of the day and in the end-of-day auction. Now admittedly, a significant portion of the auction volume in Canada is actually inaccessible.

But I am curious, do you find that volume is continuing to migrate to end-of-day on the basis of the old argument flow begets flow? And do you feel like the huge percentage of volume that's trading at the end of the day is, in fact, accessible for you?

DERMOT DUNPHY: I think you're right. Flow does beget flow. In Europe, it seems to stabilize over probably the last two, three years with the closing auction volume. It seems to stabilize at about 30% of the volumes that we see going through. And that is a big number. And we are seeing more inaccessible flow going through there.

You may see-- you may say certain people locking up liquidity, so just matching liquidity internally, whereas previously, maybe you would all meet in the closing auction. There'd be a whole load of market orders that could meet each other effectively to-- some of that is being discounted by just being netted off against each other by some brokers that are able to do that.

It does provide a source of liquidity for us, though, with our orders. We know that the volumes are going to be bigger there. I spend more and more of my time going back to my original discussion point of how I work and order. I spend more looking at the average volume that's going through in a stock on a day. I spend more of my time knowing what the closing volume traditionally is in a stock.

And with that in the back of my mind, how much of the closing auction do I want to be? I'm aware of what I may have left on a ticket. And also, how much information that may lead to my follow-on order the following day.

So closing auction is good, there's good volume, but you have to-- again, you have to be careful with it. You have to try to mitigate the signals that you'd be leaving in a closing auction if you don't get finished. And as you say, part of that may be that the inaccessible flow that previously was there that isn't there, it can have an impact on that. So we spend a bit more time looking at that closing auction.

But it's not the be-all and end-all for us. We're continuously looking at liquidity throughout the day. It's just not a goal for us to be there in the closing auction. It's just another avenue that we can utilize.

PETER HAYNES: You mentioned that 30% seems to be the stable number across Europe and the UK, which is a significant number. And obviously, the end-of-day has become really important. There was a push pre-pandemic to shorten the European trading day, which is very long, and you guys know better. And it makes even more sense now, in light of this continued shift that we've seen to volume at the end of the day.

What is the latest on the debate on shortening the trading day in Europe? And has the shift changed much about how you're trading? I understand you say you're watching the close, but are you changing sort of proactively how much you're participating in the close based on some of your recent analysis around what you can get done?

DERMOT DUNPHY: I'll take that in two parts. So the shorter hours, there was a very, very big push for that probably pre-COVID and the pandemic when we then discovered that everybody could work from home. I think pre that, it was a lot of the reasons we were talking about mental health. We were talking about diversity and inclusion and having more balanced life for people.

And then when we were able to work from home, and now at the current moment, in a hybrid environment, a lot of those challenges can now be overcome. We can do that sensibly. But we are starting to talk more and more about the shorter hours in Europe. So I think maybe that discussion point will come around again. We'll start to have that again.

I think you're right, that the amount of volume that goes through, I suspect, would not change. It wouldn't be decreased if we shorten the trading day by an hour or so. I think people would probably very much appreciate that. It would be very good.

And then the second point about how we adapt as we go through the day and the closing auction and running our data for that-- it doesn't impact us too much. It is just another factor that we build into our strategies as to how we're working the orders. We don't put too much of a weighting on it.

Again, we're always looking for liquidity throughout the day, whether it be using the algo ourselves and trying to find liquidity that way or using the high touch cash sales trader, such as the TD Cowen team here. That's what we're always looking for, I suppose. We've always been looking for that.

As I said back in 2001, the first thing we're looking for is just a natural, the other side. So whilst the close has, over the last 10-plus years, definitely increased as a kind of focal point for volume that's going through, it is not a key point for us to change our strategy. It's there as a useful tool for us, but it's not the key strategy. It's not the key decision maker for us.

JAMES BAUGH: Yeah, maybe just picking up on a couple of things there. There's no doubt the liquidity squeeze has reinvigorated that conversation about shorter hours. I think also what's kind of interesting for me is just looking at that reliance on the close, particularly for the passive indexes and the benchmark, the crossing benchmark. And whether we should be thinking about considering lessening reliance on that, on that crossing price.

Particularly, as alluded to, we're seeing more and more business, closed business, guaranteed market on closed business internalized by a number of the big banks, meaning that, perhaps, the importance of reliance of the primary closes has become somewhat diluted. And that's just generating some interesting debates over here.

DERMOT DUNPHY: And to follow on from that as well with the closing auction, you have to be slightly wary of the price moves as well. We saw it on the recent rebalancing and on the back of the quadruple witching that happened. There were some big price moves in the auctions from some stocks that were 2% price moves, which is on Friday, you end up having a discussion with the fund manager as to how the price moved that much.

So there can be some increased volatility there. So it can lead to some interesting conversations.

PETER HAYNES: And an opportunity, eh, Dermot? In certain circumstances, when you're sitting there with something outsized on your pad offsetting those substantial moves that are either expected or just happen on quad witch. We certainly saw the same thing here in North America on Friday too. So it's definitely worth keeping an eye on, especially as a fundamental investor like yourself.

And the topic about shorter trading day is kind of funny in that here we are arguing that we should shorten the trading day, and there's certainly people in North America that think the trading day is too long and should shift earlier. Meanwhile, you have 24-hour trading happening for the retail investors, and even more of a push to democratize trading as crypto and equity trading seem to converge. And I think most institutional investors understand it's not a great idea to be trading in the middle of the night North American stocks, but regardless, the retail wants to do that, and that's their direction of travel, for sure.

So James, when we talk about the potential for success of some of the US ATS's that have been popularized by the institutional community, my answer is one of doubt. And it's always to point out the notion that the US is actually the unicorn given its sheer size and breadth. So I'm curious if you think that any of the recent ATS's that have been launched in the United States that are contemplating coming to Europe, whether you think they'll be able to achieve critical mass?

JAMES BAUGH: Yeah, I think that unfortunately, whilst we want to get behind new innovations and support these platforms-- particularly, when we see how successful they've been in the US-- that unfortunately, the backdrop, as we've said already here in Europe right now is a liquidity shortfall, right? We are facing a number of challenges.

So whenever I speak to clients and highlight these new platforms, unfortunately, I do get a bit of a rolling of the eyes because it's that whole debate fragmentation versus innovation. And look, given my background at [? Citi, ?] I was very much involved in bringing conditional orders to Europe with certainly block discovery. And we were very much solving a problem there. It wasn't a case of just a me too.

And it took us a good four or five years to get that off the ground. And in a way, it was very much supported by those global only institutions that were familiar with conditional order types in the US. And being able to lean into that into Europe was very, very helpful. And I think you've seen that with other platforms like CIBO bids, where you have that direct buy side interaction, that sort of give up model where buy side in the US can access European blocks.

So I'm not saying that it doesn't work. I think it's just a timing issue, although you could always argue, when is the right time for these things? But at the very least, you've got to come I think to market with something that is differentiated and is not simply a me too, particularly given the backdrop that I kind of mentioned there.

PETER HAYNES: So North America has been introducing periodic auctions. That's a term definitely that we've stolen from European market structure. Can you talk just about, James, what exactly do you mean when you talk about periodic auctions? And how are they being incorporated into the landscape of market structure in Europe?

JAMES BAUGH: Yeah, so periodic auctions were born, I suppose, out of MiFID II, to a certain extent. And my take on it was that no longer could the big banks look to internalize that client to client, matching facilities under the old sort of broker crossing network moniker. And therefore, the periodic auctions-- initially established set up by CIBO, had first mover advantage here-- were allowing or providing that opportunity to outsource that sort of client matching business.

So again, just to pick up on Dermot's terminology, that client natural matching liquidity has really-- I think what has been behind the growth in periodic auctions here in Europe, which are now pushing above 6% of the share of business over here. Now, just to kind of explain a little bit without going through the details, but these are, if you like, mini auctions that are happening if not milliseconds, certainly, every second throughout the trading day where there's contra liquidity. Where there are matching opportunities, it will trigger an auction process.

And this business is all getting matched off at the mid price. And when you ask how that fits into our kind of execution strategies, if you imagine that execution waterfall and picking up on some of the complexities around where we actually get business done, in very simplistic terms, you have maybe an electronic block crossing opportunity, a conditional order type, conditional matching opportunity at the top of our waterfall on our electronic stack. And thereafter, you would be looking for midpoint execution, midpoint liquidity.

And periodic auctions very much sit underneath the conditional order type, so very much at the top of the execution waterfall. We see that as good quality liquidity before we even go out to the midpoint dark books. And again, it's always a work in progress, but right now, we definitely see that outperformance in periodics versus those other execution channels.

PETER HAYNES: Dumb North American question. Dermot mentioned earlier MTFs are essentially North American ATS's. Are all the MTFs dark in Europe? Or are there some that have lit quotes, or are you allowed to have lit quotes in an MTF?

DERMOT DUNPHY: Yeah, so an MTF-- yeah, a Multilateral Trading Facility can be lit, can be price forming in their own right. The only difference between an MTF and a regulated exchange is the primary listing element. So we referred to stocks are registered to trade on an MTF as opposed to listed to trade.

And MTFs will also operate midpoint dark books. They'll also operate periodic auctions and conditional order types. Any way which you want to get executed, you can look to an MTF, depending on the services that they provide. And obviously, they've been looking to differentiate themselves from those primary exchanges.

PETER HAYNES: Yeah, it's sort of like Canada. We have ATS's. The ATS's in Canada, most of them are lit, but there's one that's dark. And then in the US now, you have all the ATS's are dark, but now one that's known as an ECN, which is intelligent cross, is offering lit quotes, and obviously, wants those lit quotes to be protected, which is a debate that continues to rage in the US.

So Dermot, let's move on to T+1. Clearly, to move to a shorter settlement in North America has prompted Europe to look more closely at replicating this shift. In fact, I believe Chair Gensler of the SEC was just in Europe recently speaking publicly about the need for Europe and the UK to follow suit on T+1.

What's the status of T1 discussions in Europe and the UK? And what are some of the issues that European fund managers are concerned about with the move to shorter settlement in North America?

DERMOT DUNPHY: There's a very healthy discussion going on in Europe around T+1, and that seems to occupy an awful lot of time for us. One of the main issues that we as an asset manager face is around the settlement cycle that we have on our funds. So when people are investing money into us or taking money from us, they're settling on a T+3 basis.

So the move from T2 to T1 just increases some of the kind of complexities that we see around that. We have to fund two days earlier than the one day earlier normally. But as I say, we're used to doing that. We used to settling T2 versus T3. So to move to T1 from T3, there'll be some extra complexity in there.

But fundamentally, we will adapt to it, as we always do. We always find a way. And that's what we will continue to do. There may be some issues from the FX and the currency side, but again, for Europe, that will be probably less of an issue than if we move slightly further East, if we move out to Australia or to some of the Asian countries. Because I think there, you will have a currency issue.

It's all around the currency that you are taking the money into your funds and how you're going to deal with the FX issues there. And in Europe, it's not as big a problem as it will be for some of the other regions of the planet. But yeah, I think we know where we need to be with T+1 and we're there.

And then we just have to address the UK and Europe move to T+1 as we wait for the UK and the European Union, as such, to decide what the pair of them are trying to do, again, as asset managers, as institutions, as members of the environment that is European investment. We're having healthy discussions with both sets of politicians as to what's happening. And we will see what they decide, whether the UK goes early or whether it waits and moves with Europe or we all move together.

And it will be-- it feels inevitable that we're moving close to that T1. And, in fact, today, I heard that India is even contemplating moving to a T+0. And it's worth noting that when we trade in China, we settle with Trump and China on a T+0 basis as well. So we have the knowledge there. We know what we're doing.

PETER HAYNES: Yeah, it's not new. I get that. And James, what's your best guess on when Europe and the UK-- we'll assume they do it together, they figure it out. Europe and the UK, when do they end up T1? What's your best guess, James?

JAMES BAUGH: Yeah, so I think what I've got this right. I think UK was coalescing around sort of Q1 2025, possibly 2026. But we just don't know. I mean, again, I think Europe was out there with a 2030 handle at some stage, so that seems to have come in a little bit. But needless to say, we're talking-- yeah, we're talking multiple of years before we align.

PETER HAYNES: So James, doesn't matter where we go around the world of equity market structure. There seems to be complaints about both the access to market data and the cost to access market data. And I know this includes Europe and the UK.

What is the latest on the move to a so-called consolidated tape? Who's going to pay for it? And how much will it cost?

JAMES BAUGH: Well, all good questions. And I think we're all going to be paying more for data, not less. But let me answer those in turn. So in Europe and the UK, the priority is very much right now focused on providing a consolidated tape for bonds, with equities taking second place. So in Europe, it means we're not going to see an equity tape until at least Q1 2026.

And right now, what we do know is that the European tape for equities will be top-of-book, pre-trade, but not yet full depth. But one might say, certainly, a big step in the right direction. The UK still to confirm timelines. I did read somewhere that the UK was targeting the end of 2025, but we still don't know what the tape for equities will look like.

What we are hearing is the London Stock Exchange very much advocating for a post-trade tape, rather than a pre-trade tape. So we may end up with some differences between the two regions, which may or may not prove helpful. In terms of who pays for it, I suppose there's-- depending on how you think about it, there's different answers to the question there.

What we do know is that a number of exchanges, I think 14 exchanges, came out swinging the bat last year. I think that's possibly a baseball reference for you there, Peter. But they are looking at putting their hat in the ring under this new business that they've set up called EuroCTP.

But already, people are questioning the actual cost benefit here, the commercial opportunity for others to compete in providing consolidated tape. It doesn't necessarily look particularly strong. And then obviously, once we're up and running and we got to tape then, who's paying for that day to day? I'm sure it will probably be the respective organizations that Dermot and I work for.

And again, I suppose frustratingly there is that the sell side will continue to be paying for all those direct feeds to fuel their algos. The consolidated tape is not going to necessarily save us money here. But why the sell side has always been very supportive of the consolidated tape in Europe and the UK is, as I say, it's about greater transparency. It's about encouraging more inflows. It's about encouraging more retail interest and all of those good things that we need to try to get more turnover of business into our equity markets.

So yeah, I think that answered each of those questions. If not, shout out and I'll say it again.

PETER HAYNES: I'm disappointed to hear that you say that you won't save money, because I thought one of the goals here was that you'd be able to pay for data on the tape that ended up being provided cheaper to the consolidated tape than what you pay for directly to the marketplace right now, essentially, eroding the margins for marketplaces that provide that data. But it sounds to me like you're suggesting that that is not how things will play out.

JAMES BAUGH: No. Well, I don't-- unfortunately, I think that's the case. And in a way, I think that's why there's been concerns from the exchanges in trying to, perhaps-- I guess, it's somewhat of a sensitive subject, but clearly, they don't want those margins eroded, right? And that's why there's been this narrative around market data charges.

PETER HAYNES: Yeah. And as I say, it's an issue everywhere I turn, and here in Canada as well, because we're studying market data and expecting something from our regulators in the not too distant future. So Dermot, last week James wrote a client op-ed on some of the regulatory developments in Europe that might cascade out of European elections that are upcoming. Now, I'm stealing James's thunder as he listens on.

But one of the potential outcomes James mentioned is a more competition-friendly regulatory environment that could lead to a single supervisory board for Europe, which paves the way for a true capital markets union. Is this a pipe dream?

DERMOT DUNPHY: Well, I'm glad you highlighted James's piece, because it was very good and it was very interesting. I hope it's not a pipe dream. I think it feels like, over the last few years, that the regulators and politicians in Europe and the UK have moved to slightly more of a listening mode. And they're taking on board the issues and the problems that we see and some of the solutions that people are trying to propose to fix these things.

I think, yeah, anything that we can do to make it better and easier for people to invest in Europe. And as James alluded to earlier on when he's talking to his colleagues in the States, and they just see the mish-mash of rules and regulations in Europe when they look at it from abroad. If we could try and refine these and make it simpler and better system, then that can only be a good thing.

So I'm hopeful. I hope that we move towards that and we can get there.

PETER HAYNES: So James, as we finish up here, let's finish up where we started. And it's a carry on to the topic that we just discussed with Dermot. In order to compete with the US, there's a school of thought that EU countries need to stop competing with each other. Do you ever see any way we end up with a central EU listings platform that, perhaps, follows this central capital markets union from a regulatory perspective?

JAMES BAUGH: Yeah, so it's a really good question. And do you know what? It's not one that I've been asked in Europe so far. And I suppose my immediate response was yeah, there's no way that I can see that happening. There's just too-- the nationalist interest in your domestic market is too great.

But thinking it through a little bit more and just leaning back towards that sort of single supervisory model, it kind of makes sense, right? Particularly, as you've now got these European platforms like Euronext operating the majority of European markets. So yeah, I guess my view is why not?

And at the very least, even if you have certain bourses, certain markets that maybe-- let's say, Fintech-heavy, maybe able to differentiate in terms of different market sectors-- at the very least, make it easy, make it simple for folks to list in Europe by having a simple unified listing playbook.

Again, I'm just kind of thinking out loud, but yeah, I'd be very positive towards that if it means an increase in inflows and interest into Europe. And as I say, why not?

PETER HAYNES: And I think again it may be just as much a defensive mechanism against the gravitational pull of the US. So again, I'm with you. Why not? So James and Dermot, as we finish up here, I want to thank you on behalf of TD Cowen for your expertise. It was a great learning experience for me over the two-part podcast we just completed. And I'm sure our listeners will have gotten a lot about it.

It was literally going back to school and learning about European market structure, and I learned a ton. So thank you on behalf of our firm. And hopefully, our paths will cross in the not-too-distant future, both Dermot in London and James, next time you're across the pond here to see us in North America. Thanks again.

JAMES BAUGH: Thanks, Peter.

DERMOT DUNPHY: Thank you. Thank you very much for having me.

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