FLASH FRIDAY is a weekly content series looking at the past, present and future of capital markets trading and technology. FLASH FRIDAY is sponsored by Instinet, a Nomura company.
Predicting market structure trends is no easy feat, and revisiting those predictions a year later often reveals unexpected twists.
Kevin McPartland, Head of Market Structure and Technology Research at Coalition Greenwich, Zoomed with Traders Magazine for the third-annual ‘look back at a look ahead’, assessing CG’s Top Market Structure Trends to Watch in 2024.
Of the 10 trends highlighted in the January 2024 report, which ones happened as expected, and which ones took an unexpected turn?
1. U.S. Regulations Must Speed Up or Die, Ahead of U.S. Elections – As Expected
Kevin: “Many of the rules that were proposed in 2024 will ultimately die, given the outcome of the election. We actually wrote about this recently—Chair Gensler was going to resign, and a new chair was announced. It does seem like a lot of the outstanding rules will likely be scrapped, and they’ll step back and reevaluate where to go from here”
2. GUI Search is Out, AI Search is In – As Expected
“We’re definitely moving in that direction. Of course, not all applications can sort of tear out years of development and immediately replace it with generative AI, but it does very much feel like the world continues to move in that direction, and it’s only getting better.”
3. The Exchange Buying Spree Continues – Less than Expected
“There wasn’t much this year, so perhaps this trend is delayed a year. I would say that yet again, given the change in Washington, there is an expectation for more M&A in 2025. So less than expected, but perhaps playing catch-up in 2025.”
4. Private Markets Aren’t So Private Anymore – More than Expected
“I literally read an article this morning about how private market access is continuing to expand and how there are multiple ways to do it. We do have ETFs for private market access, so it’s certainly becoming more and more available to institutional and retail investors.”
5. Workflow Automation Becomes the Priority – As Expected
“As expected, automation will continue to be a priority. We recently published a research piece on muni dealers, and we asked about their tech priorities for next year. Again, the number one answer was automation. So this does continue to be a topic across every asset class, front office and back office alike. So, as expected and will only continue.”
6. The Market Still Cares About Crypto and Blockchain for Capital Markets – As Expected
“This trend continues to move forward. This is another trend that the U.S. election is going to drive even further, so interest should only grow here. A lot of U.S. entities are hoping for more regulatory clarity, which now seems realistic for 2025. Both on the crypto front and the tokenization front are seeing progress. Of course, you can’t ignore Bitcoin hitting $100,000 — that kind of growth is certainly going to drive interest even further forward.”
7. Central Clearing Tries to Grow – As Expected
“If we take the word ‘tries’ literally, then yes, it’s as expected, we certainly try to continue to move forward. I think treasury and repo clearing are again trying to make progress. The expectation is that these rules will stick, even with the changes in Washington, but will likely take longer to implement, the deadlines will be pushed out. This is a long-term trend
that arguably started after the financial crisis in 2010 or so and continues and will continue going forward. So definitely a push to more clearing, but it is a slow-moving train.
8. T+1 Prematurely Creates T+0 Talk – Less than Expected
“We’ve still had those conversations this year about T+0. I do think the idea is sitting with certain FinTech firms that are thinking about how to move the market forward and what opportunities might exist. I don’t think anybody foresees any regulatory action in this regard anytime soon, especially in the U.S., but that doesn’t mean the industry won’t try to make some progress in certain pockets where they see opportunity.
9. Cheap Capital is Harder to Find – As Expected
“This trend stuck with us through 2024. Even as the Fed started to cut rates, long-term interest rates didn’t come down all that much, so rates are still historically high right now, which is making it expensive to borrow. There’s also a political lean to all of this. Because of the election, there’s some expectation that additional capital requirements for banks could be scaled back or even canceled altogether, which should free up some capital on the banking side. If we’re talking about more M&A, that should hopefully create a lot of deals, allowing private equity and venture firms to sell their existing holdings or bring them public, which then frees up capital to do more investing, and it seems like that could start to shift in 2025.”
10. Buy, Build and Integrate Replaces Buy vs. Build – As Expected
“There do seem to be very few capital markets firms that are all buy or all build anymore. This ties back nicely to workflow automation — being able to move information between applications, whether internal, external, or from multiple vendors, to make that workflow more seamless and automated. These two things will just feed on each other and help continue to move this forward.”
And:
The Search for “Normal” Continues
“I do kind of feel like we’re there, right? It’s funny reading what I wrote a year ago—trains are definitely still less empty on Mondays and Fridays, although less so than they were at the start of the year. There are a lot more mandates for everybody to come back five days a week, especially with big financial markets firms and even some tech firms. It feels like the industry has found its new, new normal. Business is certainly back, the markets have been on fire, and we’ll see what next year brings.
Bonus question: What was the biggest market structure trend of 2024 that you didn’t highlight in your top 10 list from one year ago?
“Maybe this is a little in the weeds, but a lot of electronic trading focus for years has been very much about the buy side, the investors and how they interact to get liquidity. But in 2024, it seemed like there was a big focus on the dealer-to-dealer market and innovation there in electronic trading. So, we saw growth in electronic trading in that segment, along with a lot of innovations the from trading venues, with new solutions or existing ones that really started to grow. That was a bit of a surprise that come out of the data.”
Managing the Liquidity Maze in Modern Markets
By George Rosenberger, Broadridge Trading and Connectivity Solutions, and Linda Giordano & Jeff Alexander, Babelfish Analytics
A recent rise in proprietary trading has created a fresh challenge for traders: more inaccessible liquidity. Initially driven by retail trading surges, traders continue to grapple with managing this liquidity gap. Now it seems that more firms are now turning to riskless principal trading, and while this may offer a refuge from uncertainty, it can further exacerbate liquidity challenges on exchanges and in dark pools, continuing the trend towards market fragmentation and decentralization.
The New Liquidity Paradox
Retail trading surged during the COVID-19 pandemic, with platforms like Robinhood and Fidelity seeing high activity. Beyond the pop culture frenzy over meme stocks like GameStop, AMC, and Tesla, retail trading volumes skyrocketed across many widely held names, including Amazon, Boeing, and Apple. Based on FINRA, CBOE and other data sources, retail trading totals 25 to 30% of activity, but in some stocks, individual investors are driving 40 to over 50% of volume. A large portion of these trades not only transpire off-exchange, but occur via direct trading arrangements that are the result of payment for order flow (PFOF.) These mutually beneficial trading arrangements allow retail brokers like Robinhood and Fidelity to offer free commissions and price improvement and market makers like Citadel Securities and Virtu benefit by capturing the spread and controlling large quantities of shares.
Since late 2023, proprietary trading has surged as buy-side traders work to navigate liquidity-constrained stocks, intensifying off-exchange activity and further limiting accessible liquidity. Surprisingly, Morgan Stanley and Goldman Sachs’ specialty desks sometimes rank among the top ten liquidity providers, surpassing exchanges like IEXG and MEMX. With retail PFOF arrangements accounting for 25-30% of inaccessible liquidity and riskless principal trades adding another 10-15%, over 40% of shares can sometimes be locked away in direct trading arrangements. While this activity usually represents only handfuls of trades, the quantities are significant enough to disrupt broader trading strategies, especially as it is reported via “de minimis.”
Navigating a Liquidity Crunch
Reduced liquidity can lead to price discovery issues, with wider effective spreads on lit exchanges due to the significant gap in on-exchange liquidity. This distorts price signals and impacts transparency, as critical information about true supply and demand remains hidden. Volatility risks increase in stocks with higher retail participation, where prices are often driven by crowdsourced sentiment rather than fundamentals. This volatility undermines stability and raises risk premiums for institutional trades.
Market share compression becomes evident as alternative liquidity venues like dark pools and smaller exchanges see reduced volumes, requiring institutions to transact on primary lit markets. This shift raises operational costs and exacerbates challenges in sourcing liquidity efficiently. Collectively, these factors highlight the systemic complexities introduced by fragmented and inaccessible liquidity.
Impact on Algorithmic Trading
Without specifically adapting algorithms for situations with inaccessible liquidity, traders may find that they cannot achieve expectations. VWAP strategies can be disrupted as intraday volume patterns are distorted by the unaccounted-for off-exchange activity, making volume profiles not indicative of the trading reality. Traders using percent-of-volume algorithms will miss their desired participation rates because total reported volume is more than accessible volume. Liquidity seeking, dark, and arrival algos, which are typically biased towards minimizing costs by preferencing alternative destinations, may struggle to execute in low liquidity destinations. This can be calamitously inappropriate in situations when adverse momentum is present and result in extremely costly results.
These disconnects result in missed stock, information leakage, higher market impact, and worse execution prices. These challenges underscore the need for trading strategies that account for the complexities introduced by large retail participation and prop trading.
Implications for Institutional Traders
Institutional traders are increasingly faced with higher trading costs in stocks with substantial inaccessible activity. These stocks exhibit wider spreads and higher impact costs, making execution both expensive and unpredictable. Algorithms that rely on historical volume profiles are particularly vulnerable, as they are more likely to signal large orders to the market, exacerbating price slippage.
The challenges extend beyond individual trades to affect portfolio-level strategies. Fund managers encounter heightened risks when constructing portfolios, especially when managing large positions in retail-heavy names. Liquidity miscalculations can result in prolonged unwinds and additional costs. The dynamic and volatile nature of retail trading means that institutional traders must adapt to a rapidly shifting landscape, where traditional strategies may no longer be effective.
Adapting to the New Reality
In an increasingly fragmented market environment, it is crucial to understand where liquidity naturally resides, particularly during adverse price trends. Selecting appropriate strategies and destinations that account for participation is vital. This involves leveraging advanced analytics, enhancing pre-trade analysis, and adjusting order slicing strategies to address the complexities introduced by reduced liquidity conditions. Paramount to reducing negative outliers and aggregate costs, traders must match the market situation with the proper trading algorithm, using dynamic and systematic advanced analytics.
By making these adjustments, institutional traders can navigate the challenges posed by inaccessible liquidity, ultimately maintaining competitive execution and efficiency in a market increasingly influenced by retail players.
George Rosenberger is Head of NYFIX at Broadridge Trading and Connectivity Solutions
Linda Giordano is Founder & CEO at Babelfish Analytics, Inc.
Jeff Alexander is Founder & President at Babelfish Analytics, Inc.