Bringing Transparency to the Post Trade Landscape - FCA Changes One Month Later

How has the market responded since the post trade regulatory changes came into force?

By Nazed Mannan, Senior Product Manager, BMLL.

Background

On 29 April 2024, the UK regulator (FCA) made a number of regulatory changes to post trade reporting requirements, following changes brought in for the EU at the start of the year. One of the most significant changes is to introduce more exemptions from post trade reporting, with the aim of reducing operational costs and limiting the overreporting of trades. One month into these changes, using high-quality historical data, we take a look at the impact this has had on liquidity discovery, and in particular, overall addressable liquidity.

What is addressable liquidity?

One of the biggest challenges market participants often face is understanding what fraction of market volume is actually addressable. Measuring addressable liquidity, loosely defined as shares that can be ‘interacted’ with either on or off-exchange, is critical for maximising the chance of best execution, whether as a trader, investor or regulator. This is especially true for anyone trying to calculate trading volumes over time. For example, to create a 30 day average traded volume metric for a robust trading algorithm or market impact model requires an accurate view of market activities.

Figure 1 shows monthly notional traded value for London listed stocks. We observe the traded value declined by approximately £200bn in May compared to the value recorded in April. This sounds alarming, but does this really mean that the addressable liquidity dropped significantly? In Figure 2 we take a look at the volume breakdown between Addressable and Non-Addressable liquidity. The analysis shows a very interesting picture - it is Non-Addressable volume that has dropped materially by more than 50%.

Fig 1: Monthly Notional Traded (£) - London Listed Equities

Fig 2: Monthly Notional Traded Addressable vs. Non-Addressable (£)

Addressable vs Non-Addressable Liquidity - what changed?

The question we ask is whether traded volume shifted between Addressable and Non-Addressable liquidity? What really changed in the liquidity landscape due to the regulatory change? Using BMLL’s classified trade data, we examined London-listed equities for their ‘Addressability’ before and after the regulatory change. As Figure 3 illustrates, we can observe a -20% reduction in Non-Addressable liquidity market share after the change was introduced.

Fig 3: London listed equities addressability breakdown pre- and post-regulatory change

What is causing Non-Addressable trades to disappear?

As we examined above, there are fewer Non-Addressable trades being reported after the regulatory changes on 29 April. To identify the types of trades in Non-Addressable liquidity that are no longer being reported, we took a closer look at the addressability breakdown for London-listed stocks (Fig 4) and Pan-European stocks (Fig 5). The analysis leverages BMLL’s granular trade classification data.

Fig 4: Weekly Notional Traded by Addressability & Trade Classifications (£, London)

Fig 5 - Weekly Notional Traded by Addressability & Trade Classifications (€, Pan-European)

The Special Price trade classification in both Figure 4 and Figure 5 (in light blue) captures all OTC trades that are trade reported with a ‘non-price-forming’ flag. Special Price trades appear to have dropped significantly between the week beginning 22 April and after, recording approximately -20% reduction in overall market share for London and -15% across Europe. This is equivalent to more than -80% decline in absolute traded value. It appears that this reduction in the Special Price trades is directly attributable to the newly introduced exemptions on trade reporting.

The Purpose of Trade Reporting Exemptions

Examining the regulatory change in detail, the expansion of post trade reporting exemptions to include the RFMD (Request for Market Data), for instance, addresses the practice where transactions are passed from an executing broker to a client’s prime broker following the client’s request for market data (also known as ‘Give-ups’). The prime broker typically enters into a swap with the client with the equity position acquired from the executing broker as a hedge against the swap. This practice leads to over-reporting as both the RFMD and execution legs are reported.

Effective 1 January 2024, the EU regulator (ESMA) implemented measures to expand non-price-forming trade exemptions from reporting, including the removal of reporting requirements for RFMD/Give-ups. However, no substantial change was observed in our Special Price trade category between 1 January 2024 and 29 April 2024. This may suggest that most RFMD transactions are primarily conducted by UK institutions, as volumes decreased more substantially following the change on 29 April.

Benchmark Price Trades

Fig 6: Weekly Notional Traded by Addressability & Trade Classifications (%)

Although not as significant as the Special Price category overall, it is equally interesting to observe the increase in the Non-Addressable Benchmark Price category, as shown in Figure 6 above. Figure 7 provides a closer look at this trend. Volume reported under our Benchmark Price category for Pan-European equities increased from €2bn to over €20bn, raising its market share from 1 to 5% overall.

Fig 7: Weekly Notional Traded by Benchmark Price (€)

BMLL’s Benchmark Price category captures benchmark trades as well as trades reported with Portfolio and Contingent trade flags introduced by ESMA at the beginning of the year. This includes both price-forming and non-price-forming variations. We can explore this further using the BMLL Data Feed and Snowflake, as per Figure 8 below. In this analysis the BP category (in red) represents Price-Forming Benchmark trades, while the BJ category (in yellow) denotes Non-Price-Forming Benchmark trades. These segments have experienced a near fourfold increase from historical levels in 2023. Additionally we observe the emergence of YP (Portfolio) and 1P (Close) price trades, simplifying the attribution of Close Price volumes to Systematic Internalisers - a topic of ongoing interest.

Fig 8 - Trade Count by Benchmark & Price Formation

Conclusion

Changes introduced by both EU and UK regulators in January and April 2024 have significantly reduced the reporting of overall market volumes, particularly impacting Non-Addressable liquidity, which has seen a 15% decrease in overall market share and approximately €100bn on a weekly basis for a Pan-European universe. Addressable volume now represents 85% of the total reported volume. The FCA’s expansion of exemptions to trade reporting has resulted in the most dramatic change since 29 April. Whilst the removal of this reporting obligation will decrease operational costs and over-reporting, it is possible that the market has lost valuable information on the volume of RFMD flow. It is worth noting that analytics enabling the differentiation between Addressable and Non-Addressable volume through granular trade classifications already existed, providing the necessary transparency on non-price-forming volume.

Also since January, trades reported as Benchmark trades have increased across both price-forming and non-price-forming variations, primarily due to the reattribution of existing trading volumes rather than the introduction of new reported volumes. These trades continue to remain evenly split between Addressable and Non-Addressable liquidity categories.

In summary, while Non-Addressable liquidity has decreased substantially, there has been minimal impact on Addressable liquidity. It is important for market practitioners to have access to the appropriate granular trading analytics to effectively analyse market trends and derive actionable insights. Having the right analytical tools and high quality historical data is critical for understanding and responding to the impact of Addressable and Non-Addressable liquidity across the complex and fragmented European markets.