European and US Trading Landscapes: A deeper look at how market microstructure has changed in 2022

Dr Elliot Banks, Chief Product Officer, BMLL
First published in TabbFORUM, November 2022

Market microstructure of European and US Equities trading has seen continued shifts throughout 2022 in light of proposed changes to both regulatory regimes. In order to better understand and compare the effects of market mechanisms, quickly spot trends, and derive valuable insights, firms need to have a deeper understanding of these shifts.

This article analyses the differences between US and European microstructure through the lens of key topics in 2022, and examines their impact on market share, auction volumes, tick sizes and fragmentation.

The differences between European and US market fragmentation

There is not only variance in trading volumes between European and US markets (the US is much larger than the equivalent European market. For example, throughout 2022, the total traded notional across the US’ capital markets was 5.75, greater than in Europe¹, but in differing types of execution mechanisms. Both markets have significant fragmentation - European traders have to contend with the multiple primary markets, lit multilateral trading facilities (MTFs) operated by Turquoise, CBOE and Aquis, as well as multiple dark pools. The US is even more fragmented, with 16 lit exchanges as well as multiple alternative trading systems (ATS). Unlike with the US SIP, which only reports off both trades as simply off book, there is considerable transparency in European dark mechanisms, via APAs. This allows users to have visibility, not only over lit markets, but of the classification of trading mechanisms as well, such as RFQ, dark conditional or periodic auction.

This landscape leads to an issue of addressable and non-addressable liquidity. To obtain a better understanding of how markets are behaving, we have used BMLL Vantage to illustrate how liquidity around the touch and resting times can affect trading decisions:

Exhibit 1: Trading Mechanisms Across the European Capital Markets

Exhibit 2: Trading Mechanisms Across the US Capital Markets

¹ Data is based on the complete US and European BMLL universe from 1 January 2022 - 08 November 2022

Understanding liquidity shifts in Europe due to tick sizes

An important difference between European and US markets is tick size rules is that European trading has a dynamic tick size policy. Firms, particularly those operating algorithmic trading platforms, need to have an in-depth appreciation of the apparent shifts in liquidity that are driven by changes in tick sizes. In other words, it is not enough to look at touch, but an understanding of tick sizes is needed at the same time.

In contrast, there is a static tick size regime in the US, which can result in differing levels of liquidity and trading performance between stocks which are priced high or low relative to the tick size of $0.01. This is seen in terms of spread, as well as the numbers of orders at individual price levels on the order book. Europe’s dynamic tick size policy tends to lead to different outcomes; we’ve covered this topic in more detail in our March 2022 blog about Level 3 insights.

Amazon Stock Split Story

There have been a lot of stock splits in the US across 2022. Including Amazon (AMZN), which had a twenty-for-one stock split. Below, we examined the impact of the split on spreads across Nasdaq.

Firstly, we examined the Spreads in BPS (Exhibit 3) and Spreads in Ticks (Exhibit 4) from January 2022. Following the stock split, both plots show a significant spread contraction. As the price decreases relative to the tick size, we expect the spread to be covered by fewer ticks. However, we also observe the spread in basis points falling due to increased competition for order book priority compared to the higher price scenario with many incremental levels that made competing for queue position easier.

Exhibit 3: TWA Spreads (BPS)

Exhibit 4: TWA Spreads (Ticks)

Now that we understand the impact of the stock split on spreads, let's examine it from an order perspective. Before the stock split, there was an average of 6-7 orders at any time within the first five levels (Exhibit 5). However, when examining TWA Liquidity Around BBO | Ask 10 BPS Orders, there are over double the number of orders (Exhibit 6). If I want to look at the depth of the market, I can discover more orders. This is important when executing orders for large tick stocks. In conclusion, participants who take a 5-level feed often look at the first five orders (average of 6-7) on large tick stocks, which doesn't give the clearest picture of liquidity.

Exhibit 5: TWA Liquidity Around BBO | Bid 5 Levels Orders

Exhibit 6: TWA Liquidity Around BBO | Ask 10 BPS Orders

Impact of volatility on market liquidity

In 2022, we've seen extraordinary volatility in the markets due to the war in Europe and the Fed interest rate changes. Traders are, therefore, rightly interested in knowing about the impact of volatility on order book behaviour and activity levels.

  • We can see below the impact of a clear spike in volatility occurring in March 2022 across a number of European exchanges (Exhibit 7).

Exhibit 7: Intraday Volatility Across XAMS, XPAR and XLON

  • In contrast, while the US has a spike in volatility, there is a larger spike in May, due to the changing policy of the Fed with regards to interest rates (Exhibit 8).

Exhibit 8: Intraday Volatility Across XNAS

Take the advantage

In order to excel, sales traders, exchange analysts, ETF issuers and quants alike can benefit from a better understanding of best execution for different markets, a full picture of the market beyond price levels, and the ability to contrast market behaviour in reaction to world events.

By using advanced no-code data visualisation tools such as BMLL Vantage, capital markets participants can easily correlate between daily, monthly or annually aggregated data sets, compare how stocks performed on different markets, or sort and explore data via simple and easy-to-use dashboards without requiring a quant analyst, data science or cloud computing resource.

The themes of this article were covered in a recent BMLL Webinar on the “European and US Trading Landscapes: a deeper look at how market microstructure has changed in 2022”. The webinar is available here.