Give Me Your Liquidity!

A new McKinsey report on Banks in the Changing World of Financial Intermediation points out that the effect of scale on Equity Cash trading is significant. Put simply, being large in that business makes a difference in favor of the bank or brokerage for that product.


(As a point of comparison, being large in Loans Trading does not seem to bestow any particular advantages on the financial services company. The study says many other things; let us just stick to this point, for now!)


In trading, that scale brings advantage is not exactly news; if anything this study reaffirms the point. That big firms like to aggregate orders from small brokers across the country, to add to their heft is also well known.


In this world, where Big Banks want to bulk up, scale up, one option is to “buy” orders that others have. In the language of the ‘Market Liquidity’ space, those that have orders are called “Liquidity Providers”. Liquidity Providers could just be are customers; they could also be small retail brokers that have customers; and in fact any one else that is willing to ‘sell’ orders to the Big Banks.

T

hat makes Big Banks “Liquidity Takers”.


These market practices are fine, so long as regulators can be satisfied that client interests were not compromised. In the USA that means being compliant with the Manning Rule and meeting National Best Bid and Offer requirements. And in Europe complying with Best Execution rules under MiFID.


And then there is the curious case of Bank of America Merrill Lynch passing on those orders to others. When firms are in the business of ‘buying’ orders to bulk up, routing orders to others seems odd. But if those others were ‘trading partners’ with which the bank wanted to improve its relationship by providing them Liquidity, in turn.


This episode led to some regulatory action against BoA-ML. The regulatory view seems to be that Liquidity Taking and Liquidity Providing is just fine as market practices go. But customers must know where, which venue, was their order executed. So, BoA-ML replacing the name of its trading partners, with its own name, when it was not in fact the counterparty to the trade, was considered bad form.


The valid options are for the confirmations to show: executed at which stock exchange; executed at which electronic trading platform; executed against BoA-ML’s own inventory: whichever of these actually happened. Not something that the bank thought its customers would like to see.


If you want to understand all of this better, look up Order Routing, NBBO, Electronic Trading and Proprietary trading. Then come back and read this again!


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