Central limit order book platforms face uphill battle
Proponents of central limit order book (CLOB) point to its ability to deliver liquidity at times of extreme market stress, but they have yet to convince the majority of market participants that the price is worth paying.
The fallout from the Swiss central bank’s decision to remove the cap on its currency in January represented an opportunity for CLOB platforms – which allow users to stipulate a maximum purchase price or minimum selling price – to promote their ability to provide certainty of execution and two-way prices as well as liquidity.
These platforms have made various efforts to attract corporate users, ranging from FastMatch offering zero brokerage fees to EBS BrokerTec adding a money market fund platform for corporate treasurers.
As soon as it can be demonstrated and quantified that order books provide cheaper execution, liquidity will organically find its way there
Dmitri Galinov, CEO of FastMatch, says his platform offers several advantages over last look.
“Firstly, there are no rejections – you see the liquidity, you send the order and you get it,” he explains. “Secondly, execution is more rapid. A central limit order book trade is done within 50 microseconds, whereas on last look that rises to 100 milliseconds or 2,000 times slower. In addition, pricing is the same for all participants.”
However, it is that final element that is deterring many clients, according to Harpal Sandhu, CEO of Integral Development Corp.
“While standardization and price transparency may seem beneficial to participants coming from other markets, it is actually quite limiting, as it enforces a one-size-fits-all approach,” he says.
Only 25% of liquidity on FastMatch executes this way, which Galinov ascribes to CLOB always being wider than last look, whose providers can offer customized pricing and filter out the latency-arbitrage strategies run by high-frequency players.
Gil Mandelzis, chief executive of EBS BrokerTec, recently bemoaned the departure of quality order flow away from CLOB venues and into alternative models such as dark pools, adding that these venues are “based on voluntary streaming of prices by a limited and increasingly concentrated number of providers that can stop at any second”.
According to EBS BrokerTec Markets co-head Darryl Hooker, there are other reasons why market participants have migrated to alternative dark models such as direct streaming or dark pools, including technological advances, the proliferation of high-frequency strategies and the increased cost of participation in the lit market.
Gil Mandelzis, EBS
As a general trend, trading across most major asset classes is moving towards anonymized, lower-latency trading, adds Bill Goodbody, senior vice-president and head of FX at Bats Global Markets.
“This is increasingly the case in the global FX market, where electronic trading lends itself to trading highly liquid, concentrated pairs across fragmented markets in a 24-hour trading day,” he says.
Trading via a CLOB model allows for price competition among a diverse pool of participants and the ability to see the full depth of book, but Goodbody says trading via an electronic, CLOB-style platform doesn’t necessarily mean participating in an all-to-all, low-latency market.
“At Hotspot, liquidity is optimized – each customer sees a personalized order book,” he says. “Those sorts of services are particularly useful to corporate users who perhaps don’t need to be an active participant every minute of every day, but need to deal at size, with trusted counterparties, when the occasion calls for it.”
Despite such observations and the comments of Christian Martin, president and CEO of TeraExchange – who says that CLOB platforms offer a democratic marketplace through transparent, firm and executable prices – corporates remain reluctant to abandon the request-for-quote (RFQ) model.
Harpal Sandhu, Integral
However, Martin suggests the key question for CLOB platform providers is not why market participants have migrated to alternative models, but rather when they will be in a position to win new business. “The markets and products that have historically been handled bilaterally via RFQ have largely maintained that state,” he says. “The issue at hand is when will the products that are most suited for order books – for example, the benchmarks and plain vanilla products – migrate to order books and what will be the impetus for this shift.”
Martin suggests the answer lies in the type of transaction analysis that has existed for decades in equities and futures.
“As soon as it can be demonstrated and quantified that order books provide cheaper execution, liquidity will organically find its way there,” he says. “The task for central limit order book platforms is not to attract corporate users back, but to encourage market participants to abandon the status quo.”