Curating liquidity - the secret to reducing

and understanding market impact?

 Introduction
The latest instalment in The Finance Hive Digital Boardroom Series focused on curating liquidity and
the impact this had on reducing and understanding market impact. This topic is close to many of our
members hearts and is especially pertinent for those with significant flow going through algos. Over
the course of the call it was identified that curating liquidity can help you to have more control over
your execution objectives, and although a significant factor, it is only piece of the market impact puzzle.

This report features a summary of the conversation that followed, the key insights and takeaways
gathered by the buy side firms in attendance, and a closer look at the importance curating liquidity.
Understanding Market Impact
Over the course of the discussion it emerged that there were 4 main components the buy side need to bear-
in-mind when thinking about reducing their market impact:

1. Anonymity: Disclosing your name and trading intention could create

unfavorable volatility in the liquidity pools you are using. It can increase the
risk of you being exposed to front running and price fading, so anonymous
trading avoids the need to worry about this negative impact on your
trading.

2. Using Pre-trade tools: Using real-time, independent and data based pre-
trade tools can help you to better understand the market environment you
are executing in. This level of insights helps to make better informed
execution strategy decisions, but it is most certainly a roundtrip and not a
dead-end street. You want to be constantly monitoring, and using your
post-trade analytics to join up with post-trade analysis

3. Curating Liquidity: Removing yourself from pools that have last look and
HFTs participation can help to limit your market impact quite significantly. It
was also raised that you should be looking to avoid pools where banks trade
with each other, as this creates an unfavourable environment for you as a
buy side.

4. Using Algos: Larger orders and orders in less liquid currencies can benefit
from intelligently timed execution strategies that are easily accessible
through algos. Having a more structured and systematic approach for these
trades can greatly reduce your market impact and lead to significantly
better prices.
Curating Liquidity - A closer look
• For those using algos for a longer time, it was agreed that the journey from
more high touch execution was far from smooth, but there was always a clear
understanding of the benefits that they could offer, so any roadblocks along the
way were always navigated with the end goal in mind. Algos were seen as a
method of achieving operational efficiency whereby small, close-knit teams
could still work large orders and use them as a support tool so more attention
could be directed towards the orders that needed more high touch expertise.
At the same time, algos were seen as a way of reducing market impact and
ultimately improving the price early adopters were getting for their end clients.

• For those starting their journeys a long time ago, there was far less TCA in the
FX world than there is now and looking at the world now, these more
experienced algo traders considered peers who were starting to use algos for
the first time in 2020 as being in a privileged position. They pointed to the
number of very good analytics providers that can help you assess your market
impact and benchmark algo provider performance. Increased focus on the
global code was also seen as a big positive. The code has highlighted the need
to make sure buy side are comfortable executing with the liquidity they are
accessing. These two factors have led to heavy algo users re-assessing their
liquidity pools and almost starting again from the ground up to ensure they are
optimized.
Curating Liquidity - A closer look
• It was generally agreed that liquidity has to come first when you are thinking about algo
execution. Being comfortable that the pools you are accessing match up with your
execution objectives should be a huge part of any best execution framework. There are
lots of pools out there that can help you from global code pools to mid-books and client to
client matching pools. The group noted that the latter of which seems to be generating a
lot of buy side interest at the moment.

• An issue that some desks are facing is internalization from banks, where the banks aren’t
as careful with the liquidity pool as they would like. This problem has led some traders to
avoid using ECNs whenever they can. Removal of ECN’s from liquidity options has led the
trading desk to become more relationship focused. It was agreed that if you are interested
in knowing who you are interacting with and what their behavior is like you will have a
problem with ECNs as they just aren’t transparent enough for you to be comfortable.
Knowing who you are interacting with allows you to be more passive, and if that is your
trading style then being comfortable leaving orders in the market is a huge benefit.

• Measuring performance was identified as being a big part of the curated liquidity puzzle as
well. Some buy side were using in-flight tools that can advise them on slowing down or
speeding up orders and the feedback on these tools was very positive. It’s also important
to remember that sometimes market conditions have more of an effect on performance
than the algo itself. You should try to differentiate between these two things when you are
looking at ranking algos. There are a few TCA providers in the market right now who are
doing a great job helping the buy side with this especially when it comes to their post-
trade analysis flagging the algos they are having problems with.

• The group agreed that knowing who you are trading with, limiting market impact and
analyzing this properly to know you can constantly adjust your strategy is vitally important
to meeting our execution objectives.
Conversation Summary & Key Takeaways:
• Algo usage is key to limiting your market impact, spread ing your trad es, lowering
execution costs & buying back vital trader time to focus on higher value trades.
• The challenge is to choose the right algos from a huge pool of provid ers that fits with
your trading strategies and goals.
• For firms new to algos, the challenge without first-hand experience of using algos is how
to access data or prove they will have a positive benefit, particularly if you have a robust
compliance process and team.
• Anonymity across data pools without a last look & where liquidity providers are unable
to trade with one another provides a more stable environment to execute.
• Post-trade reporting is an output that should provide learning & feedback into pre-trade
assumptions and strategies and is a continual cycle to support improvement over time.
• Key rationale for using algos is operational efficiencies – putting the resource focus onto
higher value orders & minimising market impact.
• Increased focus around the Global Code has increased the need to ensure best execution
with the right liquidity providers. Firms need to avoid providers you do not wish to trade
with where last look and flash prices exist.
• Start with a bottom up approach – First get the TCA platform, then create liquidity pool
types you want to work with then the algos you will use and finally measure performance
against benchmarks.
• Regard ing liquid ity types, you need to curate the right pools for your business to give
you a passive safe spread to trad e. Speak to banks and challenge them to build your
pool specific to your needs to avoid the internalisation issues of lack of transparency, no
rules & toxic liquidity that increases price movements.
Conversation Summary & Key Takeaways:
• Avoid HFTs in your liquid ity pool and focus on ECNs that help to red uce your market impact and
avoid market leakage and where possible use no-last-look liquidity.
• When choosing algos keep to an optimum number typically und er 10, rotate them and know &
understand how each one works using inflight tools to help execute the trade.
• Review data & reports that focuses upon whether an algo behaved correctly for the environment, did
it underperform versus the fills available, so you can determine a market vs. algo issue.
• Be prepared to challenge banks with objectives, benchmarks, metrics and set targets and if they
cannot beat that target over an agreed period, rotate them off as you work with them to understand
the intricacies behind the data.
• To curate your liquid ity, you can lean on TCA provid ers and ask for d ata such as ranking tables on
providers, but ultimately you need to set strategy, make choices based upon your FX knowledge and
experience & ongoing measure venue performance to rotate and refine.
• Set up an internal committee to analyse algos, particularly if algos don’t behave as expected. Assess,
if a pattern exists and have a robust conversation with your broker on the issues and rotate if
necessary. This ensures brokers improve the liquidity pool for everyone and improves the ecosystem.
• Challenge for peer2peer liquidity is creating enough liquidity & volume & generating enough organic
matching opportunities. The future probably lies in a P2P pool that can be accessed by algos rather
than a standalone.