How is Europe’s liquidity landscape changing?

In 2022, the European equities market reached a €53.4bn average daily value, an increase of 8.2% on 2021’s daily value. But what trends are being seen as to where and what volume is being traded?

Market liquidity remained centred on the main indexes in 2022, according to a recent from Liquidnet, a global institutional investment network, entitled ‘Liquidity landscape 2023: What next for European markets?’, which covers equities only.

However, there is noteworthy change occurring in how liquidity trades. The report states: “The proportion of notional traded on lit primary markets [which distribute best-priced bid and offer to the consolidated tape] (excluding the auctions) continued to decline, down from around 40% in the first quarter of 2020 to around 30% in the fourth quarter of 2022. This is in contrast to the proportion being traded in auctions (up around 5% over the same period) and lit multilateral trading facilities up by a similar amount.”

Liquidnet’s research, based on Cboe Market Data and Bloomberg data, also uncovered differences between European countries in how transactions occur, which hampers the growth of cross-border activity. For example, dark trading only accounts for 5% in Italy, but more than 12% in Nasdaq Copenhagen.

With the greater fragmentation across European markets and methods of trading, and as continuous liquidity becomes harder to uncover, Liquidnet suggests that trading strategies will continue to evolve as a result. On dark markets and specifically their use of large-in-scale (LIS) waiver, its research found a decline in both as the dark market and the overall market continues to fall in percentage terms proportional to the whole market.

Systematic internalisers’ activity is increasingly trading in smaller clips, with the average execution size falling steadily over the past few years. The average daily principal also decreased from more than €10bn at the start of 2022 to under €5bn by the end of December.

Looking out into 2023, Liquidnet believes that the lack of progress in Markets in Financial Instruments Directive/Regulation policy objectives and the current impact on liquidity formation is likely to lead to “further political influence” both in UK and EU to stimulate secondary markets activity. “The focus for both regulators is based on a need to enhance data transparency and the harmonisation of reporting to bolster confidence in markets,” according to the report.

Future challenges include the move to one business day (T+1) settlement. Liquidnet argues that the lack of investment in automated processes and infrastructure in the back office will exacerbate a strained system. “With the majority of cash management cycles at T+3 or even T+4 but trading at T+1, there is a growing mismatch between cash and asset flows at a time of tightening margins and rising interest rates, and options for fund managers are shrinking,” according to the report.

Joy Macknight is editor of The Banker. Follow her on Twitter @joymacknight

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