A Report in the US Equity Market Structure Analysis Series

In our second report analyzing off-exchange trading levels, we go deeper into publicly available data to break down off exchange by ATS and OTC venues. We believe the current market structure works well and the retail investor has never had it better – $0 commissions, mobile access to trading platforms, research/education materials available at no charge from retail brokers, etc. – earning $11B in price and size improvement in 2020. Yet, current conversations overlook or underestimate many factors, such as the competition for order flow is a hunger game, driven by execution quality.

We highlight the following:

• 2016 to 2020: total volumes increased 50.0% vs. off-exchange volumes +69.4%, a 19.4 pps differential
• Volume breakout: (2017-2019) exchange 65.0%, ATS 12.6%, OTC 22.4%; (2020) exchange 61.6% (-3.4 pps), ATS 11.3% (-1.3 pps), OTC 27.1% (+4.7 pps)
• Transaction breakout: (2017-2019) exchange 77.6%, ATS 12.5%, OTC 9.9%; (2020) exchange 73.5% (-4.1 pps), ATS 10.7% (-1.8 pps), OTC 15.8% (+5.9 pps).

Executive Summary

Discussions continue about the increased level of off-exchange trading as a percent of total equity volumes in the U.S. (YTD 43.9%; + 2.4 pps to 2020, +6.6 pps to 2019). In our first report analyzing off-exchange trading levels, we looked at alternative views of measuring off-exchange trading – as a percent of notional value or trade count and levels by tape – showing the variances in growth rates by metric. We noted that the percent of off-exchange trading is a function of market structure, and the optimal level of off-exchange trading is the actual amount in that given time period.

This report goes deeper into the publicly available FINRA data to break down off exchange volumes across ATS and OTC venues. We highlight the following:

• From 2016 to 2020, total consolidated equity volumes increased 50.0%, while off-exchange volumes increased 69.4%, a 19.4 pps differential. The differential was less on a compound annual growth rate basis at 2.7 pps: total volumes increased 8.4%, while off-exchange volumes increased 11.1%.
• In 2020, the Y/Y growth trend for off-exchange outpaced that for both market and on-exchange volumes, a shift from historical patterns of declining or growing less than on exchange and the total market, increasing the differential between off- and on-exchange trading Y/Y growth rates.
• The pattern between off-exchange volumes and volatility (VIX) also shifted in 2020. When the VIX increased 90.1% Y/Y, off-exchange volumes increased 74.5% Y/Y versus only a 46.0% increase for on-exchange volumes. Despite high volatility, trades moved off-exchange.
• For volumes from 2017 to 2019, the breakout among trading venues averaged: exchange 65.0%, ATS 12.6%, OTC 22.4%. This shifted in 2020 to: exchange 61.6% (-3.4 pps), ATS 11.3% (-1.3 pps), OTC 27.1% (+4.7 pps).
• For transactions from 2017 to 2019, the breakout among trading venues averaged: exchange 77.6%, ATS 12.5%, OTC 9.9%. This shifted in 2020 to: exchange 73.5% (-4.1 pps), ATS 10.7% (-1.8 pps), OTC 15.8% (+5.9 pps).
• Transaction growth outpaced dollar volume growth by: exchange 13.0 pps, ATS 3.7 pps, OTC 93.2 pps. More transactions are being executed in lower value stocks, an indicator of greater retail flow
• From 4Q19 to 3Q21, while exchange trading as a percent of total market volumes declined 4.7 pps and ATS declined 1.5 pps, OTC venues grew 6.2 pps. The growth in OTC levels corresponds to volume increases. Looking at 2Q20 when the OTC level reached the 30s, OTC venues grew as a percent of total by 5.6 pps from 4Q19 (essentially the average historical level) to 2Q20. During the same time, ADV grew 82.9%.
• We also provide a list of ATS and OTC venues.

While there have been many comments on equity market structure this year, we believe the system works well. Additionally, retail investors have never had it better – $0 commissions, access to trading platforms, research/education materials available for free from their retail broker, etc. We believe the current conversations overlook or underestimate many factors, including:

• The competition for order flow is a hunger game, driven by execution quality. As retail brokers route their order flow based on execution quality metrics, the competition is centered around this one concept: who will perform better (i.e. provide best ex) for my clients’ order flow? Executing firms need to prove their worth day in and day out. Our current market structure provided retail investors $3.6 billion in price improvement in 2020. This figure increases to $11.0 billion when you add in size improvement as well (liquidity providers may price improve orders by improving the price versus the National Best Bid and Offer, or NBBO, or offering more shares than the displayed size available).
• Market participants also provide risk controls and protections for their clients during the order routing and execution processes. Without this buffer, retail brokers would have increased execution risk, which could shift costs to their clients.
• Costs are a barrier to entry for consolidators and market makers alike, requiring financial strength and operational resiliency supported by an enormous technology footprint. Firms with scale can deploy new technologies safely and smartly to meet real time market needs given the current market environment.

To continue reading…

 

 

Author

Katie Kolchin, CFA
Director of Research

The US Equity Market Structure Analysis Series

• SIFMA Insights

  Why Market Structure and Liquidity Matter

• SIFMA Insights

  Analyzing the Meaning Behind the Level of Off-Exchange Trading

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  Monthly Market Metrics and Trends

• SIFMA Research

  US Equity Issuance and Trading Volumes

• SIFMA Research

  Research Quarterly: Equities

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• Global Capital Markets & Financial Institutions Primer

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