RFQs – Ready for Quality Street… Roses, Celebrations or whatever the contents might be in the festive family bowl of chocolates? One thing is for sure, there’ll be some variety at the bottom which lies there having left a bad taste in someone’s mouth.
RFQ in equity and ETF trading is an alternative mechanism to Request For Quote directly from market makers in your preferred size and execute directly without touching the lit market.
As you can see, RFQs have been growing and are the dominant mechanism for ETF trading in Europe.
Why is it that RFQs are so popular when trading European ETFs when they aren’t in the US, or indeed for trading any other equity-like instruments? Is it liquidity, convenience/ease of execution, or perhaps better prices?
There is certainly a case for liquidity. Chart 2 shows the average daily value traded (ADVT) for one quite liquid ETF that we are going to take a look at. This is without RFQ prints showing, and…
… Chart 3 shows the ADVT for the same instrument with RFQ volumes added in.
When we measure all of these market quality metrics they would appear to be as good if not better than the underlying lit order books.
….except for the occasions when they are not.
One of our institutional investing clients asked us to look at this mechanism in more detail to see what actually happens with large trades, not just the smaller examples contributing to the examples above.
What we found was not wholly surprising yet it might raise some eyebrows.
For one of the largest trades in this same ETF using RFQ mechanisms we observed how during the period of the quote until just after the execution printed there was a widening of the CBBO spread (i.e. on the underlying lit order books), resulting in movement of the BBO midpoint and a sharp reduction in at touch liquidity, again, just during the quoting period.
After that the market returned to a more normal state. Orange creme or marzipan; delicious for some, yuck for others…
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