Brokers say they are striving to improve the quality of their pre-trade indication of interest (IOI) messages to help buy-side clients seek liquidity more efficiently.
They spoke out in response to claims reported by AsianInvestor on the misuse of IOIs, which are pre-trade messages used in privately negotiated block trades.
Several heads of sales trading acknowledge that while they need to be tactical about IOI distribution, it’s just as important to protect buy-side client order flow and operate on a basis of trust.
Recently a group of 20 buy-side head traders formed a group to canvass peers and rate the quality of IOIs distributed by brokers on Bloomberg terminals.
The initiative is borne of dissatisfaction at how IOIs are used by some brokers more as a tool to advertise transactions and tout their “active coverage” on particular stocks, often without the clients’ consent.
Buy-side traders dislike that their order flows are being shown to clients of a broker who want to see all market flows, but show nothing of their own in return.
While this practice might enable a broker to tease trades out of their clients, it may conflict with the interests of other investors who have shown their hands via IOIs.
If an IOI is backed by a sizeable order, for example, clients who want to see these pre-trade messages of interest but withhold their own flow could make their decision on whether to trade based around that.
George Molina, head of Asia trading at Franklin Templeton, says the group of 20 traders has been working with the sell-side to try and ensure they facilitate an equal exchange of information via IOIs to avoid misuse.
“This has been happening for quite some time and from my understanding it was the classic ‘if you don’t ask, they don’t tell’ type of issue with the brokers,” he says. “What we’ve done is to reach out to the sell-side community and asked that our IOIs be shared only with peers who are playing by the rules.”
In fact, brokers report that increasingly clients are asking them how they go about IOI distribution, as well as about their policies for differentiating “natural order” – agency order from a broker’s buy-side client – from those they view as not natural, such as from a bank’s own facilitation desk.
In today’s environment of shrunken trading volumes where finding liquidity tops buy-side concerns, traders say IOI misuse is destroying liquidity rather than helping to locate it.
Total daily value traded across Asia’s major markets fell for four consecutive months to below $30 billion in June, according to ITG data.
Robert Laible, Nomura’s head of sales trading for Asia ex-Japan, notes that as buy-side clients often have different views on whether to show their order flow via IOIs, his team entertain such requests but only on a case-by-case basis.
“We try to make clients understand what processes we have in place around distributing our IOIs to clients, and understand what clients’ expectations are,” he says. “It is important for us to be able to protect their order flow as much as we protect everyone else’s.”
Over the past eight months the bank’s equity division has been revamping its IT infrastructure to improve the quality of its IOIs.
One outcome of this investment is that it now has better monitoring capabilities to enable the team to customise IOIs so that when clients receive their pre-trade messages they know whether an IOI is natural order flow or not.
At the same time, brokers argue that they need to be tactical around the way they distribute IOIs, as mis-targeting their audience can break relationships.
But Andrew Maynard, global head of trading and execution for CLSA, stresses that brokers must be selective about who they send their IOIs to, and how much of an order’s size they show.
That’s because a broker needs to consider who has liquidity on the other end of a trade.
“A broker cannot send an IOI that is bigger than the average daily trading volume of an illiquid stock to all clients because showing a size that is bigger than the market to someone who cannot trade that size could move the stock price unfavourably for the asset manager who genuinely has the appetite and demand for the entire size of that order,” explains Maynard.