How Nasdaq’s M-ELO Ecosystem Feeds the Growing Appetite for Canadian Equity Execution Services
By Kevin Paul Utarid, Vice President of Sales for Nasdaq Canada
For a long time now, adverse selection and trading in the dark have been commonly debated market structure features of North American equity trading. These topics have been written about, turned into movies, books and have been the focus of many industry panels. The crux of the dilemma is that dark trading can create asymmetries. Whereas one side of the trade has fair value in mind, resting an order between the spread, the other side of the trade is often empowered by a speed advantage that can be used to interact opportunistically with the resting dark order in numerous ways.
Working for a marketplace is really interesting, as a lot of these issues are brought right to our proverbial front door on a daily basis; being a marketplace, we have a public interest mandate to create and ensure fair and equitable solutions are made available to all participants. The issues surrounding adverse selection and dark trading are best resolved by the venues where people make and take liquidity on a day-to-day basis. Recognizing the issues around dark trading in 2017, Nasdaq introduced an innovative solution intended to alleviate fears of trading in the dark by creating an enhanced order type known as the “Midpoint Extended Life Order” or M-ELO for short.
Over the last three years, our U.S. Equity Sales and Trading teams have developed and promoted this product after understanding the issues faced by users with longer-term investment horizons, fair value and calculated portfolio construction as it relates to the midpoint.
Since its inception, the U.S. M-ELO rollout has been widely adopted by many broker-dealers that have seen how M-ELO can improve their clients’ trading experience by addressing concerns about asymmetries when trading at the midpoint. At Nasdaq, we have undertaken multiple in-depth studies analyzing post-trade data surrounding the use of M-ELO, and the results speak for themselves. Leadership in this area has been shown by my colleague in the U.S., Andrew Oppenheimer (Associate Vice President, North American Markets), who created the graphic below after the rollout of M-ELO to truly demonstrate its impact. A simple mark out analysis of M-ELO demonstrates the responsiveness of the product and how effective it really is (M-ELO Newsletter, Oct 23, 2019).
The following graphic clearly demonstrates that performance is near parity with customers. Participants executing a minimum of 50,000 shares a month have mark outs +/- half a basis point using multiple time horizons from 100ms to 1 minute and within 3/10s of a basis point looking at the one-second post-M-ELO execution. We are extremely proud of this, and the performance remains great even as M-ELO volume and customers grow.
So, for my fellow Canadians, you must be asking yourself at this point, how does M-ELO actually work?
Essentially, M-ELO is an order that will only interact with other M-ELO orders. In other words, two like-minded counterparties seeking a fair price and value can use this facility to trade without worrying about information leakage or distortion. Because an M-ELO order is non-displayed, it alleviates some of the noise created when trading directly on a lit book, and because it has a timer, it removes any speed advantage of either counterparty. Once the M-ELO order enters the book, it has to wait for a half-second before it is eligible to interact with a like-minded order.
In its most basic form, M-ELO is a way to ensure two counterparties receive fair treatment and that they achieve their expected and intended outcome from using a mid-point order. In the U.S., the order type has been adopted by many institutional algo suites, which in turn has created a valuable use case for buy-side clients seeking a fair price with minimal post-trade noise. Not surprisingly, it is because of concerns about not achieving these outcomes that a number of buy-side firms stay clear of dark pools. M-ELO is the answer to these concerns as it removes the fear that an order will be detected and adversely selected when moving a size position for a long term investment strategy.
Enter Canada. While the Canadian equity market is much smaller than its U.S. counterpart, when you look at the number of venues, order types and competition between venues, we see a major global appetite for Canadian equity execution services and portfolio construction. On a day-to-day basis, there is a high volume of foreign account activity in the Canadian markets, particularly in ETFs, Interlisted and hot retail sectors. We know that a large percentage of total Canadian volume is attributed to accounts that are outside of Canada. Case in point, when there is a U.S. holiday, the overall average trading volume in Canada drops dramatically.
Fortunately for us, the Nasdaq U.S. Sales and Trading team has developed a robust ecosystem for the M-ELO order type, which Nasdaq Canada was able to leverage in September 2019 when we introduced the M-ELO on the CXC Trading Book.
The major difference between the U.S. iteration of M-ELO and the Canadian order type is the available pool of liquidity for interaction. Although our U.S. counterpart has made recent enhancements to the M-ELO after three years of use, I will be discussing this order type in its original form for the purpose of this article.
In the U.S., the vast majority of trade executions in the M-ELO facility are institutional in nature. In Canada, however, sources of liquidity extend beyond institutional accounts because of how retail order flow is managed. When analyzing Canadian trading activity, it may be surprising to note that some high touch retail trading desks do more block trade volume than some institutional trading desks on a day-to-day basis.
Although Canadian retail order flow varies significantly in terms of order size and notional value, the majority of retail flow originates the same way and uses the same in and outflows mechanically, with a similar intent. Retail orders in Canada are typically entered into an OMS or a third-party algo that ultimately will route to the best available price. Before executing at the BBO, orders will often seek price improvement by pinging venues at the midpoint, MPI level (Minimum Price Improvement) or at the touch when considering dark pools. For this reason, retail liquidity in Canada helps drive our non-display venues, pegged order types and other facilities across all venues at the minimum price improvement or midpoint levels.
The notion of price improvement is a mainstay in retail best execution practices in Canada. A facility like M-ELO makes a lot of sense for these large retail orders looking for a fair price without worrying that once on the books, the bid or offer will suddenly move against you. Although every firm is different, best execution practices around retail liquidity are often very similar for the top retail and discount brokers in Canada. Mid-point trading, or trading at the price-improved level, helps a broker justify their routing sequencing and facilities they use on exchange when reviewing best execution practices.
By understanding the issues around midpoint trading, M-ELO was designed as a solution to decrease adverse selection inside the bid and offer, while at the same time reducing information leakage and ensuring that trades are executed at a fair price. Since retail orders and institutional agency order flow in Canada look for the same havens when executing, then M-ELO should almost be considered a mandatory avenue to push large size impactful orders seeking fair execution and price improvement on a consistent basis.
Introducing our U.S. M-ELO ecosystem into the Canadian market, coupled with the additional retail liquidity available in the Canadian market, Nasdaq Canada’s version of the M-ELO should result in both retail and institutional counterparties achieving some of the cleanest and effective executions across all types of positions. The M-ELO offering in Canada currently complements some of our existing order types offered on the Nasdaq Canada books.
At this time, we feel that M-ELO can bring together like-minded parties, who have a longer-term investment horizon, fair value in mind and aim to reduce information leakage in an organized manner on a consistent basis. We feel that the use case in Canadian Equity markets for this order type is essential and can create a less segmented counterparty interaction upon execution. Currently, Nasdaq M-ELO is available on the CXC Trading Book at no cost. Please feel free to contact my colleagues or me at Nasdaq Canada to get further information on accessing and implementing this order type in your workflow.
Kevin Paul Utarid is the Vice President of Sales for Nasdaq Canada, covering both Equities and Fixed Income. Kevin brings over 15 years of experience in Capital Markets and has led various Sales and Trading teams throughout his career in both the Vendor and Broker-Dealer space covering Equities, Vendor Management and Custodial Services. Kevin is a graduate of the University of Toronto and has sat on the Board of the University of Toronto’s Economic Council.