4Q PFOF - Options Driving Retail Brokerage + SEC ATS Plans, DeFi Future, SOFR: Market Structure Weekly
A lot of content this week. Enjoy
This week on BI Market Structure {BI MKTSG <GO>}, we comment on U.S. retail-volume trends for equities and options, as well as the SEC's views on "gamification," exchanges and ATS. We talk about the accelerating shift to SOFR, Stablecoin upgrades and Ethereum's declining decentralized-finance dominance. We also share our financials team's views on Euronext, Deutsche Boerse, Amundi, DWS and Janus Henderson. (Click the blue links to access research on your Bloomberg terminal.)
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Latest Insights:
The 4Q shift in retail volume toward options and semiprofessional traders, and away from self-directed novices, was consistent with greater volatility that the more sophisticated are better equipped to handle. After a retail-volume peak in November, the VIX volatility gauge jumped 13.4% in December, rattled by omicron, inflation concern and Russia-Ukraine tension.
A SEC request for information and comment on how Robinhood and other retail brokers use technology to engage with customers, with an eye toward "gamification" of stock trading, may pose a growing threat to the sector's volume and expense. A proposal may come in the near future with comments from SEC Chairman Gary Gensler pointing to increased disclosure obligations and compliance costs, along with decreased volume.
Maintaining high options trading volume is key for wholesale market makers and retail brokers in 2022, as it propelled payments for order flow (PFOF) to brokers to $3.8 billion in 2021, up 33% from 2020, based on SEC data. Over 70% of PFOF came from options flow, with the remainder from equities. The options market's structure and lack of liquidity create a profitable landscape for market makers.
Market and SEC 606 data confirm U.S. retail investors' increasing comfort with options trading strategies. Aggregated volume shows 10 of the largest brokers catering to self-guided investors consistently account for more than 20% of options activity, with customers' participation setting a record in 4Q. The combination of Charles Schwab and TD Ameritrade dominates.
The secured overnight financing rate (SOFR) is firmly taking hold at banks and buyside firms trading in the U.S. rates market. There will still be trades in the outgoing Libor benchmark, but the transition has passed the tough part of convincing the market that SOFR is the heir apparent.
The SEC's amended proposal on the definition of an "exchange" and regulation of alternative trading systems (ATS) is broader than the original, though it remains to be seen what effect that would have on fixed-income market liquidity. Various types of firms and trading activity are likely to be included. The Federal Reserve's reduction in support for the Treasury market looms in the background as the updated rule moves forward.
An SEC proposal that would require alternative trading systems (ATS) to grant fair access to all firms when the parent's aggregate volume from multiple pools is 5% or more in a particular security or 1% of a product class, improving market transparency. It could also cause the parents to expand the number of symbols they limit in certain securities, consolidate pools, or shutter ATSs completely.
By imposing disclosure, regulatory oversight and operational and technology costs, the SEC's proposed Regulation ATS amendment risks concentrating liquidity in the largest exchanges and pools. Transparency improves, but smaller pools less equipped to comply may fall by the wayside. Both developments could be detrimental for end-users of liquidity.
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The intellectual capital swelling the ranks of decentralized finance (DeFi) has proven resistant to price volatility, which bodes well for the sector to continue to address the complex problems unsolved by the legacy financial industry. The advancement of Stablecoins, as a volatility buffer and yield instrument, is seducing a steady flow of new entrants into the world of cryptocurrency and digital assets.
Competition and diversification among layer 1 blockchains is forming the foundation for a more-resilient decentralized (DeFi) finance ecosystem. While only the fittest cryptocurrencies will survive over the bear cycle, a broadening base of chains lowers concentration risk and marks an important progression in the evolution of DeFi.
Asset Management and Exchanges Insights:
Janus Henderson's 2022 top-line estimates could expand by a low- to mid-single digit percentage to about $2.8 billion, we calculate, helped by elevated market level and a resilient fee margin. The Intech sale may cut revenue by $20-$30 million this year, but will staunching a major bleeding point. Still, volatility may pose risks to performance and flows.
DWS' strong passive inflows -- 26 billion euros in 2021 -- are likely to continue, justifying consensus revenue to be revised up by as much as 6%, our analysis shows, despite margin pressure. The 4% organic-growth target looks easily achievable too, driven by ESG (comprising 40% of total flows last year) and complemented by alternatives.
The outlook for rising rates globally could drive near-term volatility in both equities and rates and in turn benefit exchanges' trading volume. This was signaled by strong January growth in Euronext's cash equities and fixed-income products, as well as LSEG's derivatives. Deutsche Boerse still trailed peers due to its product mix.
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