Head of U.S. Equity Derivatives
Tradeweb is one of the world’s leading builders and operators of global fixed income, derivatives and ETF marketplaces. The majority of institutional investors on Tradeweb use the request-for-quote (RFQ) protocol when trading in the 20+ marketplaces supported by the firm—including the one for U.S. ETFs, which was launched in February 2016. Looking back at the success of the platform, Adam Gould, head of U.S. equity derivatives for Tradeweb, discusses how that feature has been adopted by customers.
Would you provide us an overview of RFQ trading? What is your value-add in the RFQ space when it comes to ETFs?
Though request for quote (RFQ) is not new to the marketplace, it is relatively new to ETFs. RFQ is a trading protocol that allows investors to send an electronic inquiry to a number of liquidity providers for a particular security. Previously, when requesting a quote, a customer would pick up the phone and call multiple dealers to ask at what level they would buy or sell something. Now investors can get better pricing by putting liquidity providers in competition—this process is happening in real time and more efficiently through electronic trading.
In addition to competitive pricing, RFQ trading for ETFs allows investors to access deeper liquidity. The average RFQ trade size on Tradeweb is exponentially larger than what’s available on exchange. Investors can execute a large block order in a single trade rather than potentially triggering electronic bids and offers (or other noise in the market) with algorithmic trading.
Immediacy in execution is another advantage, as investors can trade an ETF right as liquidity providers submit their pricing. Often, prices come back almost instantaneously as they are being auto-quoted. With less liquid ETFs, it may take a little bit longer for prices to come in—10 to 15 seconds versus 1 second—but customers can either wait for all those prices to come back or complete the trade if they see a price they like.
Where Tradeweb brings value is its history with RFQ—we pioneered multidealer RFQ trading in the U.S. Treasury markets 20 years ago. On Tradeweb, ETF customers can put up to five liquidity providers in competition and request a one-way or two-way market that allows them to get optimal pricing on their trade. Liquidity providers may have certain interest to buy or sell based on how their book is positioned—this type of trading provides an opportunity for investors to take advantage of this positioning in real time across multiple dealers.
Once a trade is completed, clients benefit from straight-through processing, which reduces the potential for error and allows them to update their risk position almost immediately. A record of the trade including where the ETF was on exchange, and the various prices that came back on Tradeweb, are stored on the platform in perpetuity. This data is leveraged to offer metrics that help clients comply with best-execution requirements in a systematic, organized manner.
Another significant benefit we bring to the table is the ability to allocate trades downstream to different accounts—it’s certainly very attractive to the asset management community.
What kind of liquidity are investors accessing when they trade ETFs via Tradeweb? Is this some sort of alternative block, or is it a dark offering?
Trading ETFs via RFQ provides investors with extremely transparent pricing. A client can choose the liquidity providers they want to include in the inquiry, and leverage existing relationships in a streamlined, efficient manner. They can quickly view pricing and then execute a full range of trade sizes on the platform.
As the institutional community has become more interested in ETFs, trade sizes have grown, and are typically larger than what you’re seeing at the NBBO on exchange. RFQ allows them to gain immediacy of execution, while the depth of liquidity allows them to complete block-size trades in a single transaction. Compounding that with the quality of pricing they get by putting dealers in competition is really powerful.
Investors can execute the full range of trade sizes on Tradeweb—we’ve seen trades ranging from 100 shares to 12 million shares. A large number of them choose us for block trading, which is 10,000 shares, or $200,000 in notional value. Once investors see the competitive pricing, operational efficiency and best-execution metrics on Tradeweb, they tend to move all their ETF trades here.
How are investors using ETFs as part of their portfolios? Has it changed over time?
Though the RFQ trading process is similar across the board, there are certainly intricacies relative to each product. A growing number of institutional investors are trading ETFs, and they bring a sophisticated approach to how they’re leveraging these securities—over time, we’ve seen investors use ETFs as a hedging tool.
Net asset value (NAV) trading is also a big draw, as a customer can put liquidity providers in competition on an ETF at that day’s or the next day’s closing NAV. A growing number of index managers that are benchmarked to the close and interested in trading at the end of the day are aggressing on these trades.
Market participants are also using switch trades to buy one ETF and sell another as part of the same trade. In a switch trade, the liquidity provider knows if they’re winning both sides of the trade, or neither side—they’re in a position to quote either side of that trade as if they only need to hedge the part of the two ETF indexes that isn’t correlated, which allows them to price more aggressively. Clients using ETFs find that very appealing, as ETFs are often used to express some type of tactical view on the market, so they’ll move out of one position while increasing exposure in another to address an anticipated market pullback.
Tradeweb recently launched this functionality, which allows clients to buy one ETF and sell another one simultaneously. We are also one of the only platforms to offer closed-end funds, and are seeing more interest in these securities.
Given that Tradeweb is known as a fixed-income platform, what kind of overlap are you seeing with your client base when it comes to fixed-income ETFs? Are there advantages or synergies to trading fixed-income ETFs alongside your bond trading platforms?
Absolutely. Approximately 30-40% of our trading activity tends to be in fixed-income ETFs. The overall market is closer to 15-20%, so we certainly see a larger amount of fixed-income ETF trading relative to the market. That can be attributed to some clear synergies at Tradeweb in terms of our core client base, which consists mostly of major fixed-income players, although that’s expanding as we bring in traditional equity market participants for the ETF platform.
Fixed-income investors aren’t used to trading stocks; they’re used to trading bonds via RFQ. Now they can use a familiar trading protocol on the same system to trade ETFs, which provides them with a high level of comfort. Because the ETF is a wrapper of whatever the underlying index is, but looks, feels and settles like a stock, trading it is certainly new to a lot of fixed-income money managers that are embracing them. These clients are more interested in trading ETFs than ever before, and are using them to express short-term views, and as a way to equitize cash.
So if an investor wants exposure to a certain part of the market, but isn’t sure which bonds to buy at that moment, they would use the ETF as a placeholder so they have the index exposure until they can buy the bonds, and vice versa.
To sum it up, we’re seeing an oversized amount of fixed-income ETFs relative to the market, but the system works extremely well for all ETFs. I think that’s just a function of our client base, and we’re certainly making a bet it’s going to continue to grow.
How much growth have you seen in the use of RFQ trading for ETFs?
We launched in the first quarter of 2016 in the U.S., and have had more than $57 billion notional trade on the platform, which is a number we’re certainly very happy about. Essentially, we’ve seen consistent volume growth since launch, which has certainly been impacted by inflows, overall market volume, etc. However, generally speaking, we’re seeing an increasing number of clients execute more large-size trades—all the things you’d want to see in a platform that’s growing.