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Can liquidity serve as the basis for effectively centralizing the fragmented market, and what is needed for fair and orderly interaction of all flow, regardless of source?
First, a neutral meeting point, an environment where diverse types of liquidity can interact in an anonymous, fair and orderly manner. This will require a compliance gateway to filter out any possible manipulative activity associated with orders with a very short-term trading horizon along with connectivity to the various important market centres using the latest technology available in order to access any liquidity outside the environment in a low-latency manner.
Second, algorithmic tools to interact with market. That genie is out of the bottle; algorithms will always be necessary to access liquidity in a low-impact fashion with minimal information leakage.
Third, a specialist/market maker to provide liquidity when needed whose motivation is to service order flow by providing liquidity when needed to maintain an orderly market to attract the next order, not to extract maximum trading P&L from each order by using the advantages of better market access and technologies to arbitrage the inefficiencies caused by Reg NMS, and the proliferation of multiple lit and dark trading venues. The execution of flow in this context is not simply agency (though that is the “first pass”) but actually replicates the traditional ability of order-driven market making when naturals do not meet. Here routing is simply not sufficient; but genuine market making providing liquidity as a service to the customer order completes an efficient marketplace.
Fourth, a neutral execution point that simultaneously satisfies all of the conditions above – once the aforementioned conditions are created, liquidity will naturally gravitate toward an environment that will allow orders to interact with each other in a fair and orderly price-time manner, leading to both superior price discovery and liquidity at those prices. This would create an environment that does not merely have access but aggregates the maximum possible liquidity available.
The effect, then, is as near a template as possible for an effective centralization in a fragmented market. A tall order? Not when judged against the criteria of continued market clunkiness and inefficiency.
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