With increasingly complex trading-technology infrastructure and fragmented markets, achieving balance between execution quality, opportunity costs and finding liquidity has become equally complex. Larger trades tend to cost more due to implicit costs inherent in market impact, and many smaller trades contribute to so-called ‘alpha decay’ due to high explicit costs from trading fees. Meanwhile, large visible orders contribute to information leakage and waiting for the ‘right moment’ could result in missed liquidity.

Langa Manqele, Head: Equities and Equity Derivatives at the JSE, says that market participants, particularly large institutions such as asset managers, pension funds or insurance companies are generally faced with two opposing demands. ‘They need to be able to source liquidity effectively and do so with very little or no market impact at all.’ This is even more crucial during periods of heightened uncertainty and erratic market volatility, such as the March 2020 sell-off in global stocks, which was triggered by worldwide COVID-19 economic lockdowns.

For example, he says, ‘a large asset manager who wants to move a large position in a JSE Top 40 stock could come into the market and drop one big order of, for example, R2 billion in value. But this will definitely have a significant market impact. If done on the JSE Central Order Book, the market will see the size of the order and its direction, and instantaneously this could drive the price either up or down’. This is a problem for the investor who would want to have taken advantage of the prevailing market price. For specific execution outcomes, the basic order types offered by the exchange – such as market orders, limit orders, stop orders and stop limit orders – can be limited in their ability to offer effective liquidity-seeking strategies and still avoid market impact or information leakage. This is where the trades that result from the Complex Order Suite become useful. To solve some of the execution and trading challenges highlighted above, the JSE’s Complex Order Suite is a set of orders and trade types that provide ‘safe-haven’ functionality for large-in-size orders, order protection and liquidity-seeking features.

The Central Order Book Cross, also known as an ‘XT’, enables an executing member of the JSE, such as a stockbroker, with two clients on opposite sides of the trade, to report such a trade at a pre-agreed price without being intercepted in the order book, says Manqele. This trade cannot be hidden, but it is fully protected; other participants cannot interact with this trade type. There is no minimum size requirement on this trade – the only requirement is that the trade must be crossed within the spread linked to the visible best bid/offer. To avoid a situation where the market moves away from the pre-agreed fixed price, the trader could choose the ‘adjustable price option’ for guaranteed execution.

A block trade (BT) is typically used by institutional investors. Manqele says this trade type has a minimum size requirement (based on a rolling average daily value on a tiered structure), but unlike the XT, block trades do not have the requirement of price, in that it is not limited to the best bid/offer spread. This trade type can also be used instead of an XT where markets are moving quickly. Another useful and cost-effective order type in the JSE Complex Order Suite is an iceberg order. It enables one to submit an order and only display a small portion of the total order. This will allow one to have a full order in the Central Order Book at once without disclosing the full order size. ‘A participant with an order for, for example, 15 million shares in a large-cap stock is able to place the order and only expose, for instance, for a portion of 100 000 shares that are randomly replenished after each execution,’ says Manqele. The rest of the order remains hidden but is available for execution in full against an equally large order, thus minimising price movements and reducing trading costs.

Lastly, a pegged hidden order is one that is not visible to market participants, and which allows for improved execution of large orders at prices that are relative to the best executable spread of the instrument. The innovation is that a market participant is able to peg the price to the best bid, best offer or to the midpoint between the two. Depending on the order execution requirements, the Complex Order Suite orders and trade types are able to efficiently ensure a balance between sourcing liquidity effectively, while not introducing any market impact or information leakage.

By Hilton Tarrant
Image by Gallo/Getty Images