Liquidity explained.

How to find the right provider for you

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What is
Liquidity?
Liquidity can have several different meanings, so it’s important to clarify what we
mean when discussing the function of liquidity providers.

In trading, liquidity is about providing or getting a price to buy or sell an asset.

Liquidity providers, or LPs, offer executable prices to different types of institutional
clients with the aim of delivering maximum trading efficiency and tradability.

It’s generally understood that the more liquid a market, the easier it is to seamlessly
execute a greater number and/or size of trades. What is less well understood is how
liquidity providers, by acting as key intermediaries, play a crucial role in market
functioning. When markets are illiquid, prices are more volatile and less informative.
That’s why the emergence of specialist liquidity providers has proven important in
improving market quality and functioning.

Not all liquidity providers are the same, however.

In this paper we will talk about the nature of liquidity, what a truly best-in-class liquidity
provider delivers and what multi-asset brokers should look for from a provider.
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Who supplies
Liquidity?
In the past, formal exchange specialists or market makers provided most liquidity,
for example through pricing. More recently, though, this role has been taken on by
specialist liquidity providers, using emerging technologies to deliver bespoke and
sustainable liquidity to a broader range of end clients.

There are 3 broad classes of ‘liquidity provider’; however, it is important to remember

that this space is evolving, and providers are developing their own bespoke liquidity
provision as technology advances.

Financial Tier 2 End

Institutions LPs Users

Retail brokers

Hedge Funds
Proprietary trading
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Tier 1 liquidity providers connect brokerage companies

with the ECN network – the electronic system of bid and
ask orders execution. ECN unites the largest tier
1 bank market makers.

Tier 2 providers typically act as an intermediary between

the Tier 1 liquidity providers and end clients. This often
includes smaller financial institutions, hedge funds and
retail brokers.

Prime

Prime of Prime (PoP): These providers aggregate pricing

from as wide a range of sources as possible (Tier 1 banks,
OTC brokers, dark pools, etc) into their own liquidity pool.
They are then able to deliver bespoke pricing to their
end clients.

It should be noted that Tier 2 and Prime of Prime (PoP) liquidity providers overlap, to an extent.
This reflects the dynamic and evolving nature of the marketplace; technology and changing demands
placed on them by brokers and other non-bank financial institutions means liquidity providers are
constantly adapting to the needs of their clients and the market: adaptability is a key trait of any
good provider.
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Liquidity
Pools
A PoP can curate pricing from market makers – who take risk – in order to lessen
the market impact and improve liquidity. Adding pricing to liquidity pools from
market makers who internalise risk over a short-term timeframe can significantly
reduce market impact and therefore increase pricing stability and longevity.

Finalto curates pricing from a range of Tier 1 banks and other non-bank liquidity
providers to create a liquidity pool from which clients can derive pricing. The advantage
of this is a more bespoke and sustainable liquidity. At Finalto we have developed
systems to empower clients with greater access to additional pools of liquidity.

This approach involves a focus on connectivity to multiple electronic trading venues;

the aggregation of multiple sources of liquidity from different venues; streamlining
trade workflow, such as the number of steps required to execute a trade; and creating
analytical tools to proactively manage and improve end-client experience.

Price of gold

LP1 1786.35

LP2 1786.40

LP3 1786.43
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FBS Liquidity update

Things to bear in mind when choosing an LP

Price
You can be sure that Finalto will always focus on providing bespoke and
sustainable pricing.

As you might imagine, liquidity provision is all about providing a price. However,
liquidity provision is by no means a one-size-fits-all model. As the landscape has
evolved and technology has improved to enable a wider range of products, clients are
increasingly looking for tailored liquidity that serves their needs, while also retaining
access to a large, established and respected liquidity provider.

The importance of pricing skew – how we narrow spreads for our clients.

Skewed price feeds are important as they allow us to provide a Bid/Offer that’s as
close to mid (or through it) as possible. Providers can do this by pooling multiple sources
of liquidity (pricing) and aggregating this out to meet the needs of individual clients.
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Bid and Offer price by LP:

Bid Offer Spread

LP1 1.0005 1.0009 0.0004

LP2 1.0001 1.0005 0.0004

LP3 1.0004 1.0006 0.0002

While LP3 shows us what seems to be the most competitive spread, we can make an
aggregated book to create more competitive pricing on both the bid and ask.

LP Bid Bid Offer LP Offer

LP1 1.0005 1.0005 LP2

LP2 1.0004 1.0006 LP3

LP3 1.0001 1.0009 LP1

Although LP3 has the tightest individual spread, it isn’t part of the Top of Book price
we would send to a client, as the other two spreads show a ‘skew’ at mid-price (1.0005)
on one side.
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Bespoke
Liquidity
‘The tailoring of our solution is modelled on a range of factors and depends on trade
size as well as type of client,’ says Andy Biggs, Group Head of Risk and Trading at
Finalto. For example, offering liquidity at various prices is different when we’re dealing
with a trade size of £1k, as opposed to a regular flow of £100m trades.

‘This is where our creation and careful management of deep and dynamic liquidity pools,
and the technological development to support them, has been instrumental in
us being able to service the needs of a wide range of clients,’ Biggs adds.

Additionally, different types of clients will look for different attributes. A retail broker may,
for example, be more focused on a lower average spread which enables them to add the
mark-up they can pass on to their end clients, while still being able to offer the product
with lower costs. A fund, on the other hand, will almost always want to focus on its
long-term performance by ensuring it has constant access to the best overall price.

Good communication with clients is therefore an essential part of the process, as placing
flow in the wrong pool might lead to an LP pulling or widening pricing. By ensuring that
the pricing model is best suited to an individual client, we also make it sustainable.
That’s why we place a high level of importance on setting clients on the right path and
why we create different pools to reflect our clients’ individual needs. Building a suitable
price feed for a client enables longevity of their liquidity and a client trading larger tickets
will benefit from a different structure to a client trading micros.

Another factor to consider is the lowering of market impact. The structure of a client’s
book can be created as ‘sweepable’, or tiered, to suit their execution and where possible
reduce the impact on pricing.

Minimal
market impact

Optimal speed
of execution

Sustainability

Best price
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Speed
Arguably, execution speed is every bit as important as pricing itself. Why?
Because the speed at which a price is delivered and executed can make a big
difference to performance and also plays a central role in delivering pricings
ustainability. The fact that high-frequency market makers can put out more than
one quote per millisecond means that an LP’s ability to customise what they then
pass on to the client is critical. And as some clients will want that kind of frequency
while others have no need, we believe it’s important to tailor not only the pricing
but also the ‘pressure’ on that flow, depending on the client’s needs.

These days, in-house technology plays an important role in delivering speed

of execution. So in our opinion multi-asset brokers should look to LPs who have
implemented their own technology. This will enable them to take a more precise
approach to ensuring maximum speed of execution, without compromising
on price.

Of course, some brokers may prioritise speed over price to reduce latency,
while others may prefer to get the best price at the expense of a millisecond or
two in speed. At the end of the day, it all boils down to individual circumstances.
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Analytics
In-house tech is important for another reason - data is a powerful tool for tailoring
and improving liquidity for specific clients, and liquidity providers should take a
proactive approach to maximising the utility of the data it sits upon. At Finalto we use
data in discussions with clients themselves, and with the institutions our data derives
pricing from, to constantly make improvements and fix problems before they can
become a bigger issue.

In order to maximise the benefit of data analytics, multi-asset brokers should look to LPs
who have their own technology. Again, we consider scale to be an important coefficient in
the analytic equation, for the simple reason that the speed of data delivery is vital. In fact,
the speed of the data flow itself is instrumental in lowering the number of rejected trades,
while faster data flow creates a more accurate price flow for a broker’s B Book. To put it
simply, volume of data x how this data is used = better outcomes for brokers.

Antony Parsons, Head of Liquidity at Finalto, explains: ‘Clients need an LP who’s got a
good analytics package so they know they are managing the flow correctly. And it works
both ways – our LPs will only deliver pricing to Finalto if we are analysing and optimising
all the time.’

Finally, a good LP will not only be able to analyse the flow they sit across, but will also
be able to view the data of the broker’s end clients. ‘Some brokers may not have the tools
to analyse their own clients’ flow - we have the ability to deep-dive by their end user,
which can help improve their outcomes and pricing,’ Parsons says.
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Operations
Multi-asset brokers should also consider simplifying their back-end processes
and cash management through a single multi-asset account with their liquidity
provider. However, this service isn’t available from most prime brokers and other
non-bank liquidity providers, but Finalto have developed a fully cross-margined
single currency account that facilitates trading in different assets.

These include index CFDs, FX, precious metals, energy, base metals, equity CFDs,
cryptos, and NDFs. Because separate accounts aren’t required for each individual
asset, this can reduce capital management and risk monitoring, as well as improve
data reconciliation, thereby reducing overall costs for the broker.

Support
Support and coverage are important throughout the relationship and should be
considered when looking to appoint a liquidity provider.

‘Our breakdown of Sales, Liquidity & CS [client services] means there is always a team
that can help with an issue or query,’ says Parsons. ‘CS have a fast response time and
will provide as much information to a client as they need, together with solutions to
their problems.’

Service available to professional clients only. CFDs are complex instruments and come with a high risk of
losing money rapidly due to leverage. You should consider whether you understand how CFDs work and
whether you can afford to take the high risk of losing your money. The content of the articles on this blog are
for informational purposes only and should not be construed as investment advice or otherwise.
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