US stock trading continues to evolve towards “an increasingly complex, technologically driven market structure”, with electronic trading platforms capturing 44% of buy-side US equities order flow in 2023 and algorithmic trading expected to increase.
Electronic trading platforms captured 44% of buy-side US equities order flow in 2023, up from 42% in 2022, according to a Coalition Greenwich report, US Equity Markets 2024: Trends and Opportunities. Approximately 37% of overall 2023 volume was executed through algorithms and/or smart order routers, up from 35%, while 7% was directly routed to crossing networks, flat year over year.
Speaking exclusively to BEST EXECUTION, Jesse Forster, senior analyst at Coalition Greenwich and author of the report, said: “The direction of travel is towards algos that allow the buy side to automate their workflow, gain efficiencies and do more with less while still maintaining an edge. That means not just VWAP and other schedule-based strategies, but enhanced liquidity seeking algos that can source natural liquidity even in small caps and other thinly traded names traditionally reserved for high touch sales traders.”
“All this means more of a focus on analytics and quantified execution performance as the buy side continues to embrace and take ownership of their trading data. And frankly, that means the sell side is going to have to offer electronic platforms that go head-to-head with their own high touch desks. They will have to meet their clients where and how the buy side wants to trade, which is on reliable, easy to use electronic platforms backed by high quality support. The playbook is wide open,” Forster added.
Managers are anticipating a continued upward trend, with projections expecting algorithmic trading to reach 40% and crossing networks to increase to 8% within the next three years. Conversely, portfolio trading remains relatively stable, hovering around 12–13%, with little anticipated growth in the next three years.
Electronic trading makes up an even bigger share of the business for the highest commission-paying institutions in the marketplace. Among these active institutions, 59% of flow by notional value is channelled through algorithms and 7% via crossing networks. While electronic trading continues to gain traction, it still plays a secondary role to high-touch sales trading.
As buy-side firms shift to more electronic execution, they are also cutting back on the number of brokers they use to trade U.S. equities overall. Buy-side desks have modestly reduced their equity trading counterparty lists to an average of 31 brokers, down from 31.5 in 2022.
In 2023, buy-side managers directed 55% of their equity spend toward research and advisory services, up from 53% in the past two years. Conversely, allocation to sales trading and agency execution services dropped from 41% to 38%. Hedge funds, which trade more of their flow electronically at lower commission rates, led this move, the report found.
Trading cost analysis (TCA) performance, often used in tandem with electronic trading, has also levelled off at 12% over the past few years. “Perhaps this suggests that even as the buy side continues to embrace electronic trading, it still finds value in leveraging high-touch sales traders, whether to find natural liquidity in blocks or strategically work orders in the market,” the report suggested.
Buy-side managers last year used 55% of their equity commission spend to pay for research and advisory services last year, signalling a marginal increase from the past two years. Hedge funds, trading more electronically at lower commission rates, led this move. Conversely, allocation to sales trading and agency execution services experienced a three-point decline.
Forster added: “Sourcing natural liquidity remains the buy-side’s primary determinant in allocating a diminishing commission wallet, and desks are reducing their broker lists while concentrating flow to their top providers.”
There is one exception, however. Higher commission payers are expanding their lists to an average of 44.1, “indicating a unique trend among top-tier institutions”.
Despite these adjustments, managers continue to channel a significant portion of their commission dollars to their top five brokers. This pattern has remained largely unchanged over the past three years, with approximately 18% allocated to the top broker, 12% to the second and a substantial 54% distributed across the top five. This concentration poses a notable challenge for sell-side offerings that fall outside the buy side’s established network of trusted brokers.
The report posits that the shifts in commission allocation, trading channel mix and broker concentration suggests commission allocation strategies are adapting, with a growing emphasis on research and advisory services at the expense of sales trading and agency execution.
“The electronic trading landscape continues to gain traction, particularly among the highest commission-paying managers. Ease of system use, reliability, and high-quality technical support remain paramount criteria for selecting these platforms. The industry’s clear emphasis on these factors may point to a maturation in electronic trading, further signalling a departure of the ‘speed arms race’ among brokers,” the report concludes.
© Markets Media Europe 2023
