This report reviews the OMS, EMS and OEMS offerings of six cash equities trading technology vendor offerings competing for investment bank market share in 2019. Specifically, this report – which details the findings of a GreySpark survey of each of the six product offerings – examines how cost pressures impacting the investment banking cash equities sales and trading business models are affecting the ways in which trading technology vendors are positioning the continual development of their solutions’ functional capabilities for the rigours of the competitive landscape, both in 2019 and over the next three-to-five years.
By Gianluca Mineieri, Deputy Global Head of Trading, Amundi Asset Management
Large asset managers will increasingly provide liquidity and play a leading role in the future evolution of financial markets.
Gianluca Minieri, Amundi Asset Management
During the past few years, much has been written about market liquidity and the main factors that have had a significant impact on it. These include:
– The reduction in market-making activity, due to an increase in capital charges and a reduced risk appetite across investment banks as they adjusted to a post-crisis market environment;
– The decline in trading turnover, linked both to the reduced level of liquidity available and to the nature of the asset owners (long-term investors such as asset managers, pension funds, insurance companies)
– The record increase in corporate bond issuance, incentivised by low interest rates, which created a gap between the size of the primary market and the size of the tradable secondary market
– The growth of the asset management industry
– The increased demand for liquid assets due to stricter regulatory collateral requirements.
As a result, there appears to be a consensus that investors have to accept a market environment in which liquidity is characterised by a structural lack of resilience which means that in fast market conditions most of the liquidity normally available might vanish or significantly reduce.
However, this is not necessarily true — or at least it is not true for all – because it ignores or underestimates several other factors and constraints that might drive the decisional process of market participants in different directions.
Many asset owners have unrelated investment objectives and constraints, which motivate their behaviour in disparate ways. For example, during the spike in volatility that occurred in the high yield market in December 2015, mutual funds redeemed almost $10 billion of assets from high yields funds. However, the high yield market did not register negative net flows, for the simple reason that while mutual funds were selling, other institutional investors decided to increase their high yield allocations, viewing the sell-off as an attractive buying opportunity. Hence, while increased liquidity costs might reduce investment returns and generate losses for some, it might generate profit for someone else. The fact that there are winners and losers in the market confirms our belief that what we are facing is market risk, not systemic risk.
Asset managers have to acknowledge that a structural change to market liquidity requires a structural response, a strategic change in the way they manage their business, which entails evolving and adapting governance, strategies, processes and systems.
Gianluca Minieri, Amundi Asset Management
Adapt the investment process: portfolio construction, portfolio management and turnover
Investors have to cope with the reality that liquidity is not free. Inherent in the price of every asset is the concept that liquidity has a cost. This cost increases when immediacy is needed and liquidity is scarce. For this reason, liquidity should be included among the factors to consider during the portfolio construction phase. When creating investment portfolios, trading costs, which are a direct function of the liquidity level of an asset, erode the expected alpha. Although liquidity does not qualify as an independent alpha factor, it is nonetheless a key driver of transaction costs and therefore net returns.
Liquidity must also become a major factor to consider when theoretical investment strategies are implemented into live portfolios, as there might be significant differences between transacting on paper and transacting in real markets. This gap is known as “implementation shortfall”.
Moreover, estimates of liquidity are needed to optimize portfolio turnover and ensure that the portfolio’s assets remain within liquidity risk boundaries. Indeed, research demonstrate that trading costs and turnover are negatively related to funds’ performance. As a result, a sophisticated investment process cannot ignore liquidity.
Enhance trading capabilities
Of course, trading has experienced a massive impact from regulations, technology and automation on various layers. From the back office operations to the dealing desk, new cross-border legislations combined with the rise of automation have brought sweeping changes to what used to be a manually intensive transaction-based operation. From the proliferation of executing venues and electronic platforms to millisecond executions, asset managers have to accept that without the support of a leading-edge technology at the core of their trading system, they will lose in the liquidity game.
Integrated order management systems (OMSs), execution order management systems (EMSs), connectivity to electronic trading platforms, direct market accesses (DMAs), algorithms, smart order routers (SORs) are all tools that traders must have in order to be able to find liquidity effectively and at a competitive price.
However, there is probably a more important factor that might change forever the rules of the liquidity game. If we consider that in fixed income markets, more than 90% of global outstanding bonds inventory is held by buy-side institutional investors, it is easy to come to the conclusion that the asset management industry holds the key to addressing the liquidity conundrum. Those large, dormant asset inventories held by institutional investors are a natural source of liquidity that can be used as the alternative to the greatly reduced capacity of broker/dealers to use balance sheets to facilitate clients’ trades.
From price takers to price makers
How can that be achieved in practice? The answer is for them to shift from a price-taker role to a price-maker one.
Today the trading environment is significantly more disintermediated than before and brokers/dealers are only filling a technological gap between buyers and sellers. Once this gap is filled (and it will be filled) by asset managers capable of embracing technological investments and innovative trading protocols, the reward will be for them to receive the spread instead of paying it, with the potential for significant improvement in terms of pricing and eventually performance for their clients.
This is not only true in the secondary market. It would also bring benefits to the functioning of primary markets, which are a key source of alpha for portfolio managers.
During the past few years, bond primary markets have gone through significant change in how the underwriting system works. Traditionally, in primary deals, lead managers used to buy the whole issue from the corporate borrower before it had been placed with investors. When this happened, broker/dealers committed substantial regulatory capital to the distribution process. Today the majority of deals employ the so-called “pot” system”, where the issue is priced when sufficient orders have been collected to cover the whole amount of the book. Only at this point, when there is virtually no risk of loss, the new issue is finally launched. Bonds are then allocated to clients of all underwriters by the book-running lead manager.
In other words, deals are no longer launched until they are already pre-placed with investors. Therefore, the underwriting risk has largely been taken away from the dealers. On the other hand, asset managers find it increasingly harder to understand how to play a more meaningful role in this market as the rules of engagement of the process of allocation are not always clear and transparent.
An alternative would be for the buy-side to work with the sell-side by joining distribution syndicates and acquiring their positions directly from the issuer. In such cases, the investment bank would undertake only pricing and issue management rather than also providing capital commitment. As in direct buy-side participation in the secondary market, this would allow institutional investors to buy at the syndicate-buying price (bid) rather than at the syndicate-selling price (offer).
If the buy-side could provide liquidity services successfully, it would have private and public benefits. The private benefit would be to create another source of alpha for clients. The public benefit would be a shift of liquidity provision from highly leveraged firms to unleveraged funds, which would also reduce systemic risk.
The role of large asset managers
In fact, asset managers are much better equipped to manage inventories. Brokers/dealers have their trading books highly mismatched from a maturity perspective, since they finance long-term bonds with overnight repo transactions. In contrast, asset managers do not have to re-finance their long maturity inventory every day in the overnight repo market and therefore do not have to bear the risk of not being able to roll-over repo during a liquidity crunch. They are better placed to provide liquidity to each other than are highly leveraged intermediaries.
The lessons are the following: revisit investment processes, rethink portfolio construction rules, enhance risk management tools, use capital for significant technological developments, adopt a market-maker approach to liquidity provision.
Of course, not all asset managers will be able to sustain the required investments and manage the complexity deriving from such a massive transformational approach. The operational complexity required to enhance the operating model to exploit liquidity as an alpha source would be far too demanding for small- to medium-size asset managers. Besides, the role of technology will continue to grow in importance within the asset management business, which will inevitably favour the bigger players due to the capital-intensive nature of these type of investments.
In practice, only large asset managers will have the capabilities to embark on all these challenging initiatives by leveraging on economies of scale within their organisation. Only the biggest players in the industry will be able to offer their internal and external clients dedicated global integrated dealing platforms, capable of addressing effectively the liquidity demand while at the same time exploiting new alpha source opportunities and actively contributing to the development of a more efficient market structure.
Technological advances. Flexible trading protocols. More transparency, but not too much more.
Those are a few of the structural improvements that will drive continued ‘electronification’ in the corporate credit market, said speakers at the Sandler O’Neill Global Exchange and Brokerage Conference.
Industry figures show that 20% to 25% of U.S. investment grade bond trading volume happens via electronic channels, about double the proportion for high yield bonds. Smaller-sized trades dominate screen-based trading, and while block traders are slowly warming up to electronic platforms, the industry has yet to figure out how to pry the phone from their hands.
Drivers of incremental progress toward that end are all-to-all trading, which enables transacting with a wider range of market participants; so-called alternative liquidity providers such as Citadel Securities, Virtu Financial and Jane Street, which have gained influence as big banks stepped back from the market; and potentially changing reporting requirements via regulation, in a way that ideally boosts activity without forcing institutions to show their cards.
James Wallin, AB
There is comfort in dealing with a trusted counterparty over the phone. James Wallin, Senior Vice President, Fixed Income at AllianceBernstein, said his firm’s traders need to have confidence before putting a trade on an electronic platform. “It’s not reasonable from a client standpoint and a fiduciary standpoint to put our intentions out to the public without taking the market’s temperature.”
Wallin indicated optimism about the future of electronic trading. “We are seeing development of tools and an evolution of transparency that could, down the road, give us more confidence to go out to the market with larger trades,” he said.
Ultimately, the trajectory of electronic trading comes down to “what are ways technology can be applied to help buyers and sellers find each other in less liquid markets?” said Kevin McPartland, Head of Market Structure & Technology Research at Greenwich Associates.
One structural limitation is that there are many more corporates bonds than there are equities, and each bond trades much less frequently. A newly issued corporate bond might start out trading in block size 20 times per day, then five times per day, then essentially “by appointment” only, said Sonali Theisen, Head of Fixed Income Market Structure at Bank of America Merrill Lynch.
For electronic trading to rise meaningfully in the current market structure, “there would have to be fewer blocks and smaller ticket sizes,” Theisen said.
All-to-all trading , which Wallin described as a “quasi virtual exchange for bonds,” has made inroads. “It allows the buy side to participate in being price maker, and it deepens the pool of liquidity overall,” said Matt Berger, Global Head of Fixed Income and Commodities at Jane Street.
Kevin McPartland, Greenwich Associates
“It’s one more tool in the toolkit,” McPartland of Greenwich said. While all-to-all’s 6% penetration level in corporate bonds is modest, “it’s notable that it exists at all, because 10 years ago it didn’t,” he said.
It has been proposed that for purposes of regulatory reporting, the size of a block trade be increased from $5 million to $10 million in investment grade, and from $1 million to $5 million in high yield. The idea is that lifting the block size would lead to more automated trading.
The proposal is currently being debated and remains a ways from being implemented, panelists said.
With regard to electronic trading platforms, the consensus is that new entrants would be welcomed and used if they differentiate and add real value, but the buy side is discerning on this front because connecting to each platform is a pain.
“There has to be competition but also there are limits on our infrastructure,” AB’s Wallin said. “Platforms that have taken root have helped our business. We’re open to new ones that can help with specific needs, but we can’t hook up to everybody in the world, so we’re not looking forward to 40 or 50 platforms.”
Christopher Giancarlo, chairman of the US Commodity Futures Trading Commission, said he intends to call three rulemakings on supervising cross-border swaps activity for a vote before he leaves the US regulator.
Giancarlo gave a keynote address at the FIA’s International Derivatives Expo in London recently.
In September last year Giancarlo gave a speech in London proposing to change the CFTC’s framework for cross-border swaps regulation. The next month he published a white paper on the US regulator deferring supervision to the home regulator in third-country jurisdictions that have adopted comparable G20 swaps reform
Giancarlo now discussed progress on the proposal, three rulemakings being considered by the CFTC and the plan for the remaining rules that he expect to be taken up under his successor. Giancarlo said he expects to step down as chairman in the middle of next month, to be replaced by Heath Tarbert.
He stressed that the CFTC does not have extraterritorial power and should not seek to regulate swaps activities outside the US unless those activities “have a direct and significant connection with activities in, or effect on, commerce of the US.”
“Accordingly, determining what is “direct and significant” to the U.S. financial system should be at the heart of the CFTC’s approach to cross-border issues,” he added.
In addition, the CFTC should differentiate between swaps reforms designed to mitigate systemic risk and those that address market and trading practices.
The former includes swaps clearing, margin for uncleared swaps, dealer capital, and record keeping and regulatory reporting. The latter includes public trade reporting and price transparency, trading platform design, trade execution methodologies and mechanics, personnel qualifications an examinations.
Christopher Giancarlo, CFTC
Giancarlo continued: “Mutual commitment to cross-border regulatory deference ideally should mean that market participants can rely on one set of rules – in their totality – without fear that another jurisdiction will seek to selectively impose an additional layer of particular regulatory obligations that reflect differences in policy emphasis, or application of local market-driven policy choices beyond the local market.”
As a result of the white paper, three rulemakings are now being considered by the CFTC.
The first clearing proposal addresses the registration of non-US derivatives clearing houses that that clear swaps for US persons, such as the London Stock Exchange Group’s LCH Ltd which was the first non-US derivatives clearing organization to register with the CFTC 18 years ago. Others have registered after the enactment of Dodd-Frank in 2010.
“Non-US DCOs that do not pose a substantial risk to the US financial system would have the option of being fully registered with the CFTC as a DCO but meet their registration requirements through compliance with their home country requirements,” he added. “The home country regulator would have supervisory primacy over these DCOs with the CFTC much more narrowly focused than is currently the case, from both a legal and practical perspective, on US customer funds protection at these DCOs.”
The commissioner said it is important too use objective criteria to determine whether a non-US CCP potentially poses substantial risk to the US financial system and the regulator will use two 20% tests.
“The first focuses on the percentage of initial margin from a “US origin” (initial margin posted by clearing members ultimately owned by US-domiciled holding companies, regardless of the domicile of the clearing member) at a specific non-US DCO,” he explained. “The second focuses on the US origin business of the non-US DCO as a percentage of the overall US cleared swaps market.”
Giancarlo added that objective and transparent criteria should be used by all all regulators around the world to provide appropriate predictability and stability to the markets.
The CFTC is also considering a rule proposal on the registration and regulation of non-US swap dealers and major swap participants, as well as foreign branches of US banks.
Giancarlo said he intends to call the three rulemakings for a vote before he leaves the CFTC.
He continued that the CFTC recently granted substituted compliance to Australia with respect to margin requirements for uncleared swaps. The regulator also amended a previous substituted compliance determination for Japan with respect to the uncleared margin requirements. The CFTC has previously granted substituted compliance for the European Union with respect to the uncleared margin requirements. In March, the CFTC and the Monetary Authority of Singapore announced the mutual recognition of certain derivatives trading venues.
“This is all a good start, and I am pleased that many of these comparability determinations came under my chairmanship,” he said. “However, I believe the CFTC should continue to make additional comparability determinations wherever appropriate.”
In addition to CCPs, Giancarlo said the CFTC should be committed to trying to make comparability determinations for trading venues in all the major swaps jurisdictions where the vast majority of over 90% of global swaps activity takes place.
The CFTC already has exempted trading venues from registration as swap execution facilities in the EU and Singapore, and a comparability assessment for trading venues in Japan is close to completion. After the UK leaves the European Union, the CFTC intends to extend the exemption from registration as SEFs to UK trading venues. “This leaves Hong Kong, Australia, Canada, and Switzerland to account for most of the world’s non-US swap activity,” Giancarlo added.
He concluded that swaps markets are global so regulators should not divide the world into artificially separate and less resilient liquidity pools based on the nationality of trading participants.
“That will fragment markets into individual trading pools of liquidity that are shallower, more brittle, and less resilient to market shocks, thereby increasing systemic risk rather than diminishing it,” he added. “Instead, the approach of deference is intended to thwart such fragmentation, so as not to impede hedging of financial risk that is necessary for global economic growth.”
Fragmentation
The World Federation of Exchanges has also published a statement warning about cross-border fragmentation arising from unjustified dissonance between regulatory regimes. The WFE’s statement comes days before the G20 Finance Ministers and Central Bank Governors Meeting between 8-9 June in Japan where market fragmentation will be on the agenda.
https://twitter.com/TheWFE/status/1135905258498973696
Nandini Sukumar, chief executive at WFE, said: in a statement: “We welcome the G20 focus on the topic of cross-border financial market regulatory fragmentation, under the Japanese G20 Presidency. The WFE believes that global regulatory coherence can and should be improved, both in substantive and procedural terms.
Sukumar added that a significant role can and should be played by the international standard-setting bodies, who are also well placed to address emerging trends, such as digital assets, as well as issues arising from traditional markets.
The International Organization of Securities Commissions has also published a report that examines instances of regulatory-driven fragmentation in wholesale securities and derivatives markets and considers what actions regulators can take to minimize its adverse effects.
https://twitter.com/IOSCOPress/status/1135897659615694849
Jun Mizuguchi, Deputy Commissioner for International Affairs at the Japan Financial Services Agency, and an IOSCO co-chair on this work said in a statement: “Since the financial crisis, well-intentioned regulatory implementation has sometimes led to unintended fragmentation of markets. In the spirit of the G-20 leaders in Pittsburgh, this report welcomes the advances made by regulators in deferring to one another but encourages us towards further, smoother, cross-border collaboration.”
close-up view of financial graphs, bar, circle and line charts (3d render)
In TABB Group’s soon-to-be-published International Equity Trading benchmark research study for 2019, 79% of firms interviewed are currently using conditional orders to source liquidity for their clients, and more than 30% of these traders expect to increase usage in the next calendar year.
When looking at the response weighted by each firm’s US Equity Average Daily Volume, says Campbell Peters, a TABB Group US equity market structure research analyst and author of “Conditional Orders in Equity Trading,” the response grows to a very impressive 95% of firms using conditional orders. Further, no one said they planned to decrease their use, proving, according to Peters, that while there has been tremendous adoption of conditional orders among buy-side traders, “we will continue to see buy-side growth,” says Peters.
This use of conditional orders to aggregate systematic internalizer (SI) liquidity could have implications outside Europe. “If the MiFID II rules around dark trading and SIs expand to the US,” Peters says, “there will be an even greater demand to aggregate dark liquidity among various venues.”
Conditional orders allow portfolio managers to search for hidden block liquidity without fully committing to trade, as they allow the trader to represent larger orders in multiple venues without the risk of being simultaneously executed in multiple trading venues. The rise in conditional orders is directly linked to the advancement of algorithmic interaction between the liquidity-seeking broker algos and the ATSs that offer conditional orders.
Conditional orders are financially demanding now more than ever
Routing of conditional orders in these liquidity-seeking algorithms comes in two variants: simultaneous venue routing and sequential venue routing. While conditional orders started out as mechanisms to trade blocks, conditionals are increasing being used for trading non-block size (100-1,000 shares). Not only have multiple venues expressed that their customers are exploring expanding their use of conditional orders, Peters points out that venues are also increasingly seeing conditionals being used with VWAP execution algorithms resulting in smaller conditional print sizes.
Initially developed exclusively for trading large blocks of shares, conditional orders have pivoted to be the de facto method for aggregating liquidity in a decentralized marketplace. Traditional buy-side traders continue to submit human-directed conditional orders for trading large blocks, while more sophisticated portfolio managers have implementing liquidity-seeking algorithms for moving considerable size.
As Peters notes, “marketplace fragmentation isn’t going away, as SI volume has grown to nearly 10% of the total off book volume in Europe since MiFID II was implemented.” For example, in March, Deutsche Bank announced it planned to launch a single-dealer platform (SDP) later this year, which would be the US equivalent of an SI, adding to the fragmentation of the US equity market, furthering the need for liquidity aggregation.
All these tailwinds are pointing toward wider adoption of conditional orders. “By addressing the needs of the buy side and beyond, conditional orders have demonstrated their value, which is why we expect they’ll become ubiquitous on institutional equity trading floors,” Peters says.
The 17-page report with 4 exhibits is available for immediate download by TABB equities clients and pre-qualified media at https://research.tabbgroup.com/search/grid. For more information or to purchase the report, write to info@tabbgroup.com.
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It is now a generally accepted premise that alternative data works on Wall Street. Indeed, portfolio managers and analysts use it to make better trading and investing decisions every day.
But the route from Point A (not using alt data) to Point B (fully implemented) can be a daunting one for asset managers and large financial institutions. Hurdles include a large universe of disparate data, potentially complex integration with existing systems and feeds, and an uncertain uptake timeline.
So rather than rolling out another alt data set, technology and information providers see an opportunity to optimize the logistics around alt data. FactSet, for one, enables users to try an array of alt data before buying, cutting through the need for cumbersome one-off testings.
“It used to take six months before a client was ready to do a trial,” said Rich Newman, Global Head of the Content and Technology Solutions at FactSet. “Now within hours, they can try not only the initial concept they’re thinking of, but all of our content and all of our alternative data partner content.”
Alt data is well beyond critical mass in terms of institutional acceptance. About seven of ten asset asset managers believe that using alternative data gives them an investing edge over competitors, and corporate budgets for the information increased 52% in the past year, according to a Greenwich Associates report released in May.
Alt data’s splashiest hits are in foreshadowing moves of a single stock — for example, Amazon’s June 2017 announced buyout of Whole Foods was preceded by corporate flights between Seattle and Austin, Texas, and WFM soared nearly 30% on the news. But alt data’s core, day-to-day utility is about being woven into a broader decision-making framework.
“A common misunderstanding about alt data is that it’s siloed. But you’re not just going to look at credit card, or sentiment, or satellite data by itself,” Newman said. “The key is linking that data to other data sets. No matter how exciting a new data set of foot traffic is, ultimately you still have to link that to your fundamentals, your estimates, and your pricing data.”
There’s a lot of runway for tech providers working in the alt-data space. About half of investment managers are currently using alternative data, and half of the non-users plan to start using within the next year, according to the Greenwich report. It’s rarely a DIY project: 83% of alt-data buyers say they need help from their vendors to get up and running.
FactSet partners with Microsoft Azure on its Data Exploration product. IHS Markit works with Amazon Web Services.
Rich Newman, FactSet
“Both are cloud-based platforms that scale virtually infinitely and give you native tools that allow access to large quantities of data,” said Andrew Eisen, Head of Enterprise Data Management and Cloud Strategy at IHS Markit. “That’s an ubiquitous standard today for how you manipulate and manage big data for data science, data modeling or quant analysis. Off of that we are building tools to help our clients understand the content we carry, in step with their own data, and accelerate their time to value that insight.”
A focus of IHS Markit is identifying patterns and relationships in data “that go well beyond a basic understanding of Stats 101 or Quant Finance 101,” Eisen said.
“Data in its own silo may be useful for a particular use case,” he added. “But if I need to understand the relationships between supply, demand, price, and profit, I need to be able to model those relationships not just one way, but by using multiple techniques to understand which of those relationships are important for the questions I want to answer.”
To illustrate the utility of Data Exploration, FactSet’s Newman drew a hypothetical example of an asset manager looking to screen potential investments for environmental, social and governance factors.
“You want to evaluate and test it, but there might be 30 or 40 ESG providers, and you don’t know where to start,” he said. “That’s the idea behind Data Exploration.”
FactSet Data Exploration launched in July 2018, and Newman has since observed that “the alt data revolution is real, but it’s not as far along as I had anticipated,” he said. “Some firms are using it and a lot of firms are talking about using it, but overall it’s still in the early stages. Which is why I think evaluation is so important.”
In a recent ruling the major US stock exchanges – BATS Global Markets, Chicago Stock Exchange Direct Edge ECN, New York Stock Exchange, NYSE Arca, Nasdaq OMX BX, and the Nasdaq Stock Market LLC – failed to win a dismissal from the New York Southern District Court to dismiss market manipulation allegations filed against them by investors.
In four actions originally filed in New York, various investors (the plaintiffs) brought claims under Sections 6(b) and 10(b) of the Securities Exchange Act of 1934 against seven stock exchanges – BATS Global Markets, Chicago Stock Exchange, Direct Edge, New York Stock Exchange, NYSE Arca, Nasdaq OMX BX, and the Nasdaq Stock Market – and two Barclays entities, Barclays PLC and Barclays Capital, Inc, according to filed legal paperwork.
The investors allege the Exchanges have violated securities laws by making certain information – data feeds, colocation and other information – only available to HFT firms (at discriminatory pricing levels). By doing so, the argument continues, exchanges are complicit in providing an unfair advantage that results in market manipulation.
Investors and specialists have says and are looking for updates on this new case
According to court papers, the plaintiffs allege that, as a result, they were induced to trade based on artificial price signals, only to see their trades execute at worse prices than advertised, and that the Exchanges’ role in that overall scheme makes them liable to the plaintiffs under Section 10(b) and Rule 10b-5.
U.S. District Judge Jesse Furman said claims against BATS Global Markets, Nasdaq, the New York Stock Exchange and other defendants had “nudged themselves across the line from conceivable to plausible” and should not be dismissed.
The case is set to continue in New York Southern District Court.
The case is In re Barclays Liquidity Cross and High Frequency Trading Litigation, U.S. District Court, Southern District of New York, No. 14-md-02589.
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By Michael Mollemans, Head of Global Market Structure & Analytics, and Sharif Shukr, Project Manager, Transition Management, Pavilion Global Markets
Clients are demanding a more transparent, agency-only approach to trading and sourcing of liquidity, as well as deeper discussions around venue analytics to better understand the reasoning behind order routing preferences.
As risk-adjusted performance requirements continue to drive investment allocation decisions among institutional investors, transition management services play a key role in optimizing the portfolio restructuring process by striving to minimize the inherent transaction costs, as well as controlling the potential drift in performance. Pension plan future obligations provoke asset liability reviews as underfunded pension liabilities remain a constant burden. This has motivated clients to increasingly insist on transparent cost structures from their investment partners, as they look to improve the overall performance of their assets. Clients are demanding the same transparent service model from their transition managers. Single-party accountability, risk management, fiduciary oversight and operational efficiencies across the entire trade lifecycle are all essential elements of the process. Going forward, client feedback has shown increased demand for transparency across the entire trading process with a need to better understand the liquidity sourcing preferences.
Transparent, agency-only
Transparency is often cited by clients as one of the main qualitative factors considered when making transition manager decisions. Agency-only brokers, by being free of conflicts, are naturally well positioned to earn high marks for transparency within the industry surveys. Venue analysis tools are increasingly being used to help clients recognize when a broker’s own dark pool or systematic internalizer is being preferenced, or if a venue is causing excessive information leakage or reversion costs.
Transparency of order routing logic and smart order routing prioritization settings require informed communication to help clients understand what is happening “under the hood.” Pre- and post-trade analytics can be very helpful in driving informed discussions with clients around implementation shortfall costs at the venue level and help brokers act in the best interests of clients by removing hard-coded venue biases in favor of venues that provide the most opportunity for earning spread capture and speed of execution. Guided conversations around trade cost analytics provides added depth of understanding of a client’s performance goals, which help transition managers fine tune trading strategies across various market conditions.
Michael Mollemans, Pavilion Global MarketsLiquidity relationships
Over time there has been dramatic shifts in our clients’ asset allocations, as they transition from traditional into alternative investments. The strength of the equity markets, as well as volatility fears, have led many of our pension clients to review their overall risk allocation. Client decisions to de-risk their equity allocation has led to more transition events moving from active to passive strategies, as well as defensive and low-volatility strategies. We have also seen an increased appetite for emerging market (EM) allocation changes, especially as China’s share of the emerging markets indices grows. Clients are either switching investment managers or moving into a passive EM index strategy. Large discrepancies in EM manager performance have led many plans to reallocate their funds to other EM investment managers or a different asset class all together. Liquidity is always a source of frustration, and a few illiquid names in a transition can severely damage overall performance numbers. Access to a breadth of counterparty relationships gained through experience can make all the difference when dealing with liquidity issues.
The liquidity landscape is constantly changing with new and alternative venues springing up all the time. Clients expect the transition and trading teams to stay updated on the market structure changes and consider how best to take advantage of change in new crossing venues and innovations. Experienced traders utilizing their breadth of counterparty relationships, gained over time, can help source block crosses and minimize implementation shortfall. Experience on the trading team can also help to minimize information leakage cost by managing the information flow carefully, rather than over disclosing to the market. Electronic crossing venues can be a good source of liquidity, but care must be taken to make sure they are not generating information leakage or excess reversion costs.
Centralized communication
Communication between transition management teams, global trading teams and settlement is key when implementing global multi-asset transitions. Centralized communication across teams is key when working on a customized transition event. Economic or geopolitical news can cause large moves in the markets, which may require sudden trading strategy changes intra-day. Dynamic communication between teams from a centralized location helps manage performance risk. The same is true across the entire trade lifecycle. Smooth settlement requires constant communication between traders and settlements teams, especially with the difficult emerging and frontier market account identifier matching requirements. “Lost in translation” or delayed communication between global trading and settlement desks located in various cities or countries can entail additional costs for late or failed settlements, which in some markets can be very significant. Centralized implementation across the transition management workflow process is ideal when speed of communication and implementation shortfall performance is the goal.
Managing global multi-asset transitions necessitate project management expertise to address the list of requirements across the process including: (1) a thorough pre-transition cost and liquidity analysis, (2) developing and implementing an optimal trading strategy across overlapping markets, (3) global multi-asset cash flow management, (4) global settlements, and (5) a comprehensive post-transition performance analysis.
Sharif Shukr, Pavilion Global MarketsCustomized service partnership
Every transition event is a customized service partnership, with accountability to the project manager for optimal planning and coordination among all the relevant parties in the process. Monitoring and reviewing the transition process with clients requires constant communication and yields a valuable feedback loop used to help produce the best possible performance result.
Reliability of execution is often mentioned as a key qualitative factor when it comes to making transition manager decisions. Clients do not want the burden of responsibility on them to assure they achieve the desired transition outcome. Project managers are expected to form customized service partnerships with clients by providing continual updates and gaining feedback from clients, which builds knowledge of client preferences and helps assure transition strategy goals are reached at the end of the day.
Bottom Line
Clients are asking for transparency, liquidity and communication. The transparent, agency-only service model, by being free of conflicts, is naturally well positioned to build trusted partnerships with clients. Access to liquidity, especially in the emerging markets, continues to be a key driver of transition management decisions. Communication with clients, when forming customized transition service partnerships, and centralized communication between transition management, global trading and settlement teams is key when trying to achieve the best possible performance result. With over 20 years of experience managing global multi-billion dollar transitions, Pavilion Global Markets’ value proposition is built on these client values, as they pave the road ahead in transition management.
Valery Derbaudrenghien, State Street Global Advisors
Valery Derbaudrenghien, State Street Global AdvisorsBy Valery Derbaudrenghien, Vice President – Senior Multi-Asset Trader, State Street Global Advisors
The algo wheel is a major step towards establishing an optimal workflow, making trade execution faster, systematic and accountable.
Mention the concept of “algo wheel” to a buy-side trader and visions of a passenger sitting in a driverless car might ensue. Far from that, its implementation at State Street Global Advisors proves that the buy-side trader remains “the one behind the wheel”.
If you grew up in the 80’s, this unsubtle Depeche Mode reference has probably not escaped you. “Depeche Mode” is pretty much how you could describe the hour preceding the market open where hundreds of orders must find their way to the auction. Removing trader bias and freeing up time to work difficult orders are the primary advantages of the process. A few clicks and voilà, 90% of the pad is at work in the most optimal conditions as objectively possible.
Even the most proficient algo users have a tendency to favour certain electronic destinations and select algorithms they feel most comfortable with, using settings they estimate optimal to work a given benchmark. Give a trade with an “arrival price” benchmark to 10 buy-side dealers and you’re likely to see 10 different outcomes. Yet, just like picking the wrong cash desk to route your flow deprives you of price-improvement opportunities, selecting the wrong algorithm won’t deliver the best execution.
As the use of electronic trading concentrates more risk on the shoulders of a buy-side trader, they will naturally favour destinations where sales trading support is most reactive and provides a “cushion” of safety as a second pair of eyes. Most orders though, certainly from large passive funds, require little to no oversight from brokers and therefore the wheel is a solution to optimize flow distribution on a scalable and efficient manner.
In practice, what is the wheel and what does it do?
Say you have 5,000 orders waiting in your incoming blotter in the morning, differentiated by benchmark and average daily volume. Select anything under a certain liquidity threshold and, rather than picking a broker manually, elect for each benchmark the wheel as destination in the execution management system and it will automatically dispatch the orders to brokers, based on a ranking.
The ranking is established according to previous performance. How many brokers compete in each benchmark, what percentage of the business should go to each is up to the desk to decide. This ranking process is not static. As brokers compete to improve their performance, after a certain period of time, again set by each desk, a review will be done and a new ranking will be implemented.
Another advantage of the process is to spur competition and innovation on the broker side. Each client benchmark and each market get a specific attention. One strategy setting will not fit all markets but also not all market conditions. Price prediction models, stock mapping, historical data versus real-time triggers, and more are an ever-evolving source for quantitative research.
Sales-traders are also encouraged through this process to pay closer attention to outlying orders, being part of a package expected by the client who can easily cut a broker’s wheel target if expectations aren’t met. Free from research-based commission models under Markets in Financial Instruments Directive II, attracting pure trading commissions is the new endgame and dropping off a wheel “bucket” (a benchmark-specific ranking) means a substantial loss of income.
Trends among brokers in each benchmark category eventually emerge overtime while improvements in settings or trading logics can finally be quantified. The process arms buy-side traders with an unbiased ranking of which algorithm is best candidate to trade that “tail” of less liquid orders, which typically would not be routed through the wheel. The model gradually shifts the electronic broker role to an execution consultancy one and both parties can learn as the wheel is not intended to be a static black box but rather an ever-evolving outperformance think-tank.
Keeping data uncorrupted is paramount. Events such as large benchmark rebalances, while benefiting from the wheel ranking to direct the massive flow, are best left out of the periodical re-evaluation process as they can represent a substantial share of total turnover with such wide price swings that they would trump the knowledge gained from day-to-day data analysis.
Similarly, removing “outliers”, those unusual trades that weight heavily in the balance, helps yield more consistent and meaningful performance figures. Building up a statistically meaningful database is the cornerstone of the wheel deployment and can prove a challenge for smaller operations.
Can your traders explain why a trade was executed through a certain broker in a certain way to the firm’s stakeholders or upon a regulator’s enquiry?
The wheel brings traceable accountability into the process. Can we envision a constantly re-optimized wheel capable of handling all orders, from the most to the less liquid ones? There is little reason why we could not and already some desks have implemented a straight-to-market workflow that bypasses any trader input provided that a set of conditions are met. Even the interaction with liquidity providers’ flow, such as Liquidnet, could be hardcoded and automated.
On the heels of the worldwide implementation of algorithmic trading, the wheel is a landmark step towards establishing an optimal workflow, not only in terms of speed, but also in terms of improving accountability to stakeholders by systemizing best execution. It spurs innovation and strengthens the framework within which buy-side desks operate.
So, take control of your flow and embrace this milestone evolution in global trading to make a difference for your clients.
New technology and regulations could help harmonise European post-trade securities settlement and make it as efficient as Amazon in the retail industry according to a white paper from Deutsche Bank Securities Services.
The report, Transitioning into the future of securities post-trade, asks why customers can order on Amazon for same day or next day physical delivery while institutional investors have to wait two days for securities to be electronically transferred, by book entry, into their account.
Harmonisation has improved since the European Central Bank launched TARGET2-Securities, the platform which aimed to lower the cost for settlement across borders. The project was approved in the summer of 2008 and the first wave central securities depositories joined T2S in June 2015. T2S has now been in full operation for more than a year with 24 central securities depositories and the first non-Euro transactions settled in October 2018 in Danish krone.
However T2S settlement volumes are lower than anticipated and market participants have criticised its cost, especially since the ECB increased the delivery versus payment settlement instruction fee from 15 cents to 23.5 cents from the start of this year.
Emma Johnson, Deutsche Bank Securities Services
Emma Johnson, director, regulatory and market initiatives, Deutsche Bank Securities Services and co-author of the white paper, told Markets Media: “T2S should become multi-currency – a precursor for getting more volume on to the platform and crucially the international central security depository flow.”
The white paper said T2S processes an 600,000 instructions per day and cross-CSD settlement volumes are low at just below 1%.
Johnson continued that the ICSDs, Euroclear and Clearstream, have significant volumes which would go a long way to eliminate the need to further increase costs.
“The reality is that the ICSDs provide ease of access to non-European investors which in the context of T2S means they could play an important role in realising the ECB’s ambition to make Europe more accessible to investors,” she added. “We are pleased that the subject of the ICSDs is on the European Central Bank’s agenda and really welcome some meaningful progress.”
The European Central Bank said in a special report on T2S in December 2018 that post-trade securities processing in Europe remains fragmented despite the launch of the platform.
The ECB said the barriers hampering cross-border settlement integration largely need to be removed by legislation, such as to deal with differences in supervision of securities issuance, tax regimes and securities legislation between the member states in the European Union.
Johnson added: “Tax reform to help harmonisation is one of the priorities of the ECB’s advisory group, the AMI-SeCo, and we are hopeful that it will be supported by the new European Commission.”
New technology
The Deutsche white paper argues that without the introduction of T2S the industry would have invested in new technologies and services, perhaps at a lower cost than for the implementation of T2S.
“With technology developments and product innovation such as distributed ledger technology/ blockchain, artificial intelligence and digital assets firmly on the agenda, T2S as the common European infrastructure will need to adapt or, risks becoming obsolete” added the paper.
The ECB has set up a fintech task force and the paper warned this must be agile enough to keep pace with the new technology and the new entrants.
Johnson said: “Digital transformation is happening at a faster pace than the sceptics predicted but the industry now needs to work on harmonising standards for safety and soundness, such as know your customer, and cyber security whilst also ensuring true interoperability. The digital space needs its own MiFID II, Central Securities Depository Regulation; I think there will be a new wave of regulation.”
Data
Deutsche noted that further possibilities to improve efficiency come from the data revolution. For example, settlement analytics could become a commodity in its own right and trigger client-centric services.
“These services could allow clients to plug and play solutions such as data analytics, liquidity, collateral management, inventory management and asset optimisation including lending and borrowing,” said the white paper. “These should be easily accessed and self-selected, allowing for true product and service unbundling.”
Johnson continued that the industry needs to be purposeful in implementing new digital technology and eliminate the risk of fragmentation. She said: “We need to avoid making the mistakes of the past. There is an opportunity to set up utilities in areas such as data and settlement.”
She noted there has already been collaboration through joint ventures, sandboxes and industry working groups. “The industry has a voice for a common cause and this is welcomed by regulators,” said Johnson.
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