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Data Remains Biggest ESG Hurdle

By
Shanny Basar
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Hurdles lined up on a track, fading focus.

The number of investors who said data is the the biggest barrier to integrating environmental, social and governance factors has increased in the last two years according to the latest ESG Global Survey from BNP Paribas Securities Services.

The custodian interviewed 347 institutional investors incorporating ESG strategies to monitor progress since the last survey two years ago. Like two years ago, data remains the biggest barrier ahead of costs, a lack of advanced analytical skills and the risk of greenwashing. Two thirds of investors said data is the biggest barrier, higher than 55% in the 2017 survey.

Florence Fontan, head of asset owners at BNP Paribas Securities Services, said at a media briefing today: “Practical integration has its challenges due to data and technology barriers, and deep ESG investment is still finding its feet. The next two years will be critical to achieving the right investment mix, technology and skills in place.”

Frank Roden, head of asset managers EMEA at BNP Paribas Securities Services said at the briefing that problems cited with data include inconsistent coverage across asset classes, conflicting ESG ratings and indices and the lack of forward looking scenario analysis.

“New fintech solutions are appearing,” added Roden. “One fintech uses natural language processing and machine learning to analyse research papers for their impact on the UN Sustainable Development Goals.”

He continued that data is evolving quickly as the industry collaborates and regulators look to set standards.

Andreas Feiner, founding partner at asset manager Arabesque, said in the report: “I believe data on sustainability is now viewed in a similar way to how financial data was treated around 75 years ago. This has resulted in a situation where some companies avoid disclosing some information that would potentially show them in a negative light.”

More respondents, 46%, said social is the most difficult to integrate and analyse, compared to 41% two years ago.

“A lack of consensus in the industry surrounding what constitutes the ‘S’ makes it harder to incorporate into investment strategies compared to both the ‘E’ and ‘G’,” said the study. “As such, it often acts as an interaction point between these two elements.”

Florence Fontan, BNP Paribas Securities Services

Fontan said the environment has been the main focus but social will undergo the same evolution.

“Impact bonds have to extremely targetted and you have to find the right things to measure,” she added. “For example, do you want to finance increasing the number of women employees ?”

After companies have acquired the correct data, they still find it difficult to analyse this information in-house and apply their findings across a range of asset classes, funds and sectors.

“The plethora of data sources and sheer volume of metrics require a combination of big data approaches, quantitative modelling and ESG expertise,” said the study.

As a result, one-third of respondents also cited technology costs as a barrier to ESG integration, double the 16% in 2017.

Hans van Houwelingen, chief executive of fund manager Actiam, said in the report:  “If you want to integrate ESG across all your assets, as we do within ACTIAM, you have to enrich the data, you have to add data yourself, and you have to combine various data sources. You have to do a lot of work to get a real time ESG view for investment managers within their portfolio management systems, as well as to report exposures and real-world impact to customers.”

Optimism

Despite the hurdles of data and technology costs, more than 90% of investors said at least one quarter of their funds will be allocated towards ESG by 2021.

Patrick Colle, BNP Paribas Securities Services

Patrick Colle, general manager of BNP Paribas Securities Services, said in the report: “A majority (78%) of respondents in our 2019 survey state that ESG is either playing a growing role or becoming integral to what they do as an organisation.”

More than half, 52%, of respondents ranked ‘improved long-term returns’ in their top three reasons for ESG investment. The majority, 60%, also expect their ESG portfolios to outperform over the next five years.

The study said there is a growing belief in the link between incorporating ESG into investment decision-making and better risk-adjusted returns which has been backed up by research. For example, the UN PRI’s ESG and alpha study in March last year found that ESG information offers an alpha advantage in equities portfolios across all regions.

Algo Wheels Gain Steam

By
Rob Daly
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Algorithm wheels, the automated selection of sell-side algos, is heating up, but the buy side needs to set their performance expectations, according to speakers during the FIX Trading Community’s Americas Trading Briefing 2019 in Lower Manhattan.

A recent study conducted by industry analysis firm Greenwich Associates found that only about 22% of buy-side firms are using algo wheels, according to Richard Johnson, vice president, market structure and technology at Greenwich Associates and who spoke at the conference.

“We hypothesize that the use of algo wheels will increase significantly,” he said. “It will go from a fifth to the majority in a few years. I think the amount of flow going through the wheels is going to increase significantly as well.”

When polled by Emiko Kamoda, managing director, COO of global electronic execution services at Goldman Sachs and the co-chair of the Americas Regional Committee at FIX Trading Community, regarding how much of buy-side order flows eventually will go through algo wheels during a separate panel, the audience was bullish.

Over half the audience (51%) thought that algo wheels would direct 60% of order flows. A little over a quarter of the audience (27%) estimated that 90% of order flows would eventually go through algo wheels while only 21% believed it just would be 40% of order flows.

Enrico Cacciatore,
Voya IM

Routing 40% of a firm’s order flow through an algo wheel is far too much, noted Enrico Cacciatore, senior quantitative trader, head of market structure and trading analytics at Voya Investment Management and who participated in the same panel.

Despite some asset managers automating all of their order flow, 10% to 20% of order flow is more reasonable for most firms, he noted.

If traders sent every order through algo wheels, they would never be able to compare brokerages’ best execution and performance results due to the lack of a baseline for comparison.

Cacciatore suggested that firms create benign order flows that represent 2% or 3% of their average daily volumes and would not include high notional-value trades, as well as low- and high-priced names.

The result should provide a steady state environment where there are uniform percentages of volumes, sectors, and market conditions.

“Once you have that steady state, you can do fun and exciting stuff,” said Cacciatore. “You can have one segment that is very high momentum or pre-earning/post-earning. I can start sending this and see who is the best at handling this type of flow.”

Are We Ready for Institutional Crypto Trading?

By
GlobalTrading
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Glowing bitcoin network interface against the Earth seen from space. A cityscape. Toned image double exposure mock up Elements of this image furnished by NASA

Crypto trading boomed alongside the ICO craze, but as that ICO bubble burst and the price of bitcoin and other major cryptocurrencies came back to earth, trading volumes have still grown year- on-year. According to research firm Diar, their data suggests, the combined volume on major United States crypto exchange Coinbase rose 21% in 2018 compared with 2017. Last year, crypto exchange operators Kraken and Bitfinex saw trading volumes rise 192% and 50% respectively. In addition to growing trade volumes, Coinbase had a 14.1% increase in the number of trades, with 94.4 million in 2018 up from 82.7 million the year before.

As volumes rise, and the incentive to create a smoother path for institutional money to enter crypto markets is also rising, however, key challenges to adoption remain.

REGULATION, STABILITY, CUSTODY
There are several main types of businesses trading cryptocurrencies currently: alternative or hedge funds, proprietary trading desks (which are a combination of funds) and large individual investors, and OTC brokers. Crypto hedge funds accounted for around 20% of all hedge fund launches in 2018.

Lack of regulation is definitely one area that is holding back institutional investors in getting involved. They are relatively conservative by nature, so they cannot easily invest in an unregulated market. Crypto trading is a relatively unregulated industry in some countries, and entirely unregulated in others. There is a clear need for some sort of regulation across the market, in order to encourage the larger institutions. It will be a challenge to persuade traditional long-only investors, such as pension funds, to invest and then trade in cryptocurrencies until they have a more developed regulatory structure in place.

What those regulations look like may drive how fast and how much money goes into cryptocurrencies. These regulations might not resemble those of equity and fixed income markets, but perhaps the model regime looks more like FX trading. It could potentially be the right approach to look at cryptocurrencies as a currency-type instrument. Different regulators will suggest different approaches. Even now, the SEC has a different view from ESMA, Switzerland’s FINMA, UK’s FCA, JFSA, SFC or China’s PBOC and CSRC.

There is a thought process that regulation will help bring stability, and, until there is price stability, a pension fund will not be able to rationally argue that cryptocurrencies are a place where they want to put long-term investments. While some regulation is not a ‘silver bullet’ to get traditional managers involved, it may certainly help. Currently, cryptocurrencies appeal to the hedge fund market, as they tend to run strategies that thrive on volatility.

Besides volatility and regulation, custody is probably the major issue for institutional investors looking at the crypto space. An institutional investor has to address the question of how they trade these across multiple markets as custody is typically performed by the exchanges. Not all crypto exchanges are equal, and yet they hold your assets. If you look at how conservative asset managers are in terms of counter party risk, it’s a much greater issue with sometimes smaller and occasionally less-than-transparent exchanges. For the larger institutional investors to get involved it will probably take firms such as Fidelity, who have announced their entry into the space, to provide a more traditional model. Nonetheless, custody will continue to be a big issue until there is a large custodian that can move assets quickly and has relationships with most exchanges to facilitate this.

CONNECTIVITY, EXECUTION, FRAGMENTATION
Connectivity was the first challenge in preparing for institutional scale investors. The native exchange platforms are web interfaces, and institutional investors will not want to run multiple web interfaces at once in order to trade. Most crypto exchanges do not have FIX which may be because they began their lives as a retail interface. This means that to create this connectivity in unified way there is a huge amount of work, which makes platforms such as Caspian essential.

Connecting to comprehensive sources for markets data and trading APIs remains a massive time investment. The same is true for reconciliation. Currently, investors cannot realistically always rely on exchanges for historical trade reporting, so the need to have an intraday reconciliation to check with the exchange is vital.

tora_chris_jenkins-1 For those hedge funds already trading in this space, they are looking for a consolidated price feed across exchanges. Risk, reporting, an Order management System and execution are chief priorities for hedge fund trading desks trading in the crypto markets. Ben Roth, global head of trading at proprietary trading firm, Kenetic Capital who are already trading in this space said: ”As a firm, the majority of us all came from the traditional asset management world, so in the early days we struggled with the technology component. Before firms like Caspian there was no solution to cover execution, order and portfolio management. The market was crying out for this and advanced execution tools. If the custody space can make the same advances then the future looks bright for the institutional market”

A hedge fund has investors, and while they might not have stringent best execution regulatory requirements, those investors still expect to see reporting, operational

In the next few months, investors can expect new execution tools. In particular, the market has been crying out for a smart order router to address crypto fragmentation as well as pairs trading. The overriding message in the space is that the tools required are very similar to those in the traditional space but there are key differences that make this technology shift a challenge.

This will not be a problem that can be solved by throwing people at it. There is a lot more to it than just adding headcount because the market is not reflective of any traditional market. There are many different variances and idiosyncrasies that a trader or compliance professional would not have seen in traditional asset classes. Crypto markets are learn- able for an experienced trader, but for portfolio managers at traditional asset managers, there are other elements that may make it harder to make the switch.

ABOUT CASPIAN:
Caspian is a crypto asset manage- ment platform that connects the biggest crypto exchanges in one single interface. The platform also offers compliance, algorithms, portfolio management, risk and reporting. Led by an experienced team of developers, and leverag- ing the capabilities and resources of two existing, successful finan- cial businesses as its partners, Caspian is building an ecosystem that enables sophisticated traders to operate more efficiently to protect and generate alpha.

Japan – A Look Back and Ahead to Markets in 2019

By
GlobalTrading
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By Lisa Iwaya, Head of Marketing, Electronic Trading, Phillip Securities Japan & Sedar Armutcu, Head of Institutional Execution Services, Phillip Securities Japan

The article provides a snapshot of the current trading environment in Japan and potential opportunities that exist for foreigners trading Japanese equities and futures in 2019, including the new settlement cycle, margin trading in PTSs, Futures Dark Pools. It makes brief references to Phillip Securities Japan and its involvement in this environment as well. Many Japanese companies are looking forward to the 2020 Olympic Games as an opportunity to showcase their wares and promote the potential for Japan, despite the fact that historically Japan has found it challenging to spark excitement. Burdened by decades of low interest rates and an aging population, Japanese markets have struggled to keep up with international counterparts especially in the area of market regulation. 2018 was challenging for most brokers, especially over the tail end, despite the near 27-year high in the popular Nikkei index. In 2018 we saw some significant changes to the regulatory environment. Most notable amongst these were changes to the High Speed Trading (HST) registration rules and the ETF Market Making Program introduced by the Tokyo Stock Exchange to encourage more foreign participation and support from overseas market making firms.

HST REGISTRATION
In Japanese markets, the most active high frequency firms are foreign market making firms. However, the Japanese financial regulatory body, JFSA, from April 2018, launched a requirement for all high frequency trading firms, referred to as High Speed Trading (HST) firms in Japan, to register with the JFSA in order to regulate the impact on the market by these players. Due to the stringent requirements, this unfortunately, has discouraged new high frequency entrants from staring operations and it is expected that requirements are set to become even more stringent in 2019. On the bright side, how- ever, there do exist workarounds so that foreign firms can still use low-latency infrastructure and strategies in the market such as by utilising shared servers/taps which exempt them from registration.

ETF MARKET MAKING PROGRAM

Lisa Iwaya, Phillip Securities Japan
Lisa Iwaya, Phillip Securities Japan
JPX launched the ETF Market Making incentive program in July 2018, in an effort to boost liquidity of its ETFs. More liquidity makes it safer for domestic retail and institutional investors to trade in the ETF space. Thanks to this program and the market makers who signed up to participate in it: the liquidity of several ETFs on the TSE have increased as can be evidenced by larger on-screen posted intraday volumes and tighter bid-ask spreads. Although the initial requirements to receive the incentives are quite a tall order- the exchange is looking at ways to make it more attractive for the overseas firms most of who are committed to support the exchange in its efforts to bring more participants to the local market. We expect more develop- ments in this space from Q2 this year. On our side, since the launch of the ETF Market Making Program, Phillip Securities Japan became an AP for select Asian index ETFs.

T+2 SETTLEMENT
In response to developments in other major markets, The Tokyo Stock Exchange will switch to T+2 settlement from T+3 settlement on Tuesday, July 16th 2019. Trading members of the TSE, including our company, have already started testing with the clearing organisation JSCC and the central

Sedar Armutcu, Phillip Securities Japan
Sedar Armutcu, Phillip Securities Japan
depository JASDEC to ensure a seamless transition to the new settlement cycle. Three years in the making, Japan will follow regional counterparts like Hong Kong and Korea in making the transition and will bring Japan in line with the major US and European markets.

RETAIL MARGIN TRADING ALLOWED IN PTS FOR FIRST TIME
It is estimated that around 30 to 40% of all retail trading in Japan done through retail broker mar- gin accounts. Brokers have been restricted from sending orders on these accounts to any other venue other than the main public exchange, TSE. The two main PTSs in Japan, SBI JapanNext and Chi-X Japan, despite being in operation for many years and bringing vari- ous innovations to the marketplace like night time trading have not broken through the psychological 10% market share barrier. This has allowed TSE to protect its market share contrary to other markets like Australia where Chi-X Australia has been relatively more successful.

Pairing with the switch to T+2 settlement cycle, PTSs in Japan will be allowed to accept orders from retail margin traders from the summer of 2019. This may be a plus for players who utilize strategies that take advantage of fragmentation of market liquidity, although the full effects most think will still take some time to fully realise.

DERIVATIVES DARK POOLS
In Japan, Equities dark pools became popular because they provided anonymity for traders
who wanted to hide their tracks. Dark pools for derivatives products, on the other hand, were seen more of a niche service as traders had less similar reasons for anonymity. We think that dark pools for derivatives in Japan, however, may receive more attention going forward as they provide an oppor- tunity for cost savings through the opportunity to trade inside the public bid-ask spread and smaller tick sizes compared to the regular tick size on the exchange.

For the first time, the Japanese markets will be shut for 10 consecutive days during the extended annual Golden Week holiday in May this year. The reason for this is the current Emperor’s abdication from his throne. Japanese Exchanges will be closed but other global markets will be open. Investors in Japan are being warned of a possibly major market price fluctuation when the market in Japan re-opens: an interesting development for Japanese market players.

Low Touch in Derivatives: Where do we go from here?

By
GlobalTrading
-

Over the past few months, I’ve shared my thoughts about the evolving space of electronic flow in derivatives. I’ve touched on the fact that:

1. All factors are pointing toward an accelerated change.

2. This is not trail-blazing. There’s a lot to be learned from other asset classes.

3. This is not simply about algos. It depends on the trader’s market expertise.

But the piece that maybe I’ve not explored relates to how we as an industry providing services to buy side clients actually go about making this change. And in particular, addressing the elephant in the room: why the buy side need to recognize that this marks a change to the service they’ve grown up calling electronic.

Before I start, it’s worth level setting what the electronic trading business looks like today in derivatives. Granted there could be exceptions, but for this purpose I’m focused on the service offered by the typical FCM.

Growing pains

Whether the buy-side trader uses a screen or it’s a computer model that’s sending the orders, both use the FIX protocol to communicate the intent of the order. For the sell-side firm, they have something called a FIX spec that defines the language of how to communicate that order.

Today, firms have a FIX spec that defines the algos in their toolbox. As they’ve added algos to their roster, so the FIX spec has grown. Given that different algo services or vendors likely have a different range for their ‘special’ algo tags that define an order’s behavior, this quickly ends up presenting technical complexity in certifying. This is typically a one-time piece of work, so though painful, it’s not ongoing. However, the complexity of having multiples of the same order type being potentially available as options on the buy-side order ticket does create an obvious ongoing friction. This complexity is the causality of how the flow has been defined. In the beginning, electronic flow was DMA. Then along came algos, and they too were treated like DMA – from a pricing and connectivity perspective. The broker never interjected in the flow. Whatever was needed for the Algo container was what the firm insisted was sent by the buy-side client.

Learning from the friends across the floor

Overcoming this complexity is actually relatively simple. It’s time to apply a little muscle to this and appreciate a thing of FIX-beauty that originated in Equities: FIX Normalization. Normalizing a FIX service is exactly as it sounds. Simplify the communication between the buy and sell side, and manage the outbound remapping requirements as part of your system, rather than pushing the complexity down the client’s throat. You then have a single consistent message format, regardless of how many VWAPs you can potentially access off the back of your OMS.

This does, however, raise another problem: now that you have a generic ‘I want to trade a VWAP’ instruction from the buy side, how do you manage where to send it? Again, it’s time to flex some muscle and use some routing logic that’s so standard across the floor that no one even asks if you do it. The concept is simple. Subject to terms, factors, or other decisions, the message is sent to the correct destination service. Adopting this solution in derivatives now does, however, have one advantage over Equities, in that the path has already been traveled. In Equities, we are at an inflexion point: low-touch is no longer accepted as a one-time routing process as the buy side is demanding more in terms of how their orders are executed. The routing logic is now expected to take ownership of the order throughout its life, giving rise to customization of order handling only previously seen managed by a human on a trading desk. Derivatives therefore have the opportunity to adopt this lifecycle workflow, essentially catching up with the evolutionary process in Equities.

Technology is an enabler, not the solution

Low-touch isn’t just a technology-focused story. Using these elements to make electronic trading more efficient will do just that, but we’re still just talking about a service that remains DMA-to-Algo – albeit with a little light lifting in between. As I said in the last piece, taking these technology muscles and overlaying the brain of the ‘trader expertise’ defining how the order is executed is what truly moves derivatives electronic trading to a tangibly valuable proposition for the buy side. Creating targeted execution plans is implicitly what an FCM care trader does with the orders they handle manually. And if there’s value premium in care flow and the human oversight and ownership of the order’s execution, then shouldn’t the electronic version of this command some sort of premium too?

In my view, all the FCMs wanting to provide an enhanced electronic algo execution capability – or low-touch as I’ve referenced it using the equities convention – stand at a fork in the road. Both routes will eventually get to the same destination, but the choice of the path will govern the success. Take the fork to the left and you continue down a one dimensional, narrowly focused DMA-to-Algo service. With this path comes a low degree of innovation, driven simply by the limited upside opportunity firms can recognize. The destination is therefore a lot further off and you’re going to take significantly longer to get there – ultimately mis-serving the investing buy side clients. Those taking the fork to the right see and embrace what’s at the end of the path. This path positions them to move their Algo access out of a low-value DMA channel and into a valuable service that provides the buy side with the functionality they’re looking for.

This is starting to happen. And I for one look forward to the redefinition of low-touch within the derivatives market.

Euronext Aims To Build Asian FX Ecosystem

By
Shanny Basar
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FastMatch, Euronext’s platform for spot foreign exchange trading, hopes to take advantage of being the first electronic communication network to launch in Singapore in the third quarter of this year.

Chris Topple, chief executive of Euronext London, told Markets Media: “We will be the first ECN to launch in Singapore so this should give us a little bit of a first mover advantage.”

Euronext announced the appointment of Topple as chief executive of Euronext London, head of global sales across asset classes and a member of the managing board in July last year.

Chris Topple, Euronext

“Local banks in Asia already use Euronext technology to route orders so we will partner with them for the launch this year to build a local ecosystem,” added Topple. “We hope to launch in the third quarter.”

The pan-European exchange completed its acquisition of FastMatch in 2017. FastMatch previously had three matching engines in London, New York and Tokyo.

Topple said: “Singapore is emerging as the natural hub for trading foreign exchange in Asia. The Monetary Authority of Singapore has some strong initiatives to promote the region so it is the natural place to extend our geographical coverage.”

For example, MAS and the US Commodity Futures Trading Commission have agreed mutual recognition for some derivatives trading venues.

FastMatch will initially launch spot FX trading. However Euronext intends to expand its FX product range and has a project to launch non-deliverable forwards. NDFs are derivatives that are used to hedge or speculate against currencies where exchange controls make it difficult for overseas investors to make a physical cash settlement, for example, the Chinese renminbi.

“MAS and the US have agreed mutual recognition which is very positive for NDFs,” added Topple. “We also run regulated markets in the UK and the US so we potentially have the choice of three locations to launch NDFs.”

The European Commission has also granted equivalence for certain derivatives trading venues in Singapore.

Topple continued that key benchmarks for success in Singapore will be average daily volume and new client acquisition. He added that FastMatch’s global average daily volume is currently around $20bn (€17.8bn) which is predominantly in Europe and the US.

When the acquisition was announced, FastMatch had an ADV of $17.7bn and revenue of $5.8bn in the first quarter of 2017. Last year Euronext Group had total revenue of €615m with a contribution of €21.7m from FastMatch.

Kevin Wolf, FastMatch

Kevin Wolf, chief executive of FastMatch, said in a statement: “Euronext FastMatch’s expansion in Singapore, which is currently the largest FX centre in Asia and the third largest globally, reflects its ambition to create a strong development base in Asia.”

Singapore FX market

MAS said in its Financial Services Industry Transformation Map that the central bank aims to develop Singapore as the global FX price discovery and liquidity centre in the region through encouraging market participants to set up their matching and pricing engines in Singapore.

Alan Yeo, executive director of MAS, said in a statement: “Having more players like Euronext’s FastMatch setting up in Singapore will support the formation of a regional e-trading ecosystem that will offer better connectivity and more effective execution of trades. This will enable our FX market to better serve Asia’s growing FX needs.”

Last month Singapore Exchange announced it had paid $25m for a 20% stake in BidFX, a cloud-based liquidity aggregation platform which supports FX spot, swaps and forwards for G10 and Asian currencies. BidFX was spun off as a division of TradingScreen, a provider of a multi-asset execution and order management system, in January 2017.

Loh Boon Chye, SGX

Loh Boon Chye, chief executive of SGX, said in a statement: “With this investment, we have an opportunity to offer our suite of Asian FX futures alongside the over-the-counter products offered on the BidFX platform, bringing together both pools of liquidity.”

SGX said that since it introduced FX futures in November 2013, more than $2 trillion in aggregate notional has been traded across its entire FX franchise.

FX Tape

FastMatch launched FX Tape in September 2017 to  provide centralised and global post-trade data to all market participants. The tape was intended to provide a central reference point for prices of spot FX transactions to help market participants achieve best execution.

FX Tape publishes real-time post-trade information collected from market participants in an aggregated and delayed fashion to minimize market impact and information leakage. Topple said interest in FX Tape has steadily increased, particularly from central banks monitor FX markets and want to better understand and manage market spikes.

“The tape publishes between $100bn and $120bn so is in it’s infancy,” Topple added. “There is a lot of discussion in the market about its validity.”

FastMatch also publishes data on trades executed on the ECN both historically and in real-time which he said is more valuable for trading indications.

Rule 606 Update Nears

By
Terry Flanagan
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A lot has changed in equities markets since 2000, when the U.S. Securities and Exchange Commission adopted Rule 606 to improve public disclosure of brokers’ order-routing practices.

The NYSE-Nasdaq exchange duopoly is long gone. Electronic trading has evolved from a small corner of the market almost two decades ago, to ubiquitous now. And then-speedy trades measured in milliseconds are glacial today.

So with the old Rule 606 about as relevant today as rules pertaining to 3G mobile-phone technology, the updates the SEC outlined late last year will be substantial.

“By mandating and standardizing broker disclosure of order routing, the newly adopted Rule 606(b)(3) increases transparency and removes potential barriers that investors may face in monitoring broker order handling,” said Stephen Fitzpatrick, Senior Passive Equities Portfolio Manager and Senior Trader at the $48.1 billion Colorado Public Employees’ Retirement Association. “We are hopeful that the rule change will elevate the importance of conflict-free routing with investors, and could even improve routing before it takes effect, as brokers anticipate increased investor scrutiny.”

In a November 2018 release, the SEC highlighted that the rule update will require that broker-dealers provide customers more information on so-called not held orders, or those for which brokers have price and time discretion. The intent is to help investors better understand how brokers handle and route orders and assess the impact of routing decisions on order execution quality. The rule update goes into effect May 20.

Better Comps
Given the risk of ‘information leakage’ compromising order execution, the SEC has stipulated that information about not held orders be shared with customers, but not released publicly.

Venu Palaparthi, Dash Financial Technologies

“Customers will be able to take this granular, standardized data and do a more thorough comparison of routing performance than they were able to do in the previous 606 regime,” said Venu Palaparthi, Chief Compliance Officer and Head of Regulatory Affairs at Dash Financial Technologies. “Previous 606 information was of very limited value to the customer because it was just high-level information on what percentage was non-directed broken down as market, limit or other.”

Palaparthi notes that the Rule 606 update does not cover order flow that is routed from broker-dealer to broker-dealer, “so broker-dealers will have to negotiate what data they want to share among themselves,” he said. “That will result in some information gaps, because the SEC is leaving it to market forces to sort out.”

Palaparthi indicated there may be some complacency on the buy side regarding the upcoming change. “There may be some managers who are assuming that their brokers will be providing this data and this data will contain all the information that it ought to contain,” he said. “But I think what they do not realize is that in many cases, the client-specific report will only say that the order was routed to another broker.”

Palaparthi noted that Dash clients – both on the buy and sell side – have received granular, real-time routing and fee information through the web-based Dash360 since the firm launched in 2011.

The 606 update makes very few improvements for options order handling, and there are some uncertainties with respect to actionable indications of interest (IOIs), for purposes of determining whether to include in the reporting. Palaparthi expects investment managers to ask more questions once they start seeing the first iterations of the data.

Colorado PERA “recognized the importance of monitoring broker routing prior to the rule change, and consequently we have already requested routing data from our brokers, who have been very receptive,” Fitzpatrick said. “As we continue to monitor broker routing, the standardization of disclosure details required under Rule 606(b)(3) may improve comparisons between brokers.”

Overall, the pension plan does not expect issues in brokers meeting the reporting requirements of the rule update. Large brokers should have the necessary infrastructure in place, and Fitzpatrick said in response to queries, smaller brokers “have informed us that implementation will not be too burdensome.”

Limitations

Tyler Gellasch, Healthy Markets

One limitation of the updated Rule 606 is that its public disclosures will be inadequate to use for proper broker evaluation, said Tyler Gellasch, Executive Director of Healthy Markets, an industry trade group.

‘It’s not great as a comparison tool, nor does it help the markets writ large understand the conflicts of interest that the brokers face,” Gellasch said. “The other downside is, it doesn’t apply to anything other than not held orders by institutions. There are a lot of exemptions and exceptions.”

Gellasch also noted that smaller brokers, particularly those that don’t have their own suite of trading algos and instead use ‘white label’ products of larger firms, may face challenges gathering the information they need to deliver to clients.

But overall, the Rule 606 update is a long time coming. “This reform is a very big step for improving best execution,” Gellasch said. “Investors are going to have a much better idea whether a broker is routing for best execution, or whether a broker is routing for the benefit of the broker.”

“Dash has essentially built its business on the premise that complete transparency coupled with full customization capability allows market participants to make data-driven routing decisions that ultimately reduce costs and drive performance,” added Palaparthi. “We think this approach is in the best interest of investors and are happy to see the industry moving in this direction.”

Fixed Income Trading Shifts To All-to-All

By
Shanny Basar
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The vast majority of fixed income execution venues offer an all-to-all model and volumes of multilateral trading are expected to continue to increase according to research from consultancy GreySpark Partners.

Willis Bruckermann, consultant, capital markets intelligence at Greyspark Partners, said in a report that all-to-all trading with both sell-side and buy-side liquidity providers within a single venue is the norm in 2019.

“Venues offering only one or the other category of liquidity are no longer adequate to satisfy buy-side trading needs,” he added.

The consultancy’s analysis found that more than three quarters of the venues are multilateral where multiple liquidity providers compete for trades, which is unsurprising given fixed income market structure’s secular shift towards all-to-all trading. The importance of the buy side as price-makers varies based on the product mix offered on a given venue.

Bruckermann said: “The share of bond electronic trading venues offering buy-side firms the opportunity to act as price-makers – both across single- and multi-tiered matching methodologies – illustrates that market participants, both on the sell side and the buy side, should no longer wait for change to happen: change has happened, and continues to happen at a rapid pace.”

For example, electronic fixed income trading venue MarketAxess said in its results that Open Trading, its all-to-all trading model, reached record volumes of $376.5bn (€335bn) last year, up 62.6% from 2017.

Rick McVey, MarketAxess
Rick McVey, MarketAxess

Rick McVey, chairman and chief executive of MarketAxess, said in a statement: “The fourth quarter was one of our best quarters ever for year over year market share gains, as well as volume growth in Open Trading. The liquidity pool provided by Open Trading was increasingly valuable as credit spreads widened, leading to record estimated transaction cost savings for our clients of $57m for the quarter.”

New venues

GreySpark continued that banks have begun operating multilateral electronic trading venues within the MiFID II framework.

The introduction of the MiFID II regulations in the European Union at the start of 2018 introduced best execution requirements in fixed income and mandated new reporting requirements, which are met more efficiently through electronic trading.

“Most strikingly, banks – long the bastions of bilateral trading – have begun offering explicitly multilateral venues on which the operator itself does not provide liquidity,” said Bruckermann.

The consultancy explained that the emergence of bank-operated multilateral electronic trading venues is the natural conclusion of the evolution of the banks’ business model from principal to agency trading as they were forced to reduce their balance sheets after the financial crisis.

“By running multilateral electronic trading venues, a bank’s agency trading services are made explicit; liquidity crossing services are electronified and exposed to the clients providing liquidity on the platform, which was formerly an internal and – from the client perspective – opaque ECN,” added GreySpark.

In addition new venue operators are entering global fixed income including exchange operators and proprietary trading firms that are expanding from equities and foreign exchange. Bruckermann expects a number of proprietary trading firms to launch multilateral fixed income facilities.

Willis Bruckermann, GreySpark Partners

“Exchanges take on a significantly more pronounced role as trading venues for bonds and swaps,” he added. “This growth in market share has come largely at the cost of independent brokerage venue providers.”

Bruckermann continued that despite the increase in all-to-all trading many venue operators continue to conceal buy-side liquidity, most commonly through dark matching.

“GreySpark is particularly interested in this finding as the provision of exclusively dark liquidity functions as a proxy by which venue operators express their view of the future of the market evolution and the end-state structure it will take,” said the report. “This being the case, venue operators send a clear signal regarding the further evolution of the fixed income e-trading market going forward: all-to-all trading will continue to increase in significance, across both single- and multi-tiered markets.”

Reg NMS Review Coming, SEC’s Clayton Says

By
John DAtona
-

Hold on, it’s coming.

Jay Clayton, Chairman of the U.S. Securities and Exchange Commission, said that if he has his druthers, there will be a review of Regulation National Market System or Reg NMS.

Jay Clayton, SEC

Reg NMS was first put into place back in 2005 and the broad reaching rules were designed to enhance competition between trading venues and to update the market’s rules as electronic trading (low-touch) grew while human trading (high-touch) became increasingly popular. As time has progressed, the market structure has changed dramatically and Reg NMS has remained static, leaving many in the marketplace – the exchanges, brokers, and buy-side – to wonder if NMS needs to either be updated, abolished or completely re-written.

Clayton agrees that the SEC and rulemakers need to at least revisit the bedrock regulations and that the current rules “may have missed their mark” while some others are completely with some parts of the rule, while adding that other portions of Reg NMS are extraneous.

“As technology and business practices evolve, so must our regulatory framework,” Clayton, who joined the SEC in 2017 after being nominated by President Donald Trump, said during a recent speech at Fordham University. “It is clear that the market challenges we faced in the early 2000s are not the same as the issues that we confront over a decade later.”

Speaking alongside SEC Division of Trading & Markets Director Brett Redfearn, Clayton said there are several things the regulator would explore this year to address the current market structure. Two of the most important items under review are the consolidated audit trail and another are market data fees and costs associated with them charged by exchanges.

“We currently have a two-tiered system of market data and market access in the United States — core data and proprietary data,” Redfearn said. “I believe we must assess whether the current core data system is contributing to a bifurcated landscape of market data that calls into question whether access to markets remains fair and not unreasonably discriminatory.”

“Some of the challenges we face today may, in fact, be consequences of Regulation NMS and other rules,” Clayton said. “It is important that we reassess Regulation NMS, now 14 years old, as well as whether the dissemination of, and access to, market data can be improved to better facilitate Exchange Act objectives.”

MAKING THE SHIFT: Normalising a Quantitative Culture in Fixed Income

By
GlobalTrading
-

By Carl James, Global Head of Fixed Income Trading, Pictet

carljames963

 

Quant-driven trading has been around for years, so it’s nothing new, but the pace of change is accelerating as more and more trading desks are adopting this type of trading.

Why is this the case? Regulation is forcing traders to be much more focused on delivering evidence of best execution. The phrase that best encapsulates this is, “show your work”. The standard for evidence is higher and it now has to be predicated on data. At the same time, developments in technology mean data processing is cheaper and data capture is easier. Finally, the people element is changing. The next generation of traders entering our industry is data savvy and knows how to use the data to inform their trading decisions.

The challenge facing many buy-side trading desks is how to effectively integrate these new tools and methodologies while retaining the accrued expertise and time-built relationships already present on the desk.

MANAGING THE TRANSITION

While there are clear benefits to quantitative methods, no one would reasonably suggest a head of trading make personnel decisions for an entire desk based exclusively on technological proficiency. The need for quantitative thinking depends on the asset class, geography, business mix and other factors. As a head of trading, you need people on the desk that have relationships and market knowledge, but you also need the right blend of people who understand datadriven tools or can write code themselves, in order for the entire (continued from previous page) desk to trade more effectively.

At Pictet Asset Management, we are making this transition across the front office. We are offering Python programming courses and at a recent offsite, almost everyone in attendance had done this course, including senior people. Rather than just segmenting the dealers to be the hub of data, it has become a cultural element of the whole front office. We work closely on this transition with the portfolio managers and analysts, who are also increasingly data savvy.

It is important to have people on the desk that are able to communicate this new type of additional information to the rest of the team. To do that, we must first ensure they have the tools to pull out that data as well as the data, itself, to analyse and make conclusions from. When you have people who are and are not data savvy, people from each group will come at a challenge from different angles, and the sum of the parts is more than the whole. The person who knows markets can bring their historical experience and the person with the data brings quantitative analysis, and in combination, it is quite powerful.

CHANGING CULTURE

Cultural change is always difficult, but you can make it less difficult based on how you approach it. As an industry and as a firm, we had to make changes based on MIFID II, but we challenged ourselves to ask how we could turn that into an advantage. Suddenly, this adoption of quantitative tools required for best execution reporting became a soft message. The firm as a whole took a much broader approach to encourage quantitative and digital thinking. We had townhalls looking at digitisation and printing less, not just for environmental reasons, but to encourage the usage of digital tools. Anecdotally, we can see the impact. When we recently moved offices, we were given physical storage space that’s still empty because the desk now stores materials digitally.

We are also looking for new ways to replace traditional spreadsheets with a more robust solution and remove spreadsheets entirely from our organization. We now use a commercial platform to look at data, which enabled us to completely revamp our broker review process as well as how we do internal presentations. I no longer send presentations, I just present with live data because I can manipulate it and veer off as the audience needs with live examples.

A key challenge with any cultural change is how you approach reluctant individuals. Some may cross their arms and think, why should I change, but we respond that there is no need to fight it. The skills and experience of people that have been in markets for 10-20 years are valid and important. The key is showing our experienced people that they can adapt and evolve. When they started trading, it was different from what they are doing now, so they have adapted already. The evolutionary curve has become steeper, but we can work with them through the transition phase.

If it is positioned as additional value, for some people it takes longer, but generally, they have come along. Part of this is ensuring there is a clear plan for how behaviour changes right away. In the push forward to strive for excellence, some ideas you try will not work. But as long as it is accepted to test something that does not ultimately work, people will be encouraged to learn, improve and build a base of knowledge, as well as the courage to keep trying new ideas.

CASE STUDY: BEST EXECUTION

As mentioned earlier, a fantastic example of the benefits of this transition is our best execution reporting. Internally, my mantra has been, if you want them to, the dealers can provide alpha. Some firms view their dealing desk as a processing unit, but as for me, I believe our dealers can add value because the markets we trade, the strategies we use and the technology we deploy are all complex. Culturally, we recognise that dealers add value and we’ve done largely on the back of our quantitative approach.

It took a while to get the data right and analyse it properly, but we can now demonstrate that a standard dealer produces a certain average trading outcome, but we can demonstrate how our people and technology consistently outperform the market average. This has now given us a way to turn around and show the business we have added basis points to a client’s portfolio. We are still making market calls, but our job is to make sure we are executing as efficiently as possible and we can now provide that evidence.

On the qualitative side, our use of data has improved our broker management process. We know now the hit ratio and flows that come through each broker, their hotspots and the areas they are less good at. This allows us to assess claims from our brokers based on historical data. We are not going to bash brokers, but we need to help our brokers to see where they can improve to meet our needs. This has helped increase the thoroughness of our broker reviews with our top brokers, and the feedback has been quite positive as it drives better engagement with our brokers.

As a result of all this, our dealers now go to every single morning strategy meeting. People want to hear what the dealers are saying because they can communicate market action and where the flows are. We have pushed that by looking forward at the information people do not have right now so we can help our portfolio managers work their way through the markets. As is natural in any large organisation, hiring is one part of this transition. When there is an opening on the desk, it can become all too easy to look for people based on years of experience, but this approach risks viewing people as cogs to be replaced. To stretch the analogy, the machine can never evolve. We are not quite at the stage where data is a given for every candidate, but it is asked about every time. A candidate would have to be very compelling if they did not have those data skills, and that corridor for acceptance is getting narrower and narrower.

THE ROAD AHEAD

This transition toward a more quantitative approach will accelerate across the trading industry in the next few years. On the sell-side, some people that have been hired to drive fixed income tend to have an equity background, and my suspicion is that some of the equity electronic trading protocols will come across in the years to come. I also expect a blending between portfolio managers and dealers, where portfolio managers share the exposure they want or do not want, and the dealers share how they can best get that risk on, whether that be synthetically or through a mix of instruments.

An apt analogy for where we are headed with quantitative trading in fixed income is car-making – people used to make cars, but now computers do. Now, the people tell the computers what to do and help the drivers have

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Global Trading is an industry-leading news service for the global equities capital markets: providing information, education, insights and analysis for senior professionals working within trading and execution across Europe, the UK, North America, APAC and other emerging markets. With a focus on the intersection between the buy and sell-sides, Global Trading covers all industry elements from technology and trading strategies to regulation, best execution, market structure and liquidity.

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