By Waseem Barazi

Following widespread enthusiasm in 2018 for developing digital asset trading infrastructure, some banks have recently tempered their approach, in part because regulators have yet to release guidelines on various areas of digital asset regulation. Given the current regulatory patchwork that applies to digital asset trading, investors must do their own due diligence when deciding where to trade digital assets.

That’s a tall order for most investors, including banks and other institutions; they are sophisticated financial industry market participants, but they may not have the background in digital assets necessary to evaluate exchanges, wallet providers, custodians, and other relatively new entrants. That task can be simplified by reviewing a few key questions when considering a digital asset exchange.

1: Does the exchange have a market surveillance team?
Established exchanges in the securities and derivatives industries have systems in place to monitor, prevent, and investigate any activity that appears abusive or manipulative or is otherwise potentially harmful to market participants.

Collectively referred to as “market surveillance,” these systems actively scan for and address activity that could threaten just and equitable trading principles. Surveillance staff then review the alerts generated by these systems to determine the extent and severity of any trading violations.

Although some digital asset exchanges conduct market surveillance, it is not yet standard across all exchanges. When considering whether to trade on an exchange, investors should ask whether it has a surveillance team and inquire about the team’s experience in conducting market surveillance investigations.

That team should be using the same tools employed by regulated securities and derivatives exchanges to identify and halt manipulative and abusive activity, including automated trade alerts, circuit breakers, and full-order-book audit trails.

2: Are there trade prohibitions for the firm and its employees?
In the securities industry, clearly stated and enforced rules prohibit trading with material, non-public information (commonly referred to as “insider trading”). This isn’t always the case in the digital asset space, where no similar legal prohibition exists and exchanges operate in a gray area with regard to this issue.

In the digital asset space, it’s common for exchanges to operate their own trading desks that trade proprietarily on their exchange against their own customers. This presents a conflict of interest, as exchanges are able to trade against their customers with superior information regarding trading activity and order flow.

Additionally, exchanges have come under fire recently for permitting (or failing to prevent) employees trading in advance of material, market-moving announcements, such as the listing of a new digital asset.

When considering an exchange, investors should look for clear guidelines about whether and under what conditions its employees are permitted to trade the assets it offers. Disclosure of these policies helps investors make an informed decision.

3: Is there an option for customizable user privileges and individual accounts?
In its Virtual Market Integrity Initiative (VMII) report released last fall, New York’s Attorney General highlighted the risks associated with single users creating multiple accounts because of the potential for market manipulation. While measures to prevent market manipulation are of crucial importance to institutional investors (see the surveillance section above), a “one person, one account” structure isn’t necessarily what institutional investors are looking for in an exchange; rather, institutions are more interested in account structures that reflect their organizational structures and hierarchies.

Institutional investors are used to a single account for multiple traders, with the option to assign customized trading privileges, including credit limits, trade controls, and withdrawal limits for their traders. This allows firms to ensure that no one trader exceeds his or her assigned trading power or risk limits. The practical effect is that firms can custom-tailor their trading strategies on a trader-by-trader basis and protect their firm’s capital.

Accordingly, when considering an exchange, institutional investors should consider the ability to create multi-person, segmented accounts a basic infrastructure requirement.

4: Does the exchange charge listing fees? If not, how does it determine which digital assets are traded?
Public stock exchanges publish their standards for listing a security so that anyone interested in investing in that security can investigate the exchange’s rationale for listing it.

In the world of digital assets, no agreed-upon listing standards exist and exchanges often do not publish their listing criteria. In many cases, in fact, exchanges list specific digital assets in exchange for payment in that digital asset, which can present a conflict of interest for the exchange.

Although institutional investors are typically sophisticated and conduct their own research regarding which digital assets to trade, it is conceivable that some market participants rely on exchange listings to ascertain the strength of a particular digital asset. Investors should exercise caution in this regard, and be aware that just because a digital asset has made it on to a well-known exchange does not mean that it is a viable project or reputationally sound.

5: Is the platform fully licensed and regulated?
Currently, there is no single standard for what kind of licensure digital asset exchanges must have, as digital asset trading may cross a variety of jurisdictional lines.

A patchwork of state and federal regulation may apply to an exchange offering digital asset trading. The relevant regulator may depend on whether the listed digital assets are securities or commodities, whether the exchange offers derivatives trading, and what states or countries the exchange accepts customers from.

Exchanges that are most serious about protecting investors will proactively seek the licensure that will make them eligible to host trading. Because regulatory licensure imposes strict operational, procedural, and cyber-security standards, investors should steer clear of those exchanges that seek to avoid regulation.

6: How does the exchange handle storage and settlement?
Roughly a billion dollars’ worth of digital assets was stolen from exchanges and other platforms last year, which isn’t surprising given the standard storage and settlement infrastructure many exchanges use: a single wallet or a handful of wallets to store assets from all platform participants, and a single access key to withdraw funds.

Even if a portion of assets are in cold storage, joint wallets present a tempting target for hackers and other potential thieves. And single-factor authentication is inherently easier to hack than 2-FA.

Institutional investors should seek an exchange that creates dedicated wallets for each exchange participant and enforces 2-FA and withdrawal IP whitelisting for all users. This setup means there is no one wallet that can act as a single point of failure and greatly reduces the likelihood that an unauthorized user can withdraw assets improperly.

7: Does the exchange have a credible leadership team?
Just as a VC would consider the track record of a potential portfolio company’s leaders, so too should investors consider the backgrounds of a digital asset exchange’s leaders. They can do this by researching public directors, founders, and others in high-ranking positions (often listed on the exchange’s website).

Do they have a background in finance? Fintech? Digital or emerging assets? Compliance? Leading or overseeing companies?

A strong leadership team increases the odds that the exchange will not only meet the criteria outlined above but that it will continue to evolve and adapt as needed for a changing digital asset space and put the interests of customers first.

Embracing Digital Assets
Regulatory and legal bodies will always lag the latest innovations, meaning that early adopters must engage in more due diligence than those who follow later. Armed with the right information, pioneering institutional investors can safely guide their firms and clients toward the best opportunities in emerging spaces, including digital assets.

Waseem Barazi is Seed CX’s Chief Compliance Officer and General Counsel.

By Terry Flanagan

With 13 exchanges and more than 30 active alternative trading systems, it’s no surprise that some market participants see the U.S. equity market as overly fragmented.

But there are some common misperceptions about the market and its sources of liquidity, according to Phil Mackintosh, Chief Economist at Nasdaq. Broadly speaking, the market functions well as it’s currently constituted, and exchanges are driving the bus.

“Markets are as liquid as they are today because there are a variety of venues and a variety of incentives that keep trades moving,” Mackintosh told Markets Media. “While this may bring up complaints of market fragmentation, there are many ways of looking at the market and as many ways to trade on these markets.”

More than 7 billion shares change hands in the U.S. stock market each day on average, which sums to about $70 trillion per year, according to data compiled by Nasdaq. Roughly two-thirds of that is traded on exchanges, with the other one-third executed on ATSs. “While a significant segment of the market now trades off-exchange, these venues would be lost without the important price discovery that the lit markets—run by exchanges—provide,” Mackintosh said.

New Player

The debate around fragmentation of liquidity is particularly relevant on the heels of the January announcement that Bank of America Merrill Lynch, Citadel Securities, Morgan Stanley, Virtu Financial and five other large financial firms will launch their own exchange. The new venue, called Members Exchange, will directly compete with incumbent operators Nasdaq, New York Stock Exchange, Cboe Global Markets, and IEX.

MEMX aims to boost competition among exchanges, improve operational transparency, and lower trading costs. But there is also potential downside: institutional traders already have a tough time efficiently trading blocks, and a new venue competing for order flow stands to aggravate that problem.

On a January 30 earnings conference call, Nasdaq CEO Adena Friedman didn’t seem rattled by the startup, noting that it would be at least the sixth time that trading firms have drawn up plans to launch an exchange. “We certainly can’t be surprised by continuation of what has been for over 15 years, a hyper-competitive landscape in the U.S. securities markets,” she said.

A new exchange can be helpful, even to incumbent exchanges, to the extent that it pulls price quotes onto lit markets. “To the extent they bring some of that flow that’s currently internalized into an exchange environment, we then get to compete for that,” Friedman said.

So-called dark pools, which seek to match buyers and sellers of large trades without posting their bids and offers beforehand, have less market influence than is commonly perceived, Mackintosh noted in a Feb. 11 blog post. Such venues account for just one-third of off-exchange volume, or about 12% of total average daily volume.

Exchanges’ lit quotes flow through the Securities Information Processor and onto the market in the form of the National Best Bid and Offer. “No other industry can claim to have the same, market-wide, fair and equal pricing for their customers,” Mackintosh wrote.

Off-exchange venues rarely contribute quotes to the NBBO, Mackintosh’s research noted, though trades must be reported to the SIP, via a Trade Report Facility. Data shows that dark pools comprise about one-third of TRF volume; the rest of the TRF is “other trades” that brokers match, often on a principal basis, before they reach an exchange.

“The U.S. equity market is extremely competitive,” Mackintosh wrote. “Each segment of the market has devised a number of economic incentives to attract order flow to their venues. Rebates were targeted by the recently announced Access Fee Pilot, but they are just one of the many different incentives used across the industry.”

Just last week, Nasdaq, NYSE and Cboe said they would sue the U.S. Securities and Exchange Commission over the pilot plan, which the exchanges say would constrain competition, increase costs to investors and represents regulatory overreach.

By Phil Mackintosh

Data collection is no justification for increasing investor costs.

There are plenty who call for the industry to be more “data driven” with market structure reform. But ever since SEC Chair Mary Jo White started to talk about this, what we’ve seen is data collection rather than analysis.

The SECs Tick Pilot is a case in point. Designed to deepen liquidity on the NBBO by widening spreads, the pilot was widely regarded as a costly failure. That’s mostly because artificially widening spreads added costs to investors, estimated at $300 million to $900 million, despite the pilot impacting just 2.5% of market liquidity.

But alas, before the tick pilot data has even finished being collected, we have a new Access Fee Pilot – which is also expected to widen effective spreads and reduce liquidity at the NBBO. What that should prove is that data collection alone doesn’t help design better pilots.

Golden Rule: Do No Harm

U.S. Equity markets are the cheapest, most efficient and also most transparent in the world. Our primary focus should be to protect those advantages—and do no harm.

Thanks to that transparency, we could start by using the data we already have. Did you see that FINRA recently boasted that it collected an all-time high of 135 billion records in just one day? Even more impressive, FINRA recently used that data to compute opportunity cost, something we recently said was lacking from the Access Fee Pilot proposal.

This is important as it confirms we do already have the data required to identify routing conflicts and quantify opportunity costs. Sadly the final Access Fee Pilot ruling did not quantify any benefits—although it does quantify costs—if you’re interested, start at page 222.

What the Market Tells us about Tick Sizes

Even simple data can tell us a lot about trading economics.

Let’s start by plotting all corporate stocks across price, spread, depth and market cap (Chart 1) and see what we can learn.

Chart 1: Spreads naturally widen as market cap and liquidity fall

Artificially wide spreads increase queue size

The upward sloping diagonal line shows how the 1-penny tick forces spreads wider as price falls. Note that the largest circles (depth of the NBBO or queue length) generally sit on this line. This shows that once spreads are capped, the trade-off between the cost of crossing a spread and the cost of waiting swings in favor of waiting—leading to longer queues and time to fill. These spreads are “artificially expensive” or “tick constrained.”

The second diagonal line supports this conclusion. Those are stocks in the tick pilot (the pilot ended on Sept 28, 2018), where a 5-cent spread was “artificially expensive,” incentivizing rational traders to capture spreads regardless of the longer queues that created. Note that these are the same stocks that cost investors between $300 million and $900 million above.

Artificially high prices have worse spreads, too

Higher stock prices reduces the “cost” of a 1-cent tick (in % cost). But data shows that having a stock price that is so high that your stock is no longer “tick constrained” isn’t optimal either.

In fact, what you see is that once that stocks lift off the 1-cent spread (diagonal) line, spreads in basis points actually start to rise. For example, tickers like AMZN and GOOG, despite their incredible liquidity, trade with notably wider spreads than other mega-cap stocks priced closer to $100, like MSFT.

This U-shaped curve would seem to indicate that stocks that “just” trade 1-tick wide have the best tradability. If the tick is too small, or too wide, spreads (and trading costs) actually increase.

Liquidity affects the “optimal” spread size

The chart above is also colored by market cap. This shows that market cap tends to cluster around a stock price range. But the more revealing pattern is that the U-shaped pattern persists across each group.

We’d also highlight that the optimal (minimum) spread in basis points rises as market cap falls for:

Mega caps the minimum spread is around 1bps, for a stocks priced around $100
Mid-caps that increases to around 5bps, which happens for stocks priced around $40
Small caps it is around 5bps, which happens for stocks priced around $20
While for micro caps, the minimum spread is closer to 20bps.
This is mostly because liquidity falls as market cap falls—because smaller companies are smaller, they have less capital (and usually shares) to trade.

Liquidity also varies within market cap, which largely explains why stocks trade above the diagonal line (but that’s a chart for another day).

Can existing data tell us about optimum tick sizes?

Using data like this we proposed adopting intelligent tick sizes and intelligent rebates to improve markets and reduce investor costs over a year ago.

We weren’t the only ones thinking this way. One of the data-driven innovations implemented in Europe was an intelligent tick regime. As the chart below shows, it changes the tick size as both price and liquidity change. That results in:

A consistent minimum spread, in basis points, for all similarly liquid stocks
Which just happens to fall at levels consistent with those seen in our US data too (we’ve aligned both color schemes)
Chart 2: MiFID introduced a data driven tick regime that looks surprisingly similar to how US spreads naturally work

There is much more data out there. The trick is using it.

Maybe then we can change markets for the better, or at least be pretty sure we do no harm.

‘Electronification’ and the Technology Revolution in Corporate-Bond Trading 

By Iseult E.A. Conlin, U.S. Institutional Credit Product Manager, Tradeweb

This article first appeared on LinkedIn

The term “Electronification” is thrown around a lot when talking about advances in the corporate bond market. It describes the nascent trend of using technology to trade in a marketplace where the vast majority of trades are still negotiated over the phone. Since electronic execution only accounts for roughly 20% of U.S. corporate trading volume, one might wrongly assume that efficiencies are slow to come by.

But just because a bond isn’t executed electronically, does not mean technology didn’t play a crucial role in getting the trade done.

Five years ago, if you walked by my corporate bond trading desk at one of the largest asset managers you would have seen frantic phone calls, a trader scribbling a price into a notebook, and a portfolio manager skimming through inventory spreadsheets from dealers. To put it simply, corporate bond trading was antiquated.

Today, that desk looks completely different – dare I say, calm even? This is a direct result of the advancements being made throughout the entire trade lifecycle, which we’ve witnessed first-hand at Tradeweb. Regrettably, many of these technology advancements are not quantifiable by industry standard metrics and are often underappreciated in the “Electronification” story.

Previously, pre-trade pricing information was scattered in emails, on scraps of paper and over phone calls. Now, that data is electronically organized and parsed through the aggregation of streams, axes, inventory and dealer runs that are directly routed into a client’s Order Management System (OMS).

At the execution level, All-to-All trading opened an entirely new channel of liquidity where the buy-side and dealers could trade directly with each other anonymously. Advancements aren’t stopping there – Portfolio Trading is becoming immensely popular with the proliferation of the Fixed Income ETF ecosystem, enabling designated portfolio traders at banks to access bonds via ETFs and more easily facilitate pricing client trades. A client may have a very large, market-moving trade and would prefer to utilize a designated portfolio trader at a bank to price that trade to avoid information leakage. As the Fixed Income ETF ecosystem continues to flourish, Portfolio Trading will only become more dominant.

At the post-trade level, the “electronification” continues with Multilateral Net Spotting, an innovation which truly changes the landscape for credit markets around the world. Tradeweb’s patent-pending Net Spotting technology allows clients to have one spot price for a given Treasury benchmark across multiple dealers. In 2018, $152 billion of volume was put through Netting, enabling clients to tap into $2.8 million of never before possible savings.

In fact, here are some examples:

Voice Processing: Eliminate the Need for Traditional Ticket Sending

With Voice Processing, the buy-side trader is able to electronically send an order from their Order Management System (OMS) directly to the dealer as soon as the trade is bilaterally agreed upon. Instead of waiting for the salesperson to the spot the trade, confirm the price, and manually enter the trade details, Tradeweb automatically spots / prices and/or hedges the trade for the buy-side and the dealer. All trade details are electronically returned to the OMS and the trade is booked. This reduces manual entry of transaction details and eliminates operational risk, maximizing scalability and trader productivity.

Automated Intelligent Execution (AiEX): RFQ is Getting Smarter

Intelligent technology like Tradeweb’s AiEX (Automated Intelligent Execution) allows traders to set pre-programmed execution rules to automatically execute trades that meet their parameters. These parameters can include tolerance price from composite, minimum number of counterparty responses, and negotiation time. With AiEX, you have an efficient route to market and less human trading biases, making it possible to quickly execute large volumes of trades tailored to your strategy.

Multi-Dealer Net Spotting: Savings Never Before Captured

Net Spotting is saving clients and dealers real money, but appears nowhere in industry standard measures of corporate market structure “electronification.” Let’s say Katie Smith, a Trader at XYZ Asset Management does 2 corporate trades during the day:

Buy of $50mm NOC 4.03% Oct 2047

Sell of $30mm LMT 4.70% May 2046

Since these are spread-traded bonds, in which a spread is quoted above a benchmark government bond yield, Katie must “spot” these trades against the corresponding old 30-year Treasury bond. The old 30-year Treasury bond bid/ask is quoted at 100-02+/100-03+. The Treasury Spot is imperative because it determines the price of the corporate bond.

Traditional spotting workflow would have Katie pricing these bonds separately and receiving two Treasury spot prices – one at the bid side and one at the offer side. By utilizing Tradeweb’s Net Spotting, both of Katie’s trades would both be spotted at one price instead of having to pay the bid/ask on the Treasury bond. That is savings of $7,881! This kind of cost savings was not possible without advancements in technology. Imagine the cost savings to the marketplace if all eligible volume was netted.

Outsourced trading?

Where have you gone Gordon Gekko? Bud Fox?

Outsourcing – it has happened in so many industries. Much like manufacturing, customer service and staffing, trading is no longer a holdout but rather joining the list of industries seeing this phenomenon.

In the fourteen months since it went into effect, MiFID II has proven to be a disruptive force for the financial services industry, upending existing business models and ushering in a new era of scrutiny in how firms spend their money. In Europe, trading and research can no longer be sold together as one service; even in the U.S., the global impact of MiFID has led many firms to explore full unbundling, leading to difficult questions about which costs are necessary and what it means to seek best execution.

Where there is disruption, however, there is also opportunity for growth. In this case, that opportunity can be seen as buy-side traders and hedge fund managers are increasingly enlisting outsourced trading firms to help them navigate this new normal.

A recent survey of Traders Magazine readers, representing a broad spectrum of buy-and sell-side professionals, found that 28% work for firms that have either already outsourced some of their trading and back-office operations or are actively considering doing so. That may not sound like a big number, but given outsourced trading’s longstanding reputation as a niche service for hedge funds only, it qualifies as a significant figure.

Also, research consultancy Opimas noted that though outsourced trading desks have existed for some time, interest in such offerings has increased in recent years as the asset management industry faces increasing pressure in terms of fees, fund performance, and regulation. Octavio Marenzi, researcher at Opimas, said this is leading even larger asset managers to outsource at least part of their trading desks. He forecasts that by 2022 about 20% of investment managers with assets under management greater than US$50 billion will outsource some portion of their trading desks.

Marenzi also noted several things when it came to outsourced trading:

The majority of small, start-up funds have long outsourced their trading desks to their prime brokers. There are clearly exceptions to this: Some new hedge funds‘ strategies are heavily dependent on trading, and these funds tend to establish trading desks and hire traders from the very beginning.
A newer phenomenon is that large, established asset managers are considering outsourcing all or part of their trading desk to an external provider. This reflects tougher cost pressures, as changing economic realities force asset managers to weigh which functions are essential and which can be outsourced at a potentially lower cost.
The basic rationale for outsourcing revolves around reduced operational costs and improved execution quality. While improvements in execution quality in the range of 15-20 basis points have been demonstrated, this is typically only for very small funds that do not have the necessary scale to deploy highly professional traders and systems. Execution quality improvements for larger trading operations are very limited, if discernible at all. In practice, Opimas has found that the reduction in operational costs is far more important than execution quality.
A large number of outsourced trading desk providers exist. While most outsourcing providers are registered as agency brokers, they frequently are part of larger institutions, including custodian banks, other asset managers, prime brokers, or investment banks. The future for these offerings looks bright, and we expect to see revenue growth in the range of 20-30% annually for the next few years.
Asset managers looking at providers to outsource their trading desks to should consider regional coverage, instrument coverage, number of traders and experience in instrument class, number of similar clients, number of connections to relevant brokers and execution venues, systems architecture, including review of the order management and execution management systems in place, system used for transaction cost analysis, review of historical execution quality, commission management program, trade allocation policy, and any conflicts that the provider may have, including proprietary trading or asset management.
One firm that is focusing resources and assisting institutions with outsourced solutions is Dallas, Texas-based Capital Institutional Services (CAPIS). An independent agency broker offering global execution services and commission management solutions for institutional investors, CAPIS also has an outsourced operation and services it offers to clients, said Chris Hurley, Director of Institutional Sales, who is charged with leading CAPIS’ Outsourced Trading sales effort.

“CAPIS has acted as a de-facto outsourced desk for decades” Hurley told Traders Magazine. “The difference now is technology enables an outsourced desk to direct commissions to other brokers on the manager’s behalf. Our independent research and agency-only brokerage model was a natural fit for expansion to dedicated Outsourced Trading.”

Hurley said that he finds clients are drawn to an unconflicted trading model where incentives are aligned with the goals of clients, who recognize the value of technology, high-touch trading expertise, and stealth in sourcing liquidity while offering a high level of engagement and customer service.
“An effective outsourced trading provider has the process, relationships, and resources to efficiently manage each client’s unique needs and provide best execution beyond U.S. cash equity and into the international equity, fixed income, and derivatives markets,” he said. “Managers looking to maximize their resources gravitate toward partnering with an outsourced provider who can seamlessly facilitate their current needs and growth plans while minimizing disruption and costs, and who can also consult on projects such as outsourcing middle and back office functions.”

While outsourcing is gaining steam in both the U.S. and Europe, the growth has progressed in different ways. In the U.S., where the practice has a longer history, larger funds have followed the hedge fund vanguard and are now choosing to supplement their established trading desks, while in Europe, the interest began with the largest firms adapting to the shifting regulatory landscape, with the smaller firms then following that example.

But no matter why they make the decision, firms that choose to outsource some or all of their trading operations are seeing strong results. “Given all the mounting costs and complexities around reporting and best execution, outsourcing all or parts of trading may increasingly makes sense for some firms in the industry,” Ryan Larson, Head of U.S. Equity Trading at RBC Global Asset Management, said at the Equities Leaders Summit in Miami last December.

And in the 2018 report “Outsourced Trading: Helping the Buy Side Improve Execution and Enhance Operational Efficiency,” Greenwich Associates found that among participating institutional investors using outsourced trading desks, 71% were extremely satisfied with the service. Among the study participants were 10 firms with at least $10 billion in assets under management.

Tim O’Halloran, Managing Director at Tourmaline Partners, another outsourced trading firm, said that today’s landscape increases the benefits of outsourcing for large and small managers alike.

“Historically, outsourced trading has been popular with emerging managers at launch, because those firms are less likely to have the resources to support an in-house trading desk,” he said. “As a result of new regulation, changes in technology and a host of other factors, we are now seeing larger funds experience some of these same cost pressures. In addition, larger firms that do employ traders are starting to realize our global scale and expansive network of sell-side relationships can supplement their in-house trading activities. The result is that outsourced trading has become a much bigger tent.”

Whatever forces are driving firms to outsource their trading operations, one thing is clear: running a full desk internally, with no outside help, is no longer a prerequisite for being a large manager. The buy side is facing tremendous pressure, and if present conditions persist, outsourced trading’s transformation from a specialized service to a standard practice may have only just begun.

And its not just limited to the front office or trading desk. A cottage industry is being born at the middle- and back-office as well. Stephen Dora, Director at Conformity 360, explained how his firm fits into the outsourced trading ecosystem.

“Our platform is focused on small and midsize hedge funds, where traders may take on multiple roles and responsibilities,’ he began.” An independent compliance managed service like us can be an affiant while being cost effective way to adhere to the stringent requirements that Funds must comply to.”

Due to the increased demand for soft dollar relationships and the pressure builds to lower costs, Dora added he felt this is a great opportunity for his firm to be able to partner with outsourcing desks to be able to offer a valuable service at a significant lower cost within their platform.

By John D’Antona Jr.

Budgets for buy-side trading desks in the U.S. and Europe grew 8% last year, fueled by increased spending on compensation.

A 2018 spike in compensation expenses on buy-side trading desks was by far the biggest driver of the 8% overall increase, which followed essentially flat trading desk budgets in 2017. The average budget for asset management and hedge fund trading desks is $2.73 million.

“Compensation growth last year ended a three-year run in which compensation spending was being crowded out by ever-expanding technology costs,” says Brad Tingley, Market Structure and Technology Analyst at Greenwich Associates and author of a new report, The Buy-Side Spending Battle: Compensation vs. Technology.

Technology expenses had been growing as a share of total budgets for both equity and fixed-income trading desks since 2015. Last year that trend reversed, with compensation climbing by eight percentage points, to 68% of total budgets.

Although technology costs shrunk as a share of the total, institutional investors reported significant increases in spending in a few key areas. In particular, as a share of total technology costs, spending on execution management systems (EMS) increased to 6% of total technology spend. Increases were also reported in spending for market data terminals, market data feeds and hardware.

Assessing the Impact of E-Trading and Other “Disruptive” Technologies
Despite the massive impact of e-trading to date, buy-side traders and portfolio managers consider it an underappreciated technology relative to its potential to revolutionize financial markets, and approximately 40% think the impact of artificial intelligence and blockchain are overexaggerated. “In direct contrast, our data shows that the impact of the truly transformative technologies related to big data and alternative data remain underappreciated by the market as a whole,” says Brad Tingley.

By John D’Antona Jr.

The enemy of my enemy is my friend.

In a unique twist that is the stuff of movies, exchange operators Nasdaq and Cboe Capital Markets have joined their downtown rival – the New York Stock Exchange – to sue the U.S. Securities and Exchange Commission. In what can be best described as détente between the normally contentious rivals, the exchanges have opted for an “all-in” strategy combining all their collective strength to stop the regulator from implementing its access fee pilot.

The goal of the pilot program is to examine the fees charged by the exchanges for data and see if these charges are either exorbitant or harm investors and unfairly benefit exchanges. Either way, the move looks to keep the regulator from getting an inside look at the world of trading fees and rebates, which it says might be hurtful to the marketplace. The exchanges counter that these fees are reasonable and assist in making the stock markets efficient and keep trading costs low.

Phil Mackintosh, chief economist at Nasdaq, recently penned a blog that said data collection is no justification for increasing investor costs, which he feels the pilot will eventually do.

“There are plenty who call for the industry to be more “data driven” with market structure reform. But ever since SEC Chair Mary Jo White started to talk about this, what we’ve seen is data collection rather than analysis,” Mackintosh begins. “The SECs Tick Pilot is a case in point. Designed to deepen liquidity on the NBBO by widening spreads, the pilot was widely regarded as a costly failure. That’s mostly because artificially widening spreads added costs to investors, estimated at $300 million to $900 million, despite the pilot impacting just 2.5% of market liquidity.”

But alas, before the tick pilot data has even finished being collected, we have a new Access Fee Pilot – which is also expected to widen effective spreads and reduce liquidity at the NBBO,” Mackintosh reasoned. “What that should prove is that data collection alone doesn’t help design better pilots.”

He continued to note U.S. Equity markets are the cheapest, most efficient and also most transparent in the world and the SEC’s primary focus should be to protect those advantages—and do no harm.

To that end, Mackintosh says the SEC can start any analysis or pilot by using the data already available.

“Did you see that FINRA recently boasted that it collected an all-time high of 135 billion records in just one day? Even more impressive, FINRA recently used that data to compute opportunity cost, something we recently said was lacking from the Access Fee Pilot proposal,” Mackintosh says. “This is important as it confirms we do already have the data required to identify routing conflicts and quantify opportunity costs. Sadly, the final Access Fee Pilot ruling did not quantify any benefits—although it does quantify costs.”

Last week, the Wall Street Journal published an op-ed by NYSE President Stacey Cunningham in which she explained why NYSE has filed suit against the SEC over the transaction fee pilot. She wrote:

“The Transaction Fee Pilot imposes government control on the incentives that public markets can offer. Market-maker benefits will be sharply reduced for some securities and fully eliminated for others. To no one’s surprise, dozens of public companies either have asked the SEC to spare them from being selected for forced participation in the pilot or have opposed the pilot in its entirety.”

As the Healthy Markets Association has pointed out, NYSE has been moving in this direction since the very minute the fee pilot was proposed last March. And their comments on the fee pilot proposal (May 31, 2018, July 10, 2018, October 2, 2018, November 9, 2018, and November 20, 2018) had remarkably little to do with improving it, but instead appeared to set up the legal challenge. Cunningham, of course, argued that NYSE’s lawsuit “stands on firm legal ground” because, she said “The SEC has not defined a problem to solve; it has failed to analyze costs or benefits of its experiment adequately; its stated goal of “data gathering” is insufficient to justify the program’s disruptiveness and expense; and the program unfairly penalizes lit exchanges compared with their competitors, the dark pools.

The SEC freely admits it has no idea whether its pilot program will help or harm investors, Healthy Markets reminds.

“Ultimately, we think the lawsuit will further strain relations between NYSE and investors and the SEC,” HMA says. “But it might work to stop the pilot. As we have said before, we think the SEC’s final pilot rule has some legal vulnerability in how it treats (or more appropriately, doesn’t capture) ATSs. So, while the SEC certainly has the authority to adopt a pilot, including one with all of the current parameters, we think that the analysis may leave it open to judicial second-guessing. We don’t expect any of this to happen anytime soon, meaning the pilot is now in limbo.”

By John D’Antona

What is an asset?

As defined by the dictionary it is property owned by a person or company, regarded as having value and available to meet debts, commitments, or legacies. In financial accounting an asset is any resource owned by the business. Anything tangible or intangible that can be owned or controlled to produce value and that is held by a company to produce positive economic value is an asset. Simply stated, assets represent value of ownership that can be converted into cash.

So, what is a digital asset then other than the newest market craze? It is largely defined as digitally stored content or an online account owned by an individual. Digital content includes individual files such as images, photos, videos, and text files. It also includes other digital content (perhaps as data in a database).

Traders Magazine recently caught up with Edward Woodford, Co-Founder and Chief Executive Officer at Seed CX, a new all-institutional digital asset exchange. In an interview with editor John D’Antona Jr, Woodford discussed how the exchange has just launched spot trading capabilities in the wake of the recent institutional adoption of digital assets, digital market structure, wallets, margin, operations, surveillance and other areas.

TRADERS MAGAZINE: How difficult was it setting up an all-digital-asset exchange? What makes it different than a regular equities exchange? 

Edward Woodford: As with anything that is worth doing, it was a product of a lot of hard work from the 45 incredibly talented people we have here at Seed CX. We are creating the infrastructure for a new asset class, in particular the settlement and custody of digital assets. That said, we are keen to take the best aspects of exchanges in established asset classes, with a strong focus on compliance and operational excellence.

One of the key pain points in the digital asset space is the inefficiency of capital. This is mitigated at Seed CX by offering margin trading. We also uniquely allow collateral to be posted in digital assets.

TM: Why launch spot trading? How is trading normally done?

Woodford: We launched spot trading because the majority of volume in the digital asset space is in spot. Digital asset trading currently occurs on a variety of trading venues and OTC.

In terms of derivatives, we are a regulated Swap Execution Facility. For product launch, we are waiting on regulatory approval to launch digital asset derivatives trading, which we expect will happen later this year.

TM: Has the institutional community readily adopted digital assets? We’ve heard there’s been limited interest – so did you have to incentivize? If so, how?

Woodford: Institutional investors have been interested in digital assets for at least a year, but they have been cautious about entering a market that they may perceive as unstable or insecure. At Seed CX, our mission is to build an exchange that has everything institutions need to feel safe and secure: a market surveillance team, trade prohibitions on the exchange’s employees, multi-user account setup, customizable user privileges, dedicated wallets for every participant and of course making sure the platform is fully licensed and regulated. Institutions are slowly realizing that there should be some allocation to digital assets. The allocated percentage can be adjusted based on the deemed riskiness of the asset, but its low correlation to the equities market makes it useful for diversification.

TM: Can you discuss some of the market structure idiosyncrasies in the digital asset world? 

Woodford: In the digital asset world, the concept of asset ownership is very unique. You own the asset if you hold the private key or keys. It is similar to a bearer asset. A lot more responsibility falls onto the exchange and the trader to safeguard the assets as there are no other middlemen or recordkeepers.

The same asset trades with different tick sizes and at different prices and executing at the best bid or offer is the responsibility of the trader – not too different from the early ECN days.

TM: Is trade surveillance a big topic like it is in equities? If so, why and in what areas?   

Woodford: Surveillance is a hugely important topic for us at Seed CX. We have a team of surveillance professionals who are experienced from having worked in other markets: our Chief Compliance Officer has both securities and derivatives market surveillance and regulation experience. We also have market surveillance staff who are surveilling the markets and who investigate potential manipulative behavior. This ensures a fair and equal venue for all.

TM: How do you view the digital asset landscape over the next 12 to 18 months?

Woodford: Institutional adoption of digital asset trading will continue to grow in 2019 and beyond, as these kinds of investors become more and more comfortable trading in these venues. I think in many ways, the 2018 Bitcoin slump will actually force the market to mature.

That maturation is exactly what the space needs to attract more institutional investors, whose arrival en masse will improve the market for everyone by increasing liquidity, both directly, via the funds they invest, and indirectly, via the fact of their adoption. Their entry will signal to other traders that the market is stable and trustworthy.

I believe that we will also see a growth in asset-backed tokens. Tokenization has many benefits and I believe its impact will be analogous to the impact of the electronification of markets.

By Shanny Basar

Increased equity volatility in the final quarter of last year led to the highest global trading costs in the previous three years according to research from broker ITG.

Trading in all regions became more expensive, with the exceptions of emerging Europe and Middle East & Africa. ITG said in a report that commissions per share decreased slightly in the US and remained flat for the global traded universe over the same time period.

Andre Nogueira, director, trading analytics at ITG, told Markets Media: “Market conditions from a trading perspective became more difficult in 2018 as compared to 2017, especially towards the end of the year which is exhibited in the increased global transaction costs for the fourth quarter. Additional transaction cost can reduce fund performance so more and more fund managers are investing time in optimising their trading strategies to preserve alpha.”

For Europe ex-UK, the implementation shortfall in the fourth quarter of last year rose 16%, driven by mid-caps, which became 44% more expensive to trade. The implementation shortfall last year for mid-caps in the region rose from 74 basis points in the first quarter of 2018 to 103.9 by the fourth quarter.

In the UK, which experienced volatility and uncertainty due to the country’s departure from the European Union, trading costs rose 36% in the fourth quarter, with large caps rising 47%.

Nogueira added: “The demand for data on trading costs is unprecedented. MiFID II and PRIIPs require asset managers to include transaction costs in key information documents for their funds.”

MiFID II regulations and the Packaged Retail and Insurance-based Investment Products (PRIIPs) regulations both went live in the European Union at the start of 2018.

Commission rates

While trading costs have been rising, ITG found that aggregate global commissions remained flat in the fourth quarter of last year at 4.4 basis points. In contrast commissions fell 13%over 2017 and 7% for full year 2018.

“US and European commissions decreased slightly to 1.7 basis points and 4.8 basis points, respectively,” added ITG. “Asia Pacific ex Japan commissions fell 3%, while emerging Asia commissions remained at 9 basis points. Emerging Europe commissions rose 6%.”

Last month Greenwich Associates said in a report that execution rates on global equity trades declined significantly in 2018 as markets began to feel the impact of MiFID II.

The consultancy added that MiFID II unbundling  of execution commissions and research payments has brought new scrutiny on trade costs, and many asset managers have responded by both negotiating lower commission rates with brokers and increasing their activity in lower-cost electronic trading.

Will Llamas, director and institutional relationship manager at Greenwich Associates, said in a statement: “The decrease in rates, coupled with a global shift from high-touch to electronic trading, lowered weighted all-in blended rates across markets.”

The consultancy concluded that investment managers are actively analyzing their global commission rate structure to identify markets where their cost-per-trade is higher than their peers and this has created a pressing need for reliable data on rates.