Best Execution 10th Anniversary : Lynn Strongin Dodds’ review

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October 17, 2018

Lynn Strongin Dodds looks back at the post-2008 world and how MiFID has altered the landscape.

Long before the financial crisis wreaked havoc on stock markets and investment banks, MiFID I was being hatched in the hallowed halls of the European Commission. It was officially launched in 2007 with the aim to shake up the status quo in the equity landscape. However, as events the following year proved, much more work was needed to be done to corral the worst of the excesses and improve transparency.

MiFID I also did not create the promised single market in investment products and services because the 27 European countries had their own interpretations and moved at their own paces. Moreover, best execution was still seen as a tick-box exercise due to the wording of the directive which only required sellside participants to take all ‘reasonable steps’ to achieve their objective. Equally as riling, but common with all new rules, the process was an expensive exercise. A study published in 2017 by Thomson Reuters showed that it not only cost more than expected but also took longer to bed down, as well as highlighting the need for a flexible business model.

Breaking new ground

Hindsight, of course, is always a wonderful thing and there is no doubt that MiFID I broke new ground in loosening the grip of the dominant stock exchanges. The introduction of MTFs such as BATS, Chi-X and Turquoise was initially dismissed but they soon proved their mettle and steadily chipped away at the market share of the large incumbents.

In fact, a recent report by the European Central Bank (ECB) showed that the share of equities trading on MTFs in Europe increased quickly from 0% of turnover in 2008 to 18% by early 2011. Although primary exchanges still accounted for the lion’s share of exchange-based equity trading in each country – around 60% in 2016 – MTFs comprised the remaining 40% chunk. The irony of course is that they are now back within the stock exchange fold with Chi-X being acquired by the Chicago Board Options Exchange (Cboe) while Turquoise is part of the London Stock Exchange Group.

Dark pool trading also enjoyed a boost, climbing from less than 1% of the volume of equities trading recorded on European exchanges in 2008 to 8% in 2016, according to the ECB report. While some of the initial growth in market share coincided with the emergence of new venues, in later years, the increase was mainly driven by existing venues consolidating liquidity and increasing their market share.

The one new breed of venue that did not take off was the systematic internaliser (SI) regime. Brokers instead opted for the more flexible broker crossing network (BCN) platforms which allowed their clients to interact with their principal flow on an over-the-counter basis.

“If you wind the clock back that far, the concept of equity trading was tied to the national exchanges and one intention of MiFID I was to create competition and allow the creation of pan-European MTFs,” says Adam Toms, CEO Europe of OpenFin. “Electronic liquidity providers arrived and capitalised on the new liquidity landscape. The process has only become more sophisticated with the introduction of smart order routers and more complex execution algorithms, but it has also led to fragmentation and smaller order sizes”

The dispersion of liquidity has been another major challenge. “The removal of the concentration rules under MiFID I was a good thing, in terms of competition, but one of the unintended consequences was the fragmentation of the liquidity,” says Dario Crispini, founder and CEO at Kaizen Reporting and former manager of the transaction monitoring unit of the Financial Service Authority between 2001 to 2010. “As the market evolved, this led to more complex trading strategies and high frequency traders and algorithmic trading which caused distortions.”

One of the most notable was the infamous ‘flash crash’ which was immortalised in Michael Lewis’ book Flash Boys. The US markets nosedived by 1000 points in record time due to hyperfast, computer-driven trading outfits, which now account for about half of all US equity trading, according to Credit Suisse. They also constitute a substantial chunk of trades – between 20% and 40% – in the European, including UK, market.

The evolving buy and sellside relationship

Not surprisingly, the advent of electronic trading and low touch tools changed the dynamics between the sell and buyside. “The buyside still values the sellside but it is from a different angle,” says Steve Grob, director of group strategy at Fidessa. “The relationship is being driven by technology, so they are still interested in the sellside kit – smart order routers, algos – but also in the wider execution consulting services they can offer. This means someone who is au fait with technology, is on top of compliance issues and can also communicate clearly and in a timely fashion in terms of the different trading options that are available as market conditions change.”

Jeremy Davies, Co-CEO and Co-founder at RSRCHXchange also believes that the sellside will have a role to play in the more complicated trades. “Voice trading will always be used for the larger block trades or the complex multi-leg trades.” He adds, “However, the relationship has changed over the years and it has become more professional. I think both sides appreciate the synergies they can create together. For example, corporate entertainment has virtually disappeared since the global financial crisis and the focus is much more on the services provided and not who took me to the rugby.”

The changes are not only between the two different camps but also within the confines of the buyside. “If you go back a decade, the buyside trader was almost an appendage to the portfolio manager,” says Rebecca Healey, Head of EMEA Market Structure for Liquidnet, “Today, they have a greater role in the investment process before a strategy is implemented. This is mainly due to technology and the evolution from the blunt tool of direct market access to tools that allow a more intelligent way of trading.”

Tom Doris, co-founder and CEO of OTAS Technologies, now a Liquidnet company, echoes these sentiments. “Trading desks were seen as a necessary evil and more of a clerical function,” he adds. “Today, head traders are actively involved in the investment process and are seeking to generate alpha. They have adopted a much more scientific way of trading and are systematically looking to eliminate the sources of friction. One reason is that algos have become more commoditised and the easy stuff does not require human judgement. This leaves them time to make judgement calls and apply risk management to the remaining and more difficult trades.”

The technology boom

While MiFID did have an impact on the buy and sellside connections, it was not the only factor. The credit crunch and ensuing regulation such as Basel III and Dodd Frank have had in many ways a more significant impact on the interactions between the two. The same can be said of technology. The original directive may have led to an increase in the number of cutting edge solutions, algos and services providers but the steady stream of post-financial crisis legislation triggered the fintech revolution.

In terms of MiFID itself, investment banks and exchanges were forced to bolster their infrastructure and enhance their data storage, connectivity and routing technology to comply. For example, the best execution requirement may not have been that stringent but financial institutions still had to store, as well as retrieve, data to attest to their commitment in trying to obtain the best outcomes.

MiFID also fostered strategic alliances such as BOAT, the trade reporting platform, which was created by major investment banks to help firms meet their pre-trade quoting and post-trade reporting obligations. “We have seen more partnerships between fintech and banks because financial services has become much more complicated,” says Healey. “The rules have been broken down by rapid advances in technology and institutions can’t function in the same way as they did in the past.”

“There has been a fundamental change over the past ten years where software and technology take up much greater space in terms of the value that they provide to an organisation,” says Sylvain Thieullent, CEO at Horizon Software. “This is because there is a common agreement that people have to be smarter and much more efficient in the way they trade, invest and collect data. The banks are still struggling with legacy systems but there is more of a strategic focus and long-term approach. They are looking at solutions partnerships that over the next five to ten years are scalable and will meet their requirements.”

The next chapter

MiFID II of course. “When it [MiFID I] went live, there was a clause in the directive that said a review would be held in two to three years but it took much longer than that,” says Crispini. “We knew there were gaps, especially in surveillance and transaction reporting. In the intervening ten years the credit crunch happened and that delayed the rewrite because the regulators thought there needed to be a much more comprehensive assessment.”

©BestExecution 2018

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Best Execution 10th Anniversary : Richard Balarkas on Best Execution

By

Ian Rycott

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October 17, 2018

Richard Balarkas advocates lighter touch regulation as the take-away lesson from the last ten years.

Richard Balarkas is considered a leading pioneer in electronic trading and the development of market structure, and now acts as an independent advisor and board director. Previously Richard held a number of senior global positions within leading brokerages, investment banks and exchanges, including CEO of Instinet Europe, Global Head of Electronic Trading at Credit Suisse, COO for trading at BZW, CEO of the City Group for Smaller Companies, and Head of National Market Development at the London Stock Exchange. In 2005 Richard was elected by his industry peers to serve as Co-Chair of the FPL Global Steering Committee, the organisation responsible for setting industry standards for electronic trading.

“Like pornography, best execution is incredibly difficult to define, but I know it when I see it”. These were the opening words of a short speech given in 2007 by Simon Thompson who was then global head of trading at BGI. While it is memorable for the comedic effect caused by the candour of the delivery, he was making a more insightful and serious point than many realised. Simon was borrowing from one of the most notable US Supreme Court rulings in history when, in a 1964 obscenity trial, Justice Potter Stewart carefully avoided the inherent risks associated with providing an ever more prescriptive definition of obscenity. Instead he based his ruling on the basis that “I know it when I see it”.

“I know it when I see it” is not however a response that will generate brownie points for any trader being interrogated by regulators, management or clients on how to evaluate execution quality. Regulators especially cannot be expected to trust the market as a whole, despite the fact that industry leaders have always worked to much higher self-imposed standards than those in the rule book. Instead they are prone to “Behavioural regulation”, a term I use to describe the misguided belief that more rules equals a better, safer market. The expansion of the FCA rule book in the years leading up to 2008 did not avert the next financial crisis nor the LIBOR scandal, and the prescriptive best execution rules introduced by the SEC actually created one.

Had the SEC followed Justice Potter’s lead the US taxpayer could have been spared both the expense and trauma of the so-called flash crash, as its root cause was the SEC’s policy of prescribing best execution, in particular the stipulation in RegNMS that US exchanges that do not have the best bid or offer should route orders to other exchanges that do. Add this ingredient to a recipe that includes outrageous “stub quote” or snake in the grass orders but is absent market circuit breakers, and a liquidity shock could leave lucky buyers and not so lucky sellers getting best execution at a fraction of the value of the “real” stock price. The flash crash was not a black swan event as it was so easily predictable.

Given the tendency of ethical standards in the financial sector to vaporise far more frequently than a trillion-dollar flash crash, one can forgive regulators for being prescriptive, but by being prescriptive the SEC did more than create a volatile market structure, it distorted competition between exchanges, and almost eradicated competition between brokers to achieve best execution.

The answer to best execution lies not in prescriptive rules, but in having an effective competition policy which allows for diversity amongst service providers, and which allows consumers to act as discerning buyers. Unfortunately competition policy has not been on the agenda of most regulators until fairly recently, and as a result the market has for decades been systemically anti-competitive.

In Europe regulators have been slowly moving in the right direction. With the advent of MiFID I, best execution came to be regarded more as a process than the attainment of the ‘Holy Grail’ of prices. Service providers are required to define their policy, and in theory end users should be able to choose from a menu of execution service offerings ranging from haute cuisine to everything you can eat for a fixed price. It sounds like it should be good for competition, but it only works if the competitive environment is healthy, which it was not.

Until January 2018 nearly all buyside traders in Europe were fundamentally compromised in their ability to achieve best execution by systemic conflicts of interest caused by the bundling of payments into trading commissions. Buyside traders could not act as discerning buyers of brokers’ execution services as they were the conduit by which their firms paid brokers for research, corporate access, and interesting conversations. (My suspicions about this bundled commission malarkey were first aroused when I received votes for having ‘interesting conversations’ with a client. I soon discovered these votes were IOU’s written in disappearing ink and no basis on which to try and run a business.)

Exchange competition was also sub-optimal. In late Spring 2008 the first edition of Best Execution magazine sported a picture of Peter Randall of Chi-X fame. The successful entry of Chi-X into the exchange space was taken as one of the main indicators that MiFID had been a success, especially from a competition perspective. I maintain Chi-X was a success despite MiFID, not because of it. Some major brokers took years to connect to Chi-X, most notably those who had stakes in competitors such as Turquoise, and it is still the case that the majority of brokers providing execution services in Europe have not connected to all the new major liquidity pools. Such blatant negligence however, does not appear to have affected the ability of those brokers to maintain market share.

The best thing European regulators have done for execution quality is to consign bundled commissions to history with MiFID II. Gone are the days when clients would not trade with a broker because a) you charge too little and I need to pay other bills, b) your research sucks, c) to do so would make them ‘unprofitable’, etc. Unbundling tackles the distortions caused by conflicts of interest and improves the competitive environment for sellside execution services. Selling broker execution services in a post MiFID II world must be so easy!

Given the litany of fines in recent years for execution related misdemeanours it is perhaps too much to hope that the sellside has changed completely. MiFID II still allows for plenty of dubious interpretations of what constitutes an appropriate execution policy, and as the largest piece of regulation ever drafted to protect the public from the avarice of financial services it is bewildering that spot FX is not deemed to be a financial transaction and therefore excluded.

Nevertheless my hope is that, at least in Europe, competition policy and market policy are now better aligned such that if firms fail to deliver quality execution services we will see their clients react before a regulator steps in. There are no more excuses; firms who cannot deliver quality services should go out of business. In future if any regulatory action has to be taken against a firm for failure to deliver best execution it will be a sad indictment of the market as a whole.

©BestExecution 2018

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Best Execution 10th Anniversary : Rob Boardman on the last decade

By

Ian Rycott

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October 17, 2018

Rob Boardman, CEO EMEA at agency broker ITG offers his account of the impact of the global financial crisis and Lehman Brothers’ bankruptcy on the markets both then and today.

Casting back ten years, what do you recall about the collapse of Lehman. Were you surprised they let the bank fall?

What’s amazing is that nobody really knew what was happening, from Hank Paulson at the US Treasury, to the man on Main Street, there was really very little precedent. The whole financial system was threatened and we didn’t know who the casualties were going to be. There was no playbook so no-one could predict individual events, creating a great level of fear. That is a situation I hope will never be repeated.

It exposed weaknesses in the system that many people were not aware of. Supervision of banks. Capital levels. The nature of securitisation of instruments. The amount of collateral that was put up. The limited diligence of counterparties. The amount of fear and uncertainty firms experienced set up the subsequent response in which there was an effort to restore order and structure.

At the time of the crisis, I had just arrived at ITG, and I have to say it was a great time to have a flat book, which we had being an agency broker.

What lessons have we learnt since and still need to learn?

In the derivatives space, the action to introduce mandatory clearing was one of the steps which I would applaud. There are still a few loopholes but generally that has improved. The Pittsburgh G20 Summit in 2009 was the key meeting for identifying weaknesses in the system.

There were also elements of overreach, such as looking at the equity market at certain points. But it was such a scary ride it was natural that regulators had to look at everything.

Markets fell, there were recessions around the world. It did tremendous damage, with significant job losses on Main Street as well as Wall Street. That really continued until 2013 when things started getting back to normal.

That was followed by events which Michael Lewis’s ‘Flash Boys’ book raised, around market structure and relationships, which again led to questions about what the regulators knew, it came close to accusing people of misleading clients.

Although the crisis had been macroprudential in origin, following it we saw things like the remuneration code, and transactions taxes in some countries. There were other knock-on effects that have changed the way people engage with the markets.

In addition, capital adequacy rules have impacted the willingness of banks to carry risk.

How has the buy and sellside relationship changed?

The crisis led to a tidying up of compliance on both sides, particularly around conflicts of interest. So much so that some buyside professionals are now wary about being bought a cup of coffee. It is a bit of a shame that it has reached that point, although I can understand what sits behind that; persistent conflicts of interest had to be addressed.

What brokers and asset managers say to their clients is under a lot of scrutiny. Brokers have been fined for misrepresentation to their clients. Communications have to be recorded, and auditable, whilst on the buyside transparency to end investors has increased considerably. For example, disclosure under the packaged retail investment products (PRIIPs), Key Information Documents (KIDs) and the new Markets in Financial Instruments Directive (MiFID II) involves a lot of reporting to clients, and regulators.

Overall, there is not only more reporting, but also checks on compliance, in step with the three-lines-of-defence model for risk management.

The days of people just trusting each other are gone. Personally I feel that it’s lamentable that the days of ‘My word is my bond’, the motto of the London Stock Exchange, have passed. That means that trust is still needed, but its nature has changed.

How has technology changed the industry but where do you also need the human touch?

You always had to assess both the technology and the people you were trusting, but the increased automation of trading, through the use of trading algorithms, the use of execution management systems, means that you not only need to trust your contacts at your counterpart, you need to test the systems at that company in order to trust them, and you need to quantify their performance.

The reputation of individuals was more important 20 years ago. Now, the trust you put in a firm’s product platforms, results from transaction cost analysis (TCA) and the quality of execution you get. Of course commission rates are much more competitive nowadays and quality of service is interpreted differently if it is electronic.

We estimate more than half of commissions are now paid for electronic trading, so by its nature it is a different type of coverage that firms are receiving and getting paid to provide. Although some of these changes were not triggered by the financial crisis, many of these technological and regulatory changes were happening at the same time – such as MiFID I in 2007 – and so they cannot be separated. Together they have created a very different way of working for people.

There are predictions given the high level of personal and public debt that another crisis could happen. Do you think this is the case and if so are we better prepared?

In the prudential sense we are better prepared. A historian of capital markets will tell you we never have the same crisis twice. People don’t make the same mistake, but somebody will make a different mistake. It could be a commodities crash or emerging markets could dive again. Political risk has been going up the agenda, or there might be a sovereign risk.

Trade disputes are also seen by some analysts as a risk. So however well prepared we are for the last crisis, it is never quite the same problem that comes up next time.

©BestExecution 2018

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Best Execution 10th Anniversary : Carl James, Christophe Roupie & Lee Sanders on bonds

By

Ian Rycott

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October 17, 2018

Best Execution spoke to Carl James, Global Head of Fixed Income Trading at Pictet Asset Management, Christophe Roupie, Head of Europe and Asia at leading electronic trading platform MarketAxess, and Lee Sanders, Head of Execution at AXA Investment Managers about the evolution of fixed income trading over the last decade.

How has the landscape changed over the last ten years?

Lee Sanders: Since the global financial crisis (GFC) there has been a massive focus on execution, given the inventory rebalancing and balance sheet reduction we saw. Technology has helped us to face up to those challenges along with a more forensic use of our data.

Christophe Roupie: One of the greatest challenges on the fixed income market has been the warehousing of risk. As a result of reduced sellside balance sheet, the immediacy of liquidity has faded. Before the global financial crisis, the buyside could approach a bank and get liquidity at almost any time – but not at any price – and that relationship has changed. The second impact has been the use of data throughout the trading workflow. Both the pre-trade and post-trade analysis of the market and of trading performance relies on quality data. Some firms have been able to feed data into the trade lifecycle for price formation and better understand the impact of their activity on market liquidity.

What have been your most significant challenges and/or successes over this period?

Carl James: The most significant challenge has been to ensure that we adapt and evolve. The skills required for a buyside dealer have changed, and will continue to do so. Regulation, technology, and economic reality are the three main pillars of change and of the three, regulation has had the most impact on a day-to-day basis. It is a natural step in a maturing industry, and has raised standards. Technology will be the pillar that, on a longer-term basis will absolutely disrupt the industry.

Lee Sanders: Making sure we get the job done with the best possible outcome for the client has been key, and the regulatory back drop, although onerous at times, has emphasised the importance of being able to demonstrate that. We have grown our business and stayed efficient in offering solutions to our fund managers and customers, and we have better metrics to demonstrate that now compared to where we were 10 years ago; that’s very positive.

What have been the lessons for the buyside?

Lee Sanders: I think to open your mind to alternative ways of execution and not to be complacent in your execution style. Market structure changes, and we are now in a multiple-optionality world and traders need to analyse and consider all the options available to them.

Christophe Roupie: From my previous experience on the buyside, I would say the need for trading desks to redefine their space in the investment cycle. They need to justify the value-add of their process when it comes to best execution and the quality of liquidity management, both of which are on the radar of the regulators. There is now more focus on the execution part of the investment lifecycle and how buyside trading desks can add value through more rigorous pre- and post-trade analytics. This benefits the performance of the funds and ultimately end-investors.

Carl James: Regulation and technology has allowed the buyside to take more ownership and responsibility. Refreshingly, the buyside can now drive their own destiny, with regulation driving market infrastructure change. Technology is becoming cheaper and more functionally rich.

How has trading evolved across electronic and voice?

Christophe Roupie: We have seen more adoption of low-touch auto-execution solutions, giving trading desks the ability to trade more efficiently and allowing sellside firms to better utilise their balance sheet.

The high-touch business is also evolving as buyside traders want to focus more on adding value, either with allocating time to more complex transactions in less liquid securities or in some cases managing bigger trades. The willingness and ability of the buyside to redesign their trading model has driven some of the most recent market structure changes, especially the availability of actionable pre-trade content, technology adoption and liquidity provision.

One key aspect of the buyside’s ability to tap into alternative liquidity sources is through our all-to all marketplace, Open Trading. Buyside trading desks will continue to rely on traditional liquidity being provided by banks but they are increasingly providing liquidity themselves, which gives an instant edge to Open Trading participants.

Lee Sanders: We are definitely big advocates of the tech and e-trading world and appreciate the work put in to connect us to the market. [That connectivity] also allows us more time to use our relationships to get access to balance sheet for larger trades.

Carl James: Adoption of electronic trading has accelerated. Regulation has demanded a higher hurdle for best execution, and this has had a knock-on effect. Banks now hold far fewer bonds, this means the buyside have had to adopt different trading strategies for different parts of fixed income in varying market conditions. This has forced innovation. The increasing availability of data is a game-changer for the industry and will continue to drive change.

What is the potential of AI and machine learning?

Christophe Roupie: Trading desks are generating and ingesting a lot of data, which also needs cleansing. Looking at the data and evaluating its quality has historically not been done by the buyside trading desk; time and resources – either human or financial – have not been there. Data management requires skill, time and money. The buyside is developing a stronger ability to manage pre- and post-trade information and is thus becoming more comfortable with providing liquidity.

AI and machine learning are contributing toward the automation of trading workflows for both the buy- and sellside. The sellside are likely better equipped to automate some of their processes, evidenced by the growing amount of auto-quoting we have seen on the MarketAxess trading platform. This is generating liquidity for orders up to a certain size that does not rely on any human intervention, ultimately creating more efficiency and capacity for the trading desk.

What do you see as the key challenges and key opportunities in the years ahead?

Christophe Roupie: Technology by its nature is constantly evolving and there’s considerable opportunity in leveraging it to improve how we function and interact. The increased use of artificial intelligence and machine learning is redefining the way the financial markets operate – the processing of data and signals using complex and powerful algorithms in fixed income markets is driving the new normal. Implementing technology takes planning and a clear vision, particularly in an age of invasive cyber risk, but can help you stay ahead.

Do you think there will be another crisis and if so what might be the likely triggers?

Lee Sanders: I hope not, but I read more and more about it – we are in a cycle and fixed income is an asset class that is affected by that, but I doubt I will ever see a liquidity crisis like 2008 again.

©BestExecution 2018

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Best Execution 10th Anniversary : Alasdair Haynes on delivering change

By

Ian Rycott

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October 17, 2018

Having led from the front in many innovative market developments, Alasdair Haynes, CEO of Aquis Exchange reveals the keys to delivering change in capital markets.

You have helped to drive three new concepts to fruition in European capital markets: the crossing network / dark pool with ITG POSIT; the maker-taker model MTF with Chi-X Europe; and the subscription model of platform via Aquis. What effect does innovation have on trading?

Consider the way that technology has been used to try and make sport fairer, whether via the Hawk-Eye in tennis, TMO in and rugby, or the VAR in football. There is always resistance when the idea is first proposed. There are always players who think that they might like to have influence over the umpire, and they will resist change. However the end result for both the spectator and the player has been better sport.

In capital markets, whether you are an end investor or a ‘player’ in the sense of market participant, you want to have the capability to execute your decisions as cleanly as possible. That means as free from interference as possible so you can get the best result.

Has the philosophical outlook for buy and sellside firms changed over the last ten years?

The buyside are more empowered now, but where they use that power is still questionable. The senior management regime means that heads of trading desk have that authority and there is just a question of how they use that authority. But there is no doubt in my mind that they must grab that power and use it.

Going further down the chain, the trustees of pension funds have to question what is going on here. Pension holders need to have a market structure that is better and more open. The trouble with our game has always been the series of vested interests and their influence will not go away unless we get transparency. Regulators are right to call for it, but the market absolutely hates change.

Has the dealer side changed philosophically in that time?

Not as much as we would like. There hasn’t been an epiphany moment but we are closer to it now than in the last ten years. People are able to make informed decisions more ably today than in the past. Regulators often consult the people who have an interest in preventing change about the change itself, and so that process must be open for the public to inspect. The market is not a simple thing for the end investor to understand. If you can make it more straightforward then we will have better outcomes. In the same way that rugby – with its very complex set of rules – is better understood now because referees have microphones and their judgement is broadcast to the spectators. The equivalent is needed in our business and it is coming.

What lessons have you learned from your drive to innovate?

I have learned that people do not like change. I have learnt that, no matter what industry you are in, you have to persuade people that the place you are going to is significantly better than the status quo.

Unless they can see the benefit themselves they will not start to change, which is why it is so hard to effect. People have to be walked down a very clear path of why they and their customer will benefit.

If you look at the effect that subscription pricing has achieved – it is quite outstanding. Some 30 years ago it would have cost you US$30m to get music provided by the likes of Spotify, but now you can access it for US$10 a month. Look at Amazon Prime on shopping, Netflix on movies, Sky for television; it hasn’t hit the finance industry yet but it has revolutionised access for all of those other industries.

What we are trying to do here is drive efficiency and cost benefits for the end investor. It took ten years for Netflix to break Blockbuster, and more than ten years for Amazon to break into retail. So at Aquis we know this will take a long time, however I am confident because other industries have made this change and seen the benefit for the customer.

What is needed to overcome the barriers of incumbent, vested interests?

Time, pressure, influence and ultimately patience. To succeed you have to have influence at all levels. To show that something will be better than the status quo you must persuade other people to say that it will. Then you start to see change. That is the pressure and influence. Time is needed because you cannot make things happen overnight – people who think otherwise are disappointed.

You have to be willing to sit there, with the money, to support something as it goes through to the tipping point. Once you reach there things happen very quickly. People recall the Berlin Wall falling, but everything that led to it happened so slowly that it wasn’t even perceived by most of the world until the fall.

What hasn’t changed in the last ten years?

You have to be around for some time before people will trust you. The City relies heavily on trust. You have to earn that.

Have regulators come a long way over that period?

Yes. They come in for a huge amount of criticism and have a hard job. They have to listen to a wide range of opinions to try and move people in the right direction. After policy decisions are made regulators need to find a way to make that work through the application of rules, while at the same time a lot of the very clever lawyers that work in the City look at how they might get around those rules.

Will the political fragmentation that we now see under Brexit and protectionist policies have an impact upon the regulation of the City?

Yes. One dimension is the national competent authority imposing rules, the second dimension is their interpretation of pan-European rules into a national framework and the third dimension is now managing the politics of Brexit. Regulators can enforce policy and rules if they are clear. However, if you have politicians negotiating on those rules when there is no clarity, it becomes incredibly difficult to operate in.

What a company needs is certainty; whether the rules are good or bad for a company it is better for the industry that everyone knows them.

What were the key developments in 2018?

It has been a transformational year so far. Several big name members have joined, our market share is growing strongly and our technology division has clinched some great contracts. However, the biggest milestone was our IPO in June. We are now a PLC and beginning to feel less like a start-up!

©BestExecution 2018

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Best Execution 10th Anniversary : Andy Ross on regulation

By

Ian Rycott

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October 17, 2018

By Andy Ross, CEO, CurveGlobal

The shockwaves of the deepest financial crisis in living memory are still reverberating globally. Ten years on, however, lessons have been learned and we are witnessing a significant shift in market behaviour, driven in large part by the implementation of rigorous new regulation.

Despite understandable complaints from customers about new regulation – higher costs, more cumbersome operations, additional paperwork – one apparent result of new rules is an increase in transparency. This is not just limited to what has been executed but, under the new MiFID II requirement for best execution, it also extends to greater visibility as to how and where business is executed.

It is my belief that all the information needed to comply with new regulatory requirements, as well as the information the new rules generate, will spur innovation. As happened previously in the equities, foreign exchange and fixed income spaces, the best execution standard is spawning more efficient and creative ways to measure and analyse transactions for futures, with new businesses dedicated to providing these services becoming increasingly relevant.

Inevitably, as has happened in other areas, the regulatory requirement for greater transparency – coupled with the innovation that follows – leads to a greater participation in trading overall.

As CEO of a new competitor in the futures space I hear considerable grumbling about the new rules, typically from clearing firms and trading firms. Many, however, don’t mention that execution and clearing costs under the old system were continually rising, which adversely affected the users of futures, including institutional investors.

‘Winner-takes-all’ hurts clients

Put simply, the route to both best execution, as well as greater volume, is not achieved through other venues adopting a winner-takes-all approach but by healthy competition, as is the case in many other areas – especially for over-the-counter (OTC) instruments, such as fixed income and interest rate swaps.

In these cases, no single platform achieves more than 50% of total volume traded; and a choice in platforms has kept pricing competitive, while pre- and post-trade transparency has benefited clients in a controlled but impactful way.

Without competition price quality and best execution usually deteriorates. Put another way, the answer for best price or best liquidity for futures trade execution lies not in users electing to use one venue or another but in their being able to take advantage of all trading platforms that compete against each other and innovate to gain volume.

In the futures market, it’s not surprising that other platforms seek to maintain their flow. Unlike virtually all other major financial sectors, the futures space has remained relatively unchanged for decades. Renewed competition promulgated by new venues will promote competitive pricing, more transparency and client-driven innovation. New entrants bring fresh approaches to attract order flow. Innovation, therefore, ignites competition and the result is better execution for clients across platforms.

Competition among trading platforms, of course, raises the issue of best execution increasing the complexity of position management. For example, market participants don’t want to open a position on one exchange if that trade would close out an existing position on another exchange. Of course, two positions can be held until expiry, and the maths to determine whether that makes sense is relatively easy. But if the costs of maintaining the two positions are too high, one could argue that it would be less expensive to consolidate the trades through a single trading venue.

A better solution is to use the innovative tools that have been spurred, at least in part, by regulation, to take advantage of customer choice. The technological tools to manage marketplace choices – combined order books, price checking and position management, for example – are available in Smart Order Routers built into in-house systems and, perhaps more importantly, from a number of software vendors (see Fig 1).

Benchmark innovation

In the wake of the LIBOR scandal, benchmark reference rates have come under intense scrutiny. Regulators globally are striving to improve their resilience and effectiveness, restore credibility and ultimately meet the needs of users in the interest rate futures markets.

The focus on benchmark reform is proving to be another significant driver of competitive innovation. In the UK, for example, there has been growing endorsement and adoption by market participants of the Bank of England’s reformed Sterling Over Night Index Average (SONIA*), an alternative, risk-free rate that is set to replace LIBOR by the end of 2021.

This has generated significant interest in SONIA futures, and in the swaps market there has been over 100% growth (year to date) on LCH-cleared GBP swaps with a SONIA underlying rate to more than GBP 32 trillion notional outstanding (as of August 2018). This marks a fundamental shift in the market and highlights a growing trend over the past decade for increased clearing of OTC derivatives.

Early adoption of the SONIA benchmark will help reduce any potential instability when LIBOR is changed (or discontinued) after 2021, but the key to a smooth, orderly transition to the new benchmark is the ability to hedge risk effectively. Eliminate the legging risk when trading the futures spread against SONIA, with simultaneous fills in the underlying futures contracts, is one way to do this but participants now also have the choice of trading via exchange or OTC.

And the winner is…

With MiFID II not even a year old, the requirement for best execution is only likely to increase, as the need to analyse multiple pools of liquidity over multiple venues grows. As with anything new, participants often ask themselves whether all the complexity is worth it. If we look at the experience in foreign exchange, T-bonds and equities, it’s clear that the answer is a resounding “yes,” in terms of both economics and the fiduciary duty of investment professionals to their clients.

Change is never easy, but putting customers’ interests should be at the centre of everyone’s efforts – which, in the case of futures, now translates into generating better execution. This leads to the question, can regulation be a spur to greater efficiency and innovation? As a dyed-in-the-wool free-marketeer, it pains me to say that – sometimes – it does.

©BestExecution 2018

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Best Execution 10th Anniversary : Michael Sparkes on TCA

By

Ian Rycott

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October 17, 2018

Michael Sparkes, Director, ITG Analytics looks at how the TCA industry has developed and what the future might hold.

The analysis of equity trading has been around for many years in the form of Transaction Cost Analysis (TCA), although the nature of the analysis and implementation has changed dramatically over the last ten years. Significant developments have been made to help measure and manage increasingly complex trading and execution processes while the scope has broadened from equities to other major asset classes. The result is that the benefits are now appreciated by a far wider audience.

In the intervening years Europe has undergone profound changes in terms of the regulations, market structure, technology or even the human behaviour of the participants. In a number of cases these ingredients have reacted to each other, often with unintended or unexpected consequences.

Financial markets have mirrored numerous other industries in the increased use of electronic systems and increased production of vast amounts of data with considerably better granularity and definition. This has sharply improved the accuracy of analysis for trading, and fostered the development of a broad range of sophisticated decision support tools for traders.

Past performance

Ten years ago some asset managers only reviewed their trading data once a quarter, sending files to a TCA provider for processing sometimes several weeks after the end of the period. The TCA vendor would often process the data and return the results via courier in the form of one or more bound volumes, similar to old-fashioned telephone directories (another relic of a bygone era!). This meant that the client reviewed trading results four or five months after the fact and only had hard copy reports.

In addition to the huge lags in the monitoring process, the data analysed was far less granular than today. There was typically no record of the venues on which the trades occurred, for instance, or any details of the algo strategies employed. In fact algos were only used by a relatively small number of clients and details were lacking with strategies simply labelled as just algos.

While there were pioneers who engaged positively with TCA to understand the drivers of their costs, the interval VWAP or the open, close, high and low for the day were commonly used metrics to demonstrate whether or not a trade achieved a simple definition of best execution. Implementation shortfall benchmarks were used by some but by no means all clients while the cost models did not always take into account market conditions during the trade, which is a fundamental element in assessing the outcome. Similarly, peer‑based comparisons were usually relatively high level, which made it difficult to compare apples to apples.

TCA gains traction

The widespread take-up of analytics by the industry has been surprisingly positive over the last decade. There has been a clear move towards improved measurement and management of trading processes which has led to better cost control and investment performance for the end investor. This has not just been the case in equity trading, but across other asset classes such as FX and Fixed Income thanks to pressure from regulators and clients.

Benchmarking has also become much more sophisticated and is typically centred on Implementation Shortfall (essentially the movement in price between the start and end of the order, also known as slippage), often in conjunction with a model of expected costs for a given order and strategy combination. The use of algos is now prevalent in equity markets and is growing in FX trading as well. The precise measurement of the performance of these strategies is a core element in contemporary TCA.

These days, most firms use electronic Order Management Systems or Execution Management Systems (OMSs and EMSs) to facilitate their trading. Together they provide the data that is accelerating the proliferation of analysis. This includes a range of FIX tags that provide greater colour and insight than ever before. Which venue? Which algo? Which strategy?

All can now be monitored closely, and fine-tuned to obtain better results. Timestamps are often calibrated down to the millisecond, and with each fill of an algo being recorded there can be hundreds if not thousands of separate records for a single order. That can mean millions of rows of data per annum to be processed and analysed for one trading desk.

The concept of best execution has moved on from simply observing whether the price was the best available at a point in time to a more holistic view of the investment process. In many cases it starts upstream in portfolio construction, stock selection and manager timing, flowing through into the strategy selected for the execution process. Once the order has been completed many clients also look to see if there is any reversion in the price potentially implying excessive impact either at the granular fill level or at the level of the overall trade. The way an order is traded should reflect other aspects of the investment process such as market conditions in order to capture as much alpha as possible.

Other asset classes

While equity TCA and its usage has rapidly advanced over the years, the analysis of FX and Fixed Income is still catching up. The well-publicised issues with custodial bank law suits and scandals surrounding trading irregularities on the WM/R Fix and LIBOR have sharply focused minds. The challenges for TCA though are far greater in these markets which have traditionally traded over the counter. Obtaining comprehensive market data has been virtually impossible historically but a combination of increased electronic trading and enhanced post-trade reporting requirements are changing the dynamics.

The increased use of Electronic Communications Networks (ECNs) in FX trading has helped considerably as far as clean and accurate data is concerned. However, the variety of trade types and strategies, including forward trades, swaps, non-deliverable forwards, fixing trades, hedging strategies and so on means that the inputs have to be varied and applied with care to assess the client’s activities correctly. Despite these challenges the development of TCA in the FX market is now well established and a range of important benchmarks is available, going well beyond a simple mid-price or bid-ask spread at a given point in time.

Fixed income is experiencing the same trends, although the challenges are greater. Not only is there voice trading, often coupled with highly illiquid, infrequently traded instruments, but there are many sub-classes of instrument, each with their own peculiarities. There has been an increase in electronic trading in some parts of the fixed income market, and regulators are requiring more post-trade transparency. This is making better data available but it has been a slow process.

Looking ahead

The question of course is what will the next ten years hold for TCA? There are some trends which will undoubtedly continue – better data, more FIX tags, greater granularity, sophisticated models and a more in-depth insight into FX and fixed income markets.

There is likely to be far more joined-up thinking between pre-trade, real time and post trade analysis. The current norm of end-of-day processing coupled with T+1 and quarterly reporting is rapidly becoming outdated. Embedded analytics are seen in most OMS and EMS platforms and these will grow further, almost certainly enhanced by aspects of artificial intelligence to identify and analyse patterns as they develop live in the market. The volumes of data are simply too great to be handled effectively by a human brain.

New technologies are being developed such as the algo wheel approach which aims to further reduce the unintended biases created by human intervention in the selection of counterparties or algo strategies. This further enhances the reliability of the data set, whether looking at one client’s results or across a broader peer group.

Even quarterly peer analysis conducted four times a year may eventually be replaced by something closer to real time, such as a rolling three months that is updated daily, retaining large enough data comparisons for strong statistical significance while introducing much more recent data with which to compare performance. Additionally the ability to analyse one’s own history, and that of a broader peer group, for similar orders in similar market conditions is becoming a key requirement. Questions are being asked as to which algo should I use in current market conditions to minimise cost, or risk, or both? How much confidence do I have in this choice?

Over time, the idea of having separate analysis for each asset class is likely to be replaced by true multi-asset analysis. For example, this could mean looking at the cost of delaying an FX trade for 24 hours or more versus the related trade in an equity or a bond. Currently great effort may be put into shaving a few basis points off the implicit cost of trading an equity position, only for ten times that saving to be given away by an inefficient process for handling the resulting currency trade.

The concept of measuring and managing a trading process through the collection of highly detailed data is here to stay. The same applies to the use of data from previous experience to inform and support decisions regarding future trades. The enormous volumes of data being processed and the rise of the data scientist on the trading desk will also inevitably be an embedded feature. The ways in which an asset manager can enhance their performance and mitigate their risk will vary, but the ability to use TCA and a broad range of analytics to help achieve improved investment performance has never been better. That trend is only likely to accelerate.

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Best Execution 10th Anniversary : Niki Beattie

By

Ian Rycott

-

October 17, 2018

CEO, Market Structure Partners

Can you please tell us about your career journey? Was this the field you had intended to go into?

No – nothing was what I intended. I was definitely one of those people who didn’t know exactly what I wanted to do and it all sort of unfolded along the way. I tried a few different things in between travelling the world before ending up at an investment bank and then worked my way up through different departments. Nonetheless I have very much enjoyed the journey.

Looking back, how have things changed over the past ten years in terms of diversity and career progression and what does the industry need to focus on today?

I think a significant amount has changed for the better. When I look at some of the dialogue I have in the boardroom and also with the staff in the different businesses I am involved in, I have to remind myself how different it was ten years ago. That’s not to say there isn’t room for improvement. I still see some of the same old stuff repeating itself but (and no surprises here) I see that most in companies that are still very male dominated. I think the industry still needs to work from top to bottom on aligning its values with a more diverse population both as customers, suppliers and employees.

What lessons have been learnt and how can senior managers, but in particular middle managers, drive change and retain people?

It’s really a circular thing. When you have a well-balanced and diverse work force, diversity just isn’t an issue in the way that it is in more male dominated places. The conversation in the office is different, how people think is different, the risks and rewards are different and that leads to better decisions and behaviour all around. The big question is how to get that balance and attract a diverse workforce.

It all starts with how people view the firm. Whether on-line or in the office, firms have an image and they need to think about how they present themselves. Often firms think they have done everything they can to attract a more diverse group but people will see through lip service and box ticking very quickly. However, if the values and culture shine through, reflecting an attractive environment for a diverse range of people, then it’s a good start. Obviously having clearly articulated policies that appeal to a diverse group and honouring those policies is also important (i.e. flexible working).

It’s a two-way street as well. There was a time when women were encouraged to think they might be able to have it all. But no one has it all and both men and women will have to make sacrifices and trade-offs with personal life during their working career. Acknowledging that and making sure that both sides feel they are sharing the burden at work and at home is a good thing (for example by also showing men that it’s OK to take paternity leave). These sort of things start to change the thinking of a whole generation.

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Best Execution 10th Anniversary : Pinar Emirdag

By

Ian Rycott

-

October 17, 2018

SVP, Head of Digital Product Development and Innovation, State Street

What was your career journey?

Looking back, I do not think I had a specific field that I intended to go into. I was trained to become a scientist, until I accidentally discovered something called entrepreneurship. It seemed to be the ultimate problem-solving challenge and I sailed into a career in financial services. Early on, I tried to step into positions which did not require me to do the same things that I was doing in physics such as building computational techniques, models, etc. I wanted instead to learn how organisations worked, so I moved to strategy positions. I worked at start ups, large banks, brokers and exchanges, doing a wide range of seemingly random roles. I say seemingly random, as I would like to think they were often driven by a few standard themes; often curiosity around the next big problem, which is then the next business opportunity and I work on it. Somebody told me that entrepreneurship is a tool. I agree with that. To clarify; if the probability of success for a new idea – based on desired risk/reward – is more favourable if executed through setting up a new venture, one should just do that. If it is more favourable at a large organisation, due to an existing market, client base, etc; then work on it. Also, we now can define our own fields. We can be market scientists!

How have things changed and what does the industry need to focus on?

There seems to be more genuine interest in diversity in our industry. I am especially happy to see the emergence of diversity of backgrounds and experiences as popular topics in the recent years. Again, the nature of jobs themselves has been changing. As we use technology for competitive advantage across financial services, interdisciplinary approaches become necessity. Almost no problem is strictly a business or technology problem anymore. New opportunities are created by people and teams which cross the traditional roles and silos. Knowing what we don’t know, looking to connect the dots between different experiences, embracing different ways of thinking, are all the attributes of diversity in action. Our clients, as well as new entrants to our industry are also changing, their preferences are different. We often talk about building ecosystems and end-to-end network opportunities. Diversity is intrinsic to these topics which define not only the future of our industry but also the future of work. Diversity is a competitive advantage in nature; it should be for us as well.

What lessons have been learnt and how can managers drive change and retain people?

Driving change, making an impact and being part of a big vision often attracts cutting edge talent and keeps them focused and motivated. There are fundamental factors that help retain people; such as being empowered, being appreciated, learning and improving, having clear objectives and accountability. As we drive change and create new ways of doing things, it makes sense to implement these factors. We often talk about the importance of collaboration between organisations. Similarly, it makes sense to build teams which collaborate and work well together in addition to hiring stars. We all have strengths and weaknesses, and I would argue that even our weaknesses can be assets for a team that truly complements each other, and help drive unique achievements. I certainly do not claim to have learned all the lessons. I am amazed every day.

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Best Execution 10th Anniversary : Jayne Forbes

By

Ian Rycott

-

October 17, 2018

Independent Consultant and former Deputy Global Head of Trading and Securities Financing at AXA IM

Tell us about your career journey?

I started my career in technology, progressing from developer to product development and ultimately management. I had always focused on finance as an industry, but came into the financial services sector as part of the integration team working on the Deutsche Bank and Bankers Trust merger in 1999. This assignment also thrust me into the securities financing arena.

Was this the field you had intended to go into?

I’m not sure I had set my sights on any particular sector or career path. However, I had always wanted to be part of something where I could add value, deliver and work with amazing people. We are at work for such a large part our lives that we should do our best to make it worthwhile, and for the most part enjoyable. For me though, the most fulfilling aspect is being part of a great team.

How have things changed in terms of diversity and career progression and what does the industry need to focus on today?

I think the situation is regressing not progressing. The financial crisis caused difficulties for the general population and our industry was targeted as being unethical. At the time, it seemed to me that far more women left, or were asked to leave their positions. Maybe the heightened tension of that working environment, coupled with coping with the normal challenges of our careers became too much. Possibly the low numbers of women in the industry to start with meant that any reduction would have a disproportionately large impact.

To counter this the ‘female allocation/quota’ drive began. Lessons on how to progress your career were then promoted, but often to the detriment of our belief that our own ability was enough to succeed.

I often hear that being female puts you at the top of the selection list for promotion and for interviews, but I’m not sure that’s true, and to be honest it shouldn’t be.

Success as a woman was, and still is, hard, and it wasn’t helped by the ramifications of the financial crisis which changed the way we worked. The scrutiny we were under and the reduction of the workforce removed a lot of the team spirit and morale we had once enjoyed, and as managers we needed to focus on this along with the control, transparency and ethical practice. However, this impacted both men and women equally.

What lessons have been learnt and how can senior managers, and in particular middle managers, drive change and retain people?

Balance and understanding. If everyone in management thinks the same way, then we are destined to repeat the mistakes of the past. Managers need to understand that diversity can provide competitive advantage, and is not just a box-ticking or quota-filling exercise. Change is inevitable, and I believe essential, however it needs to be managed with balance and understanding. I am convinced that a more considerate and nurturing environment will help prevent the talent leakage that unconsidered change encourages.

Irrespective of their sex, background or beliefs, colleagues need to feel that they are trusted by, and in return can believe in, their company.

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Lynn Strongin Dodds looks back at the post-2008 world and how MiFID has altered the landscape.

Richard Balarkas advocates lighter touch regulation as the take-away lesson from the last ten years.

Rob Boardman, CEO EMEA at agency broker ITG offers his account of the impact of the global financial crisis and Lehman Brothers’ bankruptcy on the markets both then and today.

Having led from the front in many innovative market developments, Alasdair Haynes, CEO of Aquis Exchange reveals the keys to delivering change in capital markets.

By Andy Ross, CEO, CurveGlobal

Michael Sparkes, Director, ITG Analytics looks at how the TCA industry has developed and what the future might hold.

CEO, Market Structure Partners

SVP, Head of Digital Product Development and Innovation, State Street

Independent Consultant and former Deputy Global Head of Trading and Securities Financing at AXA IM

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