Liquidity Seeking Algorithms: How Can Alpha Expectations Influence Strategy Selection Optimisation?

By

-

February 12, 2017

By Rahul Grover, SVP in Quantitative Strategy, Jefferies and Ben Springett, Managing Director, Electronic and Program Trading, Jefferies

Liquidity seeking algorithms (LSAs), often with an “I would” feature, provide traders with the potential to reduce risk faster than schedule- or participation-based algorithms (SBAs). Faster risk reduction is achieved through the search for outsized short term liquidity which can be accessed at low incremental cost.

The time variance of the size and source of available liquidity increases the complexity of allocation decisions within LSAs. Strategy decisions are more sensitive to factors such as expected alpha (short term) in clients’ flow, average information content in execution venues’ past executions, and the stock’s dislocation from its peers. Below we discuss how the development of customised liquidity seeking strategies is influenced by these elements.

Incorporating Client Alpha
LSAs perform best when they are customised to a client’s short term alpha. Given uncertainties in alpha duration and magnitude, it may take a few iterations to get the appropriate urgency and parameterisation into strategy selection. Clients can often rely on brokers to help estimate their short term alpha.

Brokers can use statistics such as comparison of expected-versus-realized impact, and post-execution reversion to tailor the urgency level. To avoid bias in alpha estimation, analysis should exclude orders where multiple slices are received for the same stock in the same day given the obfuscating impact this would have on the data. This analysis often results in statistically insignificant outcomes for a reasonable proportion of client flow, but when significance can be established analysis is very useful in identifying client flow subsets suitable for further discussions on strategy tuning.

Chart 1 shows how the combination of the magnitude of reversion statistics and their statistical significance can be used to identify subsets of client flow that may benefit from changing urgency levels. Allocation strategies that are tuned to this expected alpha profile can avoid either the unnecessary restraint or an indiscriminate search for liquidity.

Information Content in sourced liquidity
Large block executions provide immediate benefit to orders by significantly lowering residual risk, and therefore avoiding incremental trading cost. These executions come at the hidden cost of potentially missing a better price for some fraction of the filled shares. This hidden cost can be assessed by comparing the performance of strategies with and without access to “blocks”. In addition, proprietary analysis methods can use post-execution price movement to differentiate information content in liquidity sourced from different venues.

For block executions, it’s relevant to use a proportionately long time horizon (post execution) given the alternative to achieving a block execution would involve working the order over an extended period of time. Venues that show a statistically significant improvement in prices after block fills can be restricted for use only by higher urgency orders. Chart 2 shows that for block executions >1% ADV, average return from execution-to-close is within one standard error for most venues. Chart 3 shows that the average cost avoided by block executions is significantly higher than the average return to the close.

Dislocation from industry/sector
Tactical allocation by LSAs to dark pools should take into account a stock’s dislocation to its industry or market. While dislocation itself is not a sufficient factor to change allocation, when it is taken in conjunction with an understanding of expected alpha and the client’s view on dislocation, it can be very useful.

As an example, if a stock is highly correlated with its industry, and the client expectation is that the correlation will persist in the short term, a LSA may underweight a short term allocation for a stock which is unfavourably dislocated. Conversely if the client does not expect the correlation to persist, or if it expects short term alpha, the LSA may continue with a search for outsized liquidity.

Conclusion
The ability to identify expected alpha profiles of trades should serve to enable the implementation process to be more finely tuned, thus reducing implementation costs either in terms of impact incurred or opportunity cost taken. Whilst this has traditionally been the domain only of more predictable quant driven investment strategies, we are increasingly seeing greater attention on trading catalyst and portfolio manager modelling taking place across more diversified trading desks.

Advanced execution brokers are well placed to help clients model profiles and refine order instructions / parameterisation (or to develop bespoke customisations), but only when they have garnered enough data points to draw statistically significant conclusions. The likelihood of one broker having sufficient transparency of the investment strategy origin and trade catalyst for order flow originating from a centralised dealing client is low, and thus the onus is more frequently being passed upstream to the buyside to gather and analyse the relevant datasets.

Broker contribution to the flow optimisation process can then take place as a second phase, seeking to best-fit flow being sent via more standardised algo selections designed to meet the needs of a specific subset of client flow by urgency, ADV (or another measure of difficulty to trade), time of day, etc.

Source of data for all charts is Jefferies trading universe.

We’d love to hear your feedback on this article. Please click here

Multi-Asset Trading: To Specialise Or Not To Specialise?

By

GlobalTrading

-

February 8, 2017

With Fabien Oreve, Global Head of Trading, Candriam Investors Group

In recent years, more and more asset managers have had many good reasons for installing a multi-asset trading desk.

First of all, for reasons of operational efficiency and cost control. Recent improvements in the order and execution management system (OEMS) technology used to handle different asset classes are powerful factors behind operational efficiency and economy of scale. It is, for example, easier to output large numbers of transaction reports when these are generated by a consolidated desk equipped with a multi-asset OEMS.

Another reason is portfolio managers’ growing need to actively invest in a greater variety of instruments, including – globally – listed derivatives and foreign exchange.

Finally, the development of multi-asset execution teams derives from a greater reactivity to the changes brought about by electronic trading. The growing electronification of the markets has enhanced convergence among asset classes as different as bonds, equities and foreign exchange. The growing sophistication of the multi-asset OEMS has enhanced innovation in data consolidation, with pre-trade, trade and post-trade information directly available in the same place, on the same screen, for every large asset class.

The introduction of consolidated trading desks raises questions such as: Is there a standard definition used by everyone for multi-asset trading? Is there a standard trader profile within this new structure? Should this structure be organised at management level only or at trader level? Does the trader have to be a specialist or a generalist?

For some time now, thanks especially to improvements in electronic dealing, specialised fixed income traders have assumed a bigger role in foreign exchange transactions. And it is not uncommon to see equity traders negotiate futures on indices and other highly liquid derivatives.

With a multi-asset OEMS, buy-side traders, regardless of their expertise, gain visibility across all asset classes. It is useful to have one system that is structured into multiple order blotters, and coordinate team efforts to smoothly trade equities, futures and currencies, or bonds, futures and currencies.

A certain level of multi-tasking can help smoothly absorb sudden variations of volumes in a specific asset class. It’s not at all a matter of an equity trader dealing in illiquid bonds or large-size bond orders. However, today the OEMS technology enables traders to filter and select orders by level of difficulty and to delegate the easiest part of the job to less experienced or more generalist colleagues.

Well-documented and internal best-execution procedures regularly updated by the head of the multi-asset desk are also indispensable tools for encouraging less experienced staff to help their more experienced colleagues, while maintaining the same high levels of execution performance.

Becoming multi-skilled in an execution team also limits the risk of weariness in professionals whose main job involves working the same type of instrument day in, day out. Encouraging the multi-skilled, flexible approach also means that the team is not necessarily handicapped by the unscheduled absence of a colleague (for personal reasons, illness, etc.).

Nonetheless, multi-tasking should not take priority over motivation or individual performance. In other words, multi-tasking should not inhibit the accumulation of the expertise that staff need to guarantee certain levels of performance at all times. Such expertise is essential, especially as regards the most challenging asset classes and the least liquid financial instruments.

Fixed-income, in particular corporate bonds and emerging market debt, obviously requires such specialisation and expertise. Equities, too, rely on experience and savoir-faire to deal with large lists of complex orders that require combined electronic and voice trading.

From an organisational point of view, the optimal solution could lie, eventually, in balance. Multi-asset trading desks should have their fair share of specialists capable of handling the major equity and bond asset classes (in particular, the less liquid buckets) and, at the same time, allow its specialists to widen their skill set and promote teamwork on the most liquid markets, with the support, in particular, of the ever-more sophisticated OEMS and trading platforms.

The topics covered in this article were discussed at the Institutional Investor’s International Trader Forum in Rome on September 7th, 2016.

We’d love to hear your feedback on this article. Please click here

Shenzhen-Hong Kong Stock Connect Gives Global Investors Access To China’s New Economy Stocks

By

GlobalTrading

-

February 8, 2017

By Nicholas Ronalds, Managing Director-Equities, ASIFMA with Tamir Abdelwahab, Analyst-Equities, ASIFMA

Investors around the world chafing to invest into some of the more dynamic companies in China’s restricted market are about to get their wish. The Shenzhen Stock Exchange (SZSE) will be added to the existing “Shanghai-Hong Kong Stock Connect” link, giving investors ready access to such Chinese “neweconomy” stocks as Focus Media Information Technology, East Money Information Co., and about 878 other mostly small-cap issues.

(Although the Stock Connect scheme also accommodates Southbound flows enabling Mainland China investors to buy and sell Hong Kong-listed stocks, this article focuses on Northbound flows only, which are more relevant to non-Mainland investors.)

Sophisticated international investors have been able to use other channels to buy into the China story, in particular through the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Institutional Investor (RQFII) programmes, since the early ‘oughts. However, these QFII programmes are restricted to blue-chip institutional investors and have been hemmed in by rules on how much can be invested in which asset class, and more irksome, by restrictions on the timing and amount of repatriation is allowed.

Stock Connect avoids these disadvantages. It allows any investor to buy eligible China A shares, and to sell them any time—subject to the caveat that day-trading is prohibited on Chinese exchanges.

What are the eligible Shenzhen shares? Stocks in the SZSE Component Index and SZSE Small/Mid-Cap Innovation Index with a capitalisation of at least RMB 6 billion ($885 Million) will be eligible. The SZSE Component Index is made up of the Shenzhen exchange’s 500 largest stocks; the SZSE Small/ Mid-Cap Index is composed of small and mid-cap issues including those in the ChiNext Board, which features stocks of China’s most speculative—but presumably also some of the most dynamic and promising—young companies.

There is one restriction on access to these Shenzhen stocks: only institutional “professional” investors will be allowed to buy names on the ChiNext board, at least initially, to safeguard retail investors from exposure to volatile and risky issues. The capitalisation of the 880 stocks in Shenzhen Connect adds up to RMB 15 trillion, nearly threequarters of the exchange’s total capitalization. For comparison, the 567 shares in Shanghai Connect represent a market cap of RMB 21.8 trillion and 85% of the Shanghai Stock Exchange’s (SSE) total market cap. When it comes to trading volume, Shenzhen punches well above its weight, typically trading more in terms of either share volume or share value than the SSE.

Dynamic Young China
The SZSE lists more companies from China’s young, dynamic companies in IT, health care, science and manufacturing. For example, Shanghai lists 30 IT and software companies compared with 150 in Shenzhen. Shanghai has seven companies in scientific and R&D fields, Shenzhen 15. Most of China’s publicly traded media companies are listed in Shenzhen, which also has more than twice as many manufacturing companies—1,272 versus Shanghai’s 599.

Valuations
It’s usually the case that exciting growth companies carry high price tags, and valuations in Shenzhen are no exception. The average price-earnings ratio (PER) of A-shares in Shanghai is a reasonable-looking 15.6; Shenzhen’s is 43. This average conceals quite a range—the 546 Chinext stocks’ PER’s hover at a lofty 78. The flip-side of the valuation story is that fastgrowing companies often have zero earnings because cash flow is being ploughed into growth. Hence, a high PER doesn’t necessarily imply overvaluation. (For comparison, Amazon recently had a PER of 181.) Stock pickers will have good reason to scrutinize Shenzhen stocks and some skilled (and some lucky) investors will doubtless score enviable returns on their picks in the coming months and years.

The A-H Anomaly
In addition, Stock Connect includes all A-shares on the Shanghai and Shenzhen exchanges for which H-shares are trading on the Hong Kong Stock Exchange (HKEX). H-shares are shares of Chinese companies listed in Hong Kong. A subset of H-shares (about 38%) is dual-listed on both the HKEX and one of the Chinese exchanges: there are 70 dual listed Shanghai Exchange H shares and 17 dual listed Shenzhen H shares. A- and H-shares are economically identical in the sense that they represent the same ownership share, voting rights, and receive identical dividends per share.

When Shanghai Stock Connect launched in November 2014, many investors thought arbitragers would use stock connect and on-shore channels to keep A- and H-shares at parity. It turned out to be a badly losing bet. The A-H differential actually increased steadily after the launch and averages around 20% as of end-October, 2016. For example, Zhejiang Shibao, traded at HKD 11.58 in Hong Kong and RMB 43.71 in Shenzhen. Adjusting for the currency difference, the H-share was at an astonishing 77% discount to the A-share—an H share of the same company could be bought at less than a quarter the price. Similarly, Luoyang Glass, an H- share dual-listed in Shanghai and Hong Kong, traded at one-fifth the price of the A-share.

The A-H anomaly has not surprisingly attracted considerable interest from academics and traders. Index manager FTSE has even created an index that seeks to exploit the variation in the A-H differential over time in a modified China A50 index that swaps into the cheaper share, A or H, on pre-determined criteria.

What’s different about Stock Connect?
Stock Connect is a link between exchanges inside and outside China such that orders for Chinese shares (Northbound) have to go through order routing and clearing links from HKEX to Shanghai or Shenzhen via a broker who is a member of the Hong Kong Stock Exchange. The more typical arrangement for customers in one country seeking to trade on an exchange in another country is via their broker’s relationship with a broker in the country of the target exchange, not via a link between the exchanges.

The reason for this “link” mechanism between exchanges rather than the more conventional model is that the Chinese authorities want to create access to China’s equity markets but in a way they can easily supervise and adjust if need be. RMB used to buy stocks through Connect, for example, must be returned in Hong Kong when a stock is sold and can’t be re-used for other purposes in China. Such a “closed loop” for the currency wouldn’t be possible using conventional arrangements.

Fire Your Unprofitable Clients

By

GlobalTrading

-

February 8, 2017

By MDSL

In a market with falling volumes and revenues, it’s important for investment banks to know they’re being billed correctly for their transaction costs and that they are being allocated appropriately. The advent of commission unbundling also points the spotlight on client costs beyond research to ensure you have profitable execution relationships.

Can you be sure you know the costs of dealing with your clients? How much are you paying for non-trading clients? How do you know that EMS, OMS, trading venue and FIX connectivity providers are charging you correctly?

MDSL’s Transaction Reconciliation Reporting (TRR) is an expense management platform for your trading costs, from exchange fees to client connectivity. It ensures you’re being billed correctly and that invoices are allocated to the right clients or desks. Having all this spend in one system gives you a global view across multiple asset classes, which can then be used to make informed business decisions.

Whether we are looking at the multiple trading venues (on and off exchange), network connectivity or the EMS/ OMS providers, they all enjoy finding the most varied ways of charging you for their service. The invoice comes in; the invoice is paid. Questions are seldom asked, and even then only after someone has spent hours within multiple spreadsheets trying to get the information together to check it.

You need a service that will give you confidence that you’re being billed correctly. This shouldn’t tie up your own resources or be outsourced to a costly army of people (increasing opportunities for human error). TRR uses a calculation engine that can predict the invoice amount for each trade placed, for each vendor involved in the process. A solution that simply compares the invoice totals is no longer sufficient, identifying only that there is a difference, (and not why there is a difference), means there is a separate task of analysis that needs to be performed later and manually by another member of staff. TRR can compare the invoice detail against its prediction and provide you with any discrepancies to raise with the vendor. Our red-amber-green reporting makes it easy to focus on the lines of interest, reducing the time taken to review and raise disputes.

The next problem for a financial institution is how they then distribute those costs incurred to the correct desks and clients. This is a task requiring a vast amount of data, and if you’re not including the costs for their transactions, many will appear as profitable when in fact they may have been making a chronic loss. It’s not just external allocations; we frequently hear stories of disgruntled users on desks who have received an even split of a bill (for which nobody can justify if it is seldom used for their desk) or worse yet that the whole invoice has hit their cost centre.

TRR correctly assigns the invoiced amounts to the right clients and area of your business. All the invoicing is allocated at a trade level so that you can easily see how the total is created. Our flexible online reporting portal means that you’re never more than a few clicks away from seeing the cost of a client or desk. These are easily shared to the appropriate audience with live data.

With TRR, you have all this information managed within a database, combined with a powerful reporting portal. Upon entry from various sources, the data goes through our mapping engine to ensure that you’re seeing a normalised data set from the beginning, saving countless hours of file manipulation. Contracts and associated information are also loaded into our role-based portal, so that you can enable the right people to view this information (e.g. an electronic version of a contract). Our alarms mean that you never miss a key contract date again, with customisable emails sent out to contract owners and sourcing teams.

By using TRR, you are using a solution built from our award winning expense management platform, with $7 Billion of spend under management. With commission unbundling either underway or having already taken place at your institution, there has never been a better time to put your execution costs under the microscope and ensure the agreed commission rates are profitable.

Buyer’s Guide: Buyside Multi-asset OEMS — An Evolving Market Landscape

By

Ian Rycott

-

February 7, 2017

Buyer’s Guide: Buyside Multi-asset OEMS — An Evolving Market Landscape

GreySpark Partners presents a report exploring how, in 2017, asset managers, hedge funds, institutional investors and wealth managers are under pressure from regulations and tighter margins to cut operational and technological costs. Regulations, particularly those concerning trade and transaction reporting, that require additional data generation and recording are causing buyside firms to reassess their technology stack and the systems and processes in place. Operating margins and profit margins across the industry continue to remain tight while costs soar as regulatory compliance and digitalisation projects are undertaken.

https://research.greyspark.com/2017/buyers-guide-buyside-multi-asset-oems/

Blog : Expect the unexpected : Lynn Strongin Dodds

By

Lynn Strongin Dodds

-

February 3, 2017

EXPECT THE UNEXPECTED.

Donald Trump has only been in office for two weeks but it feels like years with the number of edicts or executive orders cranked out. Equity markets have cheered and the Dow Jones broke through the all-important 20,000 barrier but within days markets slumped on the controversial immigration ban only to rise again due to healthy employment and economic data.

The question now is whether equity markets will continue on this roller coaster ride for the rest of the year. The so-called Trump effect saw a steady climb with the S&P and Dow ratcheting up 7.25% and 9.61% respectively since the 8 November election. Markets reached these dizzying heights on the promise of deregulation, infrastructure spending and job growth and as these items are systematically being ticked off the list, investors cheered.

However, forbidding certain nationalities to enter the country sparked protests across the US and the world, while the building of a wall with Mexico and the scuppering of major trade deals gave investors pause for thought. All of a sudden the potential reputational damage these policies started to take hold and the retreat began.

The problem perhaps is age old. Markets hate uncertainty and while Trump is delivering on many of his promises, few expected the extent of the backlash. As Ulrich Leuchtmann, analyst at Commerzbank, said: “This is all about the financial markets not approving of hectic, surprising political moves that create chaos. Measures of this kind make the US unattractive as a location for investment and the dollar unattractive as an investment currency. Who knows whether the next presidential decree will not have considerable macroeconomic effects after all?”

However, if history is any guide, trade protectionism is never a good idea. The Smoot-Hawley tariff bill of 1930, which was one of the most criticised pieces of legislation in US history, was blamed by some for not only triggering the Great Depression but also contributing to the start of the Second World War. Although few are predicting a repeat of those dire days, the likely impact is a restriction of consumer choice, higher inflation and prices across the board as well as retaliation by global trading partners.

The global impact may also be significant. Back then, exports of goods and services only accounted for about 5% of US gross domestic product (GDP) but today it is roughly 13%.

Of course it is still early days but if Trump has taught markets anything – it is to expect the unexpected.

Lynn Strongin Dodds

Managing Editor, Best Execution

©BestExecution 2017

[divider_to_top]

Trading In The Primary Markets

By

GlobalTrading

-

February 2, 2017

By Laurent Albert, Global Head of Trading, Natixis Asset Management

What are the most interesting recent trading practice developments in the fixed income primary market?
By way of an example of how things are moving forward, I’d highlight an industry collaborative initiative. Eleven major international banks are sponsoring a new application that will provide comprehensive details about new European primary market deals on a dedicated, centralised website. It will include information on price guidance, the size of the issue and the book and the likely timing of the launch. The intention is to publish the details of around 80% of new European fixed income issues, giving access to both sell-side and buy-side market participants, and is planned to go live by the end of this year.

Although the service does not aim to offer real-time data, it has attracted a lot of interest within the industry because it is important for several reasons.

First, it sets a precedent for the sharing of sensitive information among market participants. Second, it will provide greater transparency beyond the immediate stakeholders. And third, it should facilitate more robust database construction.

The initiative is especially significant now, because at a time when euro-denominated bond issuance volumes have soared, there has been a decline in the fluidity of the book-building process and the visibility of book sizes.

What reforms would you propose to help improve the functioning of the primary market?
There should be a closer correlation between the issue size posted in the book and the actual size that the issuer wants. This requires a greater level of control than at present, which often has a negative impact on the final yield spread and therefore penalises investors.

Are there other deficiencies in the market that need to be remedied?
Poor liquidity in the secondary market is a major challenge. More and more banks are widening their bid-offer spreads, so the growth of a vibrant repo market would be a great help.

The high yield market in particular suffers from both a lack of liquidity and transparency. There is almost zero visibility during the book-building phases of new issues, and the buy-side is unable to benchmark their ultimate allocation against an average allocation.

How can the primary market issue managers help improve secondary market trading?
Banks must be fully involved and engaged in the secondary market, by providing liquidity and competitive prices, especially if they are awarded lead manager mandates for primary market deals.

Who is best qualified to resolve these problems, the regulators of market participants themselves?
The over-arching regulation underway will actually lead to a reassessment of the regulatory approach and perhaps even a reduction in the focus on topdown prescriptions. The industry and its commercial participants must resolve the key issues themselves, and enhance market efficiency, liquidity and transparency by exercising better discipline.

We’d love to hear your feedback on this article. Please click here

Nordics Briefing Review 2016

By

GlobalTrading

-

February 2, 2017

By Tim Healy, Global Marketing And Communications Manager, FIX Trading Community

Although the 2016 Nordics Briefing changed its usual venue and time of year, attendance was at a record for the day. The sessions provided thought-provoking comments and analysis with regulation very much at the heart of the discussions. The uncertainty that continues to overshadow the markets was clear and it was interesting to hear about particpants called the unintended consequences of more regulation.

There was undoubtedly a general feeling that the cost base for investment firms would rise as sytems are upgraded to comply with regulatory requirements. As it becomes more expensive to do business, there were also concerns that the trading community might shrink.

However, there was a difference of opinion evident in several of the sessions, with some participants confident that rising regulation will actually present opportunities. As the saying goes “one man’s meat is another man’s poison.”

It was particularly interesting to hear the buy-side’s perspective on increased regulatory measures and the direct impact that they will likely have on their businesses. For instance, best execution under MiFID II is a major undertaking for the buy-side and especially, it was noted, for their fixed income operations. However, the sanguine view was that successful compliance would be an affirmation of the independence of their trading desks and their ability to seek and discover the best execution for their clients.

In the afternoon session, the conference separated into two streams, with one focussing on non-equity issues in general and on blockchain in particular, while the other concentrated in more detail on the effects of new regulatory measures.

The overriding theme for the day was collaboration. Cooperative action is essential and FIX provides that perfect platform to examine guidelines and recommend the best practices for the whole industry to implement.

The Nordics region has a long history of fintech innovation. Recently there has been consolidation in the region, as there has been across the globe and that trend will likely continue. However, it was interesting to hear how important crowd funding has become to the region for fintech and, how it will perhaps supplement the role of banks.

Julia Streets, founder and CEO, Streets Consulting chaired the FIX Nordics panel on “Market Innovations”. She offered some forthright views about the fintech industry, providing a circumspect opinion to counter the hyperbole that often surrounds discussions about its disruptive impact:

“Fintech is not a new phenomenon. If it is, I have to ask what have I been doing with my time? Decades ago, fintech was born in the capital markets: electronic trading, algorithms, ultra-low latency connectivity, FPGA processing, market data handling. I can – and do – go on.

Like it or not, every response to ‘what’s new?’, must give a nod to blockchain, named by many as the technology to deliver huge efficiencies, and participants and commentators alike are keen to see real-use cases emerge. Some claim wholesale CCP reform is inevitable, others counter that in the quest for real-time settlement the extent of industry participant evolution may be prohibitive. We may have some distance to travel to reach post-trade utopia, however blockchain hands do not rest idly and we’ve seen private share market and share registrar services come to market and some predict that custody is ripe for blockchainification.”

We’d love to hear your feedback on this article. Please click here

Governance, Standardisation Driving Securities’ Blockchains

By

GlobalTrading

-

January 25, 2017

A roundtable write-up by Will Haskins, GlobalTrading

As discussion of blockchain continues to generate media coverage, the securities industry waits for the promised benefits. But the wait might not be long.

Like it or not, blockchain technology is associated with its most public iteration, Bitcoin. Yet, the hallmarks of bitcoin’s appeal – transparency, decentralisation – are seen as antithetical to much of the securities world.

Successful applications of blockchain technology in the securities industry will likely be a shared ledger rather than a fully public ledger, marrying the immutability and simultaneous auditability, but without the public transparency.

Speaking at a GlobalTrading Blockchain and Securities Industry Roundtable hosted by Citi and sponsored by Serisys, participants agreed that within 10 years, there may be hundreds or thousands of securities industry blockchains, but the real question is which will each firm join?

The significance of the answer stems from the enormous cost savings projected to come from distributed ledger technologies, as blockchain is also known, with Banco Santander estimating savings at up to US$20 billion across the securities industry.

Proprietary
2016 has seen a focus on development of proprietary and consortium blockchain applications. While many firms are already involved, participants questioned whether Asia’s heads of trading or their back-office teams know which consortia their companies belong to, or their firm’s strategy for blockchain.

Banks have hedged their bets by actively joining multiple consortia, but the major work to be done in applying blockchain to the securities industry is in the adjoining applications rather than the actual blockchain technology. Despite the offer of real-time, shared access to information, it is unclear whether banks will be willing to change all of those adjoining systems.

As a result, most banks are currently investing in exploratory use cases. Rather than reframing all back-office processes along the lines of a blockchain, certain participants hope to use blockchain to address existing regulatory costs. When adoption does achieve critical mass around any certain application, one of the likely effects in the securities industry is that securities processing revenues will shrink. Within Asia, a China-specific consortium is looking at blockchain, but the domestic Chinese banks are not discussing it internally. For the Chinese banks, deployment of any blockchain applications will require an official push from the China Banking Regulatory Commission or China Securities Regulatory Commission. Meanwhile, the international Chinese firms are exploring use cases, but many expressed it is unclear what problem desperately needs to be solved by blockchain. Chinese firms are also concerned how much will it cost to realise the purported benefits?

Governance and standardisation
A key piece to keeping implementation costs low is standardisation. Already the exploratory work has revealed intriguing questions about blockchain applications. If a blockchain controls an asset, who determines who is allowed to convert into and out of the blockchain? What happens to the cash that is exchanged for the original asset?

Peer oversight is needed to ease concerns about decision-making on these matters, and the regulators agree. Regulators know governance is required, as they need to certify the identity of the beneficial owner to conduct proper AML checks, but they are agnostic as to whether governance will come from individual consortia or at a global level. A helpful example of how standardisation can expand the value of a blockchain technology is a KYC blockchain utility, based on certified information.

All participants agreed, the overriding, continuing question in the securities industry will always be how to establish trust and with whom.

We’d love to hear your feedback on this article. Please click here

Key To The Highway: The Changing Face of High And Low Touch Execution

By

GlobalTrading

-

January 25, 2017

By Steve Grob, Group Strategy Director, Fidessa

In the beginning, there was high touch where brokers provided a high-value, solution-based approach to finding the liquidity their buy-side clients were looking for. This worked in an era of high fees and low scrutiny of what end-investor trading commissions were actually funding.

However, as markets electronified, and buy-side operations tooled up, a new paradigm was born: low touch. This reflected the buy-side’s growing desire for cheaper execution, especially for trades that weren’t that hard to execute, and it also offered a path that minimised information leakage.

The result? Two routes to market with very different price tags. The problem was that brokers had to duplicate their trading infrastructure despite receiving fewer net commission dollars. This spawned the short-lived concept of mid touch which offered the worst of both worlds: junior sales traders with neither the experience nor the expertise to manage either. And so the industry muddled along ignoring the operational overhead of running two technology stacks.

Today, however, the industry is at a cross-roads. Regulation, combined with the global economic environment, means that the idea of providing separate high and low touch channels is more flawed than ever.

A radical new approach is needed. One that converges technology stacks where appropriate and equips brokers to provide a blended service of premium (high touch) and standard (low touch) services. Most important is that they can be provided to the buy-side in such a way that they switch seamlessly between the two, across the day and throughout the lifecycle of each individual order.

Hellhound on my trail
The determination by regulators to increase transparency and accountability remains unbowed. The most recent example is the European move to unbundle the relationship between research provision and trading execution fees. Soon investment managers will be forced to either pay for research out of their own P&L or ensure that execution commission payments are clearly not to the detriment of their end investors.

The flip side of this regulatory coin will be a renewed focus on execution outcomes and so providing the optimum combination of high and low touch services will be more important than ever. On top of this, the regulators are doubling down on their requirements over the transparency of the buy/sell-side relationship which means further costs to keep both high and low touch platforms in line.

And it’s not as if finding liquidity is getting any easier, especially when firms wish to trade in size. As a result, a number of initiatives such as intraday auctions and block crossing capabilities have all aimed to orchestrate the liquidity available, but because they compete the resulting cacophony just makes matters worse.

Change my way
The good news is that the buy-side is willing to pay to resolve this complexity, but it requires a completely different approach from the traditional high/low touch separation of old. The fragmented nature of equities trading means that even a relatively low touch order in a liquid stock needs to visit tens of venues in order to be properly executed. Low touch platforms therefore need to stretch across many different venues. The challenge to create a single market access fabric is considerable. Furthermore, sophisticated low touch algorithms are needed to nullify the effects of this fragmentation and provide good execution outcomes for clients.

Today’s high touch trader needs a range of technology too. This might be dark-seeking algos, smart routing or CRM systems that track who is holding or likely to be holding liquidity. The high touch desk will often look at the automation and tools employed by low touch or program trading teams for inspiration, and, in some cases, borrow their technology directly.

So while the activities and business models of high and low touch are diverging the underlying technologies are converging. This requires careful management to avoid unnecessary duplication and cost while optimising the very different business service a high or low touch client receives. This then allows a standard (low touch) and premium (high touch) service to coexist and be interlinked. If architected correctly, the separation between these two can be viewed as a permeable membrane though which orders can travel in either direction, at the client’s discretion, with a higher fee charged whenever the order is in the high touch/premium zone.

Smokestack lightning
It is a simple fact that low touch service lines were established after high touch ones and so made the creation of a second whole new technology stack inevitable. This led to a new set of market gateways, a super-lite OMS that could support low touch algos and a FIX interface for receiving client order flow. But, by then, the high touch desk was receiving the bulk of their orders electronically too and, of course, sending them out to market the same way.

The sensible approach, then, is to collapse all the technology supporting both business lines together. This allows more effort to be put into market and asset class coverage, performance, speed and resilience – benefitting both high and low touch service lines. It is something that can be extended to other desks too, such as program trading, and even between asset classes or completely separate business units.

Cross cut saw
The premium zone is where the real differentiating technology can be found, but because it is now sitting on a converged stack its operational costs are much lower. This frees up resource to deploy cool, high touch tools that can quickly solve any liquidity problem.

Intelligent IOIs are one way to do this, but only if they can be underwritten by genuine merchandise. Another will be pulling together all the information held within a firm about a particular stock. Other decision support tools will all form part of a more sophisticated, but above all technology-fuelled, high touch service.

This allows for some intriguing approaches to solving trading problems for clients. One example is that an investment manager may be using a low touch channel for an order so as to minimise its execution cost. It may be, however, that a smart IOI has uncovered a large block in the same stock over on the high touch desk. Because they both share the same technology, it’s now easy to communicate the block opportunity to the client and execute it. In this way orders can navigate through high and low touch zones so as to achieve the optimum liquidity outcomes for clients.

This is hip
The terms high touch and low touch seem clunky and outdated as they are simply too crude a reflection of the practical realities of trading today. They might well be part of the lexicon of our industry but they imply a separation of technology that simply doesn’t have to be there. This costs money and worsens execution outcomes for clients.

While it is true that the spectrum of trading challenges is getting broader, truly effective trading is about allowing clients to combine a range of different services.

Firms that implement a blended approach will be able to dominate liquidity in their chosen areas. What is more they will operate at lower costs whilst providing a more valuable service to clients.

They really will have the key to the highway.

We’d love to hear your feedback on this article. Please click here

.cls-8{fill:#fff;stroke-width:0px;}

EXPECT THE UNEXPECTED.

.cls-8{fill:#fff;stroke-width:0px;}