Industry viewpoint : Dr Robert Barnes : Turquoise

February 1, 2016

TURQUOISE BLOCK DISCOVERY™ FIRM UP RATES: INTEGRITY MATTERS.

Robert Barnes, CEO Turquoise

At a time of global passive indexation¹ and an electronic order book environment that naturally leads to small average trade sizes², investors that wish to outperform benchmarks are calling for innovation in electronic block trading.³

To answer this call for innovation and still trade in the presence of anticipated MiFID II double volume caps, one needs a respected and working trading mechanism that can match orders above 100% of the Large In Scale (LIS) threshold determined per stock by ESMA.

Turquoise has a working LIS innovation with demonstrable quality: Turquoise Block Discovery™ which matches undisclosed block indications that execute in Turquoise Uncross™.^4,5

Turquoise facilitates electronic trading of larger orders

Turquoise midpoint dark order book is different to those of other European dark pools. Turquoise prioritises orders by size and features innovations such as Turquoise Uncross™ and Turquoise Block Discovery™ that deliver the first example of a broker neutral venue that is reversing the electronic trend of shrinking trade size. Turquoise Block Discovery™ now averages more than E200,000 per trade, and this average is more than twenty times larger than the average E10,000 for electronic trades matched by continuous dark order books.

MiFIR Article 4(1)(c) can allow dark trading for orders received by a venue that are LIS compared with normal market size and not include them in the MiFID II double volume cap calculations. This is a challenge for the current market profile where much less than 1% of trades matched on European lit order books trade in sizes greater than LIS.

Turquoise features a differentiated profile:

• 1% of Turquoise continuous matching in its midpoint dark book traded values in sizes greater than LIS; this is similar to other external dark order books.

• 2% of Turquoise overall dark book value [adding in Turquoise Uncross™ executions] trade in sizes greater than LIS.

• 20% of Turquoise Uncross™ value traded is in sizes greater than LIS.

• 50% of Turquoise Block Discovery™ value traded is in sizes greater than LIS.

The insight is that Turquoise today has a working mechanism for larger orders, including those LIS compared with normal market size.

I will now outline metrics that address the integrity of the trading mechanism.

Turquoise Block Discovery™: high firm up rates and robust reputational scoring

Turquoise Block Discovery™, launched October 2014, has more than a year’s worth of empirical measurements evidencing consistently high firm up rates. These high firm up rates result from robust automated reputational scoring, which measures the difference between the original block indication and the subsequent firm order.

Since launch, more than 95% of order submission requests (OSRs) resulted with firm orders into Turquoise Uncross™ within the specified time window – under half a second – and with both price and size parameters inside the minimum requirements of the service defined with input from buyside and sellside users.

Furthermore, in more than 90% of all OSRs, the firm order met the minimum requirements and was at least the full size of the originating block indication or larger.

Figure 1 clearly shows that only in less than 5% of OSRs did the respondent fail to come back within the prerequisite core time and size parameters. The key insight from this is that the vast majority of Turquoise Block Discovery™ OSRs successfully firm up.

Turquoise Block Discovery™ block indications firm into Turquoise Uncross™ for execution. Turquoise Uncross™ is an innovation that provides randomised uncrossings during the trading day, ideal for larger and less time sensitive passive orders.

Turquoise Uncross™ has been the subject of multiple studies by LiquidMetrix, the independent analytics firm that specialises in venue performance metrics and execution quality analysis.

LiquidMetrix repeated its analysis in October 2015 and, for the third year in a row, spanning before and after the 2014 launch of Turquoise Block Discovery™. LiquidMetrix again concluded that trades occurring on Turquoise Uncross™ had a far lower correlation with sharp market movements on primary venues than trades occurring on other continuously matched MTF Dark Pools.⁶

Surveillance of Turquoise activity, including monitoring of price movements ahead of Turquoise Uncross™ is undertaken by the independent London Stock Exchange Group Surveillance team. Suspected manipulation of the reference price will be referred to the UK securities regulator, the Financial Conduct Authority (FCA).

A combination of robust automated reputational scoring, independent quantitative analysis evidencing empirical quality of the LIS trading mechanism, and an independent surveillance oversight add further to confidence in the integrity of Turquoise Bock Discovery™ for the matching of undisclosed block indications that execute in Turquoise Uncross™.

Footnotes:

1. Barnes, Robert. “European Equities: How We Got Where We Are Today”, Global Trading, Q1 Issue #53, 13 March 2015, pages 48-49. https://fixglobal.com/home/european-equities-how-we-got-where-we-are-today/

2. Barnes Robert. “Dark pools and best execution” Best Execution, Summer 2015, pages 79-81. www.bestexecution.net/analysis-dark-pools-best-execution/

3. Barnes, Robert. “Dark pools and best execution: Turquoise Block Discovery™”, Best Execution, Autumn 2015, pages 69-73. www.bestexecution.net/analysis-dark-pools-best-execution-3/

4. www.lseg.com/markets-products-and-services/our-markets/turquoise/turquoise-products-services/turquoise-midpoint-dark-book/turquoise-uncross%E2%84%A2/turquoise-block-discovery%E2%84%A2/turquoise-block-discovery%E2%84%A2-explained

5. www.lseg.com/markets-products-and-services/our-markets/turquoise/turquoise-video-resources/how-does-turquoise-block-discovery%E2%84%A2-work

6. LiquidMetrix Turquoise Uncross™ – Execution Quality Analysis by Dr Darren Toulson & Sabine Toulson, extracts of presentation to Turquoise Block Discovery™ Buy side round table, 13 November 2015.

[divider_line]©BestExecution 2015

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All bets are off : Lynn Strongin Dodds

Lynn Strongin Dodds

February 1, 2016

ALL BETS ARE OFF.

Given the unexpected jolt to the markets, it is no surprise that participants at the recent World Economic Forum were skittish. Plummeting oil prices, plunging stock markets and a sluggish China are enough to shake anyone’s confidence. The fear is that global growth has truly stalled and another interest rate hike – which everyone wanted last year – would only make matters worse.

This is in sharp contrast to last year when participants were chiding the Federal Reserve for its indecisiveness about raising rates. The argument was that the US was in a healthy state with falling unemployment. Fast forward to today and the picture has changed rapidly. In fact, ever since the Fed Fed raised the benchmark interest rate 16 December – the first time in almost a decade, the S&P 500 stock index has slid 9.5% with oil prices plunging 16% over the same period.

Morgan Stanley estimates suggest that the tightening of financial conditions wrought by the turbulence has been equivalent to four interest rate increases. It was not surprise then that on 28^th January, the central bank kept rates unchanged to 0.25% to 0.5%.

The move has made markets jittery but Zhu Min, the International Monetary Fund’s deputy managing director sounded the alarm bells at Davos, warning that another upward move would trigger further market volatility, thereby putting even more pressure on liquidity.

Part of the problem is banks are operating with one hand tied behind their back. The regulation, which is designed to make financial services a safer and more transparent place, has also drained liquidity out of the system as once active participants have taken a step back. The other problem Min highlighted is the intense popularity of some investments and strategies makes certain asset classes “dangerously correlated” and overcrowded, which also impacts the ability to easily buy and sell securities.

The big question of course is how will the rest of the year unfold? Crystal balls have already been muddied and soothsayers are looking at every angle. Analysts are now mulling over the Fed’s next move with many still expecting it to raise rates at its next meeting, in March. However, there is also a growing cadre that argues the central bank’s concerns may push back the next rate increase to the summer months, or later. All agree though that the once projected four quarter-point rate increases this year is unlikely.

As always the economy is the linchpin and views are also divided over its robustness to weather a global downturn. There is one camp that believes there is little evidence that slow growth in the rest of the developed world, as well as China’s and other emerging markets, will interfere significantly with relatively strong domestic growth. The other camp, though are not as sanguine and see these global problems impinging on the country.

If the beginning of this year is to any guide, it is best perhaps to take all opinions with a grain of salt.

Lynn Strongin Dodds
Managing Editor

©BestExecution 2016

A Trader’s Guide To The FIX Protocol

GlobalTrading

January 29, 2016

By Irfan Syed, Managing Director, Fixnox
The FIX protocol, like many other computer protocols, has always been a domain of techies. They are the ones to set up new FIX connections and ‘certify’ them by complying with FIX rules of engagements of counterparties before the users – traders in the case of FIX connections – start to trade over them after minimal testing.
And for any changes or enhancements, traders communicate requirements to their connectivity team, and in turn these techies enhance FIX connectivity software to support the changes and ‘certify’ the FIX connection again. Or if the connectivity team didn’t fully understand the business and/or the protocol, they would just reject the requirements with an excuse that requirements are not supported in FIX, in a particular version of it, or their FIX engine software.
In most organisations, connectivity teams’ understanding of the FIX protocol is often incomplete due to the very fact that many of the terms used in FIX specifications, white-papers and guides will only make complete sense to someone who understands the business of trading well. It should not be expected that technical people will understand “order capacity”, “price improvement” and “participation rate” without reasonable knowledge of the business and industry. But these very terms are used all over the FIX documentation.
In an ideal world, all traders should be well-versed with FIX protocol specifications and adopt a habit of using these as a reference during conversations about trading connections. But most traders, who are already overwhelmed with information in today’s fast moving markets, do not realise the value and competitive edge which can be gained by acquiring knowledge of FIX protocol and using it to set their trading connections ‘right’.
However change is in the air. In the highly competitive world of buy-side trading, where trading technology and infrastructure has a direct impact on performance of buy-side trading desks, traders have started to take ownership of their tools. They are starting to have deep conversations with their technical teams so that they have correct and properly implemented tools to make precise trading decisions.
They have also started to realise that a complete understanding of a broker’s FIX capabilities – and shortcomings – must be an important factor in selecting a new execution provider.
And that is why we think a simplified FIX protocol guide for buy-side traders, with the most important stuff, should exist.
In collaboration with GlobalTrading magazine, we have created a first version of this guide which can be found at https://fixglobal.com/home/trader-fix-tags-reading/. This version is geared for buy-side traders who are active in equities and use FIX versions 4.2 and 4.4. In the near future and after collecting feedback from the community we aim to update this guide to include other asset classes and functionality specific to FIX 5.0. This guide covers the following business areas:
1. Security identification
FIX field 55 (Symbol) in FIX is still a very common method for security identification but this may not always be the best choice. A preferred alternative is to use a combination of fields 22 (SecurityIDSource) and 48 (SecurityID) which allow using any of a number of global security identification databases. ISIN, CUSIP, SEDOL, Bloomberg, RIC, all of them are supported.
Field 107 (SecurityDesc) can also be used to describe the security for manual trades, and field 207 (SecurityExchange) allows for indicating the market from where security identification was taken. Field 167 (SecurityType) in FIX can carry the type of stock (i.e. preferred stock) or CFICode for a futures product.
2. Order and venue identification
Buy-side firms identify their orders using Client Order ID field 11 (ClOrdID) but brokers use field 37 (OrderID). When requesting amendments or cancellations of an order, Original Client Order ID field 41 (OrigClOrdID) comes into play and chains ClOrdID of new trading instruction with the existing one being amended or cancelled.
In multi-market environments, buy-side institutions can indicate the market where order should be executed by providing its Market Identifier Code (MIC) in Execution Destination field 100 (ExDestination). In execution reports provided by sell-side firms, field 30 (LastMkt) is used to indicate the market where the order, or part of it, was filled.
Sell-side firms may also use field 851 (LastLiquidityIndicator) to indicate whether current fill was result of a liquidity provider providing or liquidity taker taking the liquidity.
Field 39 (OrdStatus) exists in all execution report messages so that sell-side firms can indicate the latest status of the order in their system.
3. Quantities
Buy-side institutions use Order Quantity field 38 (OrdQty) to specify the number of units of a security they wish to buy or sell. Quantity can also be provided as cash value – e.g. for FX trades – in field 152 (CashOrdQty). For CIVs, quantity is provided in field 516 (OrderPercent).
FIX protocol also contains fields for brokers to provide changing quantity information to the buy-side during order execution. Field 32 (LastQty) carries quantity executed in current fill, 151 (LeavesQty) contains quantity open for execution, and 14 (CumQty) has the quantity executed in current order so far.
For multi-day orders FIX has additional fields to carry intra-day quantity information. 424 (DayOrdQty) contains quantity open for execution and 425 (DayCumQty) carries executed quantity during current day. Both of these fields are applicable from 2^nd day onward.
4. Prices
In FIX, price for a limit order is provided in field 44 (Price) and associated currency can be indicated in 15 (Currency) field. There is also tag 99 (StopPx) which is used to provide stop price of appropriate order types. In execution reports, sell-side firms use field 31 (LastPx) to indicate the price at which quantity in current fill executed, and field 6 (AvgPx) to provide average price of total executed quantity in current order. Then there is field 140 (PrevClosePx) which can be used to indicate the instrument’s previous day’s closing price. This field is sometimes used as an aid in security identification when symbology in use does not guarantee a unique instrument.
For multi-day orders, the sell-side may use field 426 (DayAvgPx) to indicate average price of quantity filled during current day. And if they have made any price improvement, they can send its value in field 639 (PriceImprovement).
For trades which are executed in one currency and settled in another, field 120 (SettlCurrency) indicates the currency in which those should be settled.
5. Execution management
FIX protocol supports various order types, and buy-side institutions can use field 40 (OrdType) to indicate the appropriate one for their orders. Order side is provided in field 54 (Side).
Buy-side institutions can also instruct their brokers how they should work on the order by using fields 21 (HandInst) and 18 (ExecInst). Field 21 carries general handling instruction of the order (automatic vs manual) while field 18 allows for provision of one or more specific execution instructions – for example “All or none”, “Stay on bid-side”, “Go along” or “Cancel on trading halt” etc.
FIX also allows the buy-side to control how their order should be displayed in the order books of the trading floor. Field 111 (MaxFloor) is used to indicate the quantity which will be visible on the trading floor at any given time, and 210 (MaxShow) indicates the maximum quantity which a broker can show to their other customers. The latter is useful in IOI flows as it restricts brokers not to fully disclose an order’s quantity in the IOIs they may send to their other customers.
Other useful tags for execution management are 110 (MinQty) – minimum quantity in the order which must be executed, 114 (LocateReqd) – if a broker is required to locate the stock for short sell orders, 847 (TargetStrategy) – name of strategy if order is for one e.g. VWAP, 848 (TargetStrategyParameters), 849 (ParticpationRate) – if target strategy is “Participate”, and 636 (WorkingIndicator) – a flag sent by a broker to indicate they are currently working on the order.
6. Date and time
FIX protocol has the following fields for carrying different date/time information in orders and execution reports. Note that most date/time fields in FIX use UTC/GMT times.

60 (TransactTime): Time when a trading instruction, e.g. an order was created in the trading system.
52 (SendingTime): Time when a FIX message was sent out by the FIX engine.
59 (TimeInForce): Effective time of an order. This can be Day, Good Till Date (GTD), Good Till Cancel (GTC), Immediate or Cancel (IOC), or Fill Or Kill (FOK) etc.
168 (EffectiveTime): Time when instruction provided in the FIX message takes effect. For example start time for an order instruction to become active.
432 (ExpireTime): Time when an order expires. This is always local time, instead of UTC.
75 (TradeDate): Date when a trade happened. Useful when a broker is reporting trades of non-current day.

7. Parties in trade
FIX also provide means to identify various parties involved in the trade, both from buy-side and a broker’s perspective. For example the buy-side institutions may use field 528 (OrderCapacity) to indicate their agency, proprietary, individual or principal capacity and 529 (OrderRestrictions) to specify restrictions on an order (e.g. foreign entity, market maker).
Brokers use 29 (LastCapacity) to indicate the capacity in which they executed the order – e.g. as an agent, principal or crossing as either. If they executed the order via a third-party, they may identify it in field 76 (ExecBroker).
FIX 4.4 and later versions also support repeating groups which can carry information about all parties involved in the trade. The information which can be exchanged may comprise of party ID, source of this identification, party’s role and party information like address, phone number and email address.
We believe that this guide will be useful for buy-side traders who are starting to take ownership of their trading connections. This will answer at least some of those FIX questions you always had but never asked.
At the very least, knowledge gained from this guide will lead to some ‘interesting’ conversations with your brokers, execution venues and internal connectivity teams.
Those conversations should in turn lead to more questions and a desire for even better understanding of FIX. We hope that you will send those questions to us so that we can address them in next update of this guide.

Beta Play: The Future Holds ETFs

GlobalTrading

January 23, 2016

By Susan Chan, Head of iShares Asia Pacific
Institutional investors have used financial futures to achieve beta in their portfolios in a quick and targeted manner for decades.
Futures are particularly popular among sophisticated investors such as asset managers and pension funds that need to invest efficiently and cheaply in liquid, easy-to-access markets. This long-held acceptance of futures has created a huge industry with exceptional liquidity.
However, the evolution of financial markets has produced new methods of gaining beta exposure efficiently, and many institutional investors are now adopting them. The efficiency of ETFs, in particular, is surpassing that of futures in many cases due to current market conditions, forcing institutional investors to reconsider their choice of financial instruments. By the end of 2014, assets under management of S&P 500 ETFs surpassed open interest of the respective futures contract for the first time.
Different tools, different costs
Listed equity index futures are among the most widely used derivatives contracts available in the financial markets. As of end December 2014, there was more than $ 353bn in open interest on S&P 500 futures only.¹
Futures can be used by institutional investors to implement several types of strategies, such as sophisticated trading strategies, leveraged strategies and simple beta plays. For this comparison we will focus on using futures and ETFs for the simple implementation of a beta play.
ETFs and futures are similar in many respects. They are both delta-one instruments which aim to replicate an index, net of fees, and their prices are therefore linked to the index. Both vehicles have become extremely popular due to their intra-day liquidity, exchange-traded nature, relative safety, transparency and other unique benefits they deliver to investors.
However, the mechanisms of ETFs and futures are very different, resulting in varying levels of efficiency as market conditions change.
One key difference is that futures contracts expire on a monthly or quarterly basis, while ETFs are open-ended vehicles with no maturity constraints. Investors wishing to maintain their futures exposure beyond a contract’s expiry incur the cost of rolling the futures contract.
There are also other cost differences. ETFs’ holding costs are driven by rebalancing costs and replication methodology while occasionally being partially offset by securities lending revenues. ETFs’ trading costs can be summarised as clearing, execution commissions and primary market creation or redemption costs.
Futures’ trading costs include relatively low execution and clearing commissions. However the major driver of the price of futures, aside from the underlying index level, is the “basis”, which is the difference in price between the future and the index. This is very dependent on offer/demand imbalances, as well as the cost of carry (including funding). The impact of the basis materialises when rolling a futures contract to the next expiry, within the investor’s holding period. The cost for funding a short futures position and the natural imbalances between offer and demand mean that futures typically trade rich, and therefore that the roll is done at a cost for a long investor.
The rising cost of futures
One of the challenges facing equity index futures today is a specific supply and demand dynamic. While pension funds, endowments or asset managers may go long or short financial futures, demand for long exposure far outpaces that for short exposure.
Futures investments require two parties, and therefore a short must exist for every long. Investment banks are the main suppliers of short futures, which they synthetically manufacture.

The bank must hedge those short positions, which forces them to deploy their balance sheet. As a consequence of changing regulations, such as the Basel framework in Europe, bank capital is becoming more expensive, driving up hedging costs.
This has resulted in the market suffering from a lack of institutions willing to sell futures, while demand for buying futures remains strong. Over the last 12 to 15 months futures contracts have become more expensive than their long-term historical average, particularly around year-end, (i.e. for the December rolls), when banks are more unlikely to enter into or maintain long carry positions.
Futures contracts exhibit what is referred to as ‘cheapness’ or ‘richness’ in a similar dynamic to that of premia versus discounts in the ETF space. Currently, futures contracts are “rich”, creating a performance drag and making them less efficient in delivering cheap access to benchmark indices.
This performance drag is well-documented² and illustrated by the recent trend for futures contracts to roll rich. For example the roll cost on TOPIX had an average roll cost of 0.11% from 1998 to 2014 and has been rolling on average for the past 12 months 57bps rich. This trend is also seen in the S&P 500 futures contract versus corresponding ETFs, which are currently cheaper. See the chart below on the comparison of the tracking difference between an S&P 500 ETF and a corresponding futures contract.
This trend is also seen in futures tracking a wide range of other global indexes³. In Asia, aside from TOPIX equity index futures, the trend is seen on the NSE Nifty, the Hang Seng, the Nikkei 225 and the MSCI Singapore, among others. In Europe, a group of major index futures, including the EURO STOXX 50, the FTSE 100 and the DAX-30 are rolling richer than the longer term average. While in the US, the Russell 1000 and the S&P MidCap are other examples of the tendency.
As the cost of futures rises institutional investors need to consider alternative investment instruments. By contrast, the overall cost ratio for ETFs has fallen sharply, there is a wider spread of liquidity throughout ETFs and fund volumes have increased significantly. As a result, ETFs may be the better choice for some institutional investment portfolios.

Developing TCA For Fixed-Income

GlobalTrading

January 16, 2016

With Fabien Oreve, Global Head of Trading, Candriam Investors Group
In the equities world, Transaction Cost Analysis (TCA) is an important analytical tool which has expanded to FX and more recently to fixed-income. Nonetheless, there are many more challenges in fixed-income than there are in FX and equities. Three main factors explain this expansion to fixed-income. The first is the current economic policy of zero-interest rates. This has forced investors hunting for yields into a wider range of fixed-income instruments and less liquid securities; that has, subsequently, increased the need for post-trade analysis.
The second factor is regulation, the impact of which is being felt on both the sell-side and the buy-side. On the sell-side, the regulatory pressure on balance sheets means that asset managers have no choice but to diversify their access to liquidity and expand their broker lists, which include more specialised and regional banks. This, in turn, naturally means that investors need more analysis to understand who is doing what. The other aspect of regulation pressure is on buy-side. We are now seeing increasing numbers of reporting and transparency requests from portfolio managers and different departments, including compliance, risk management and auditing. The final reason for the expansion of TCA into fixed-income is technology: the growth of electronic trading, the integration of multi-dealer trading platforms into OMSs and the sophistication of those OMSs have greatly facilitated the processing of post-trade data.
Challenges
The implementation of TCA is considerably more challenging in fixed-income than it is in equities. Fixed-income contains a far greater number of instruments and a far greater number of different types of instrument. On top of that, the publication of post-trade public data like TRACE in the US does not exist in Europe. Poor transparency is a challenge to post-trade analysis in fixed-income.
Fixed-income is further complicated by the complexity of categorising bonds as liquid or illiquid and the challenge of defining the appropriate thresholds of voice trading (vs electronic trading) across various categories of bond instruments. Building up a best-execution process that identifies when to trade electronically and when to adopt traditional methods (telephone or IB chats) requires not only a dialogue with compliance officers but also full and deep attention to portfolio managers’ opinions.
Another challenge is the execution benchmark. In order to evaluate best execution in fixed-income, each trade can be compared against the composite mid-“bid-ask” spread (the market mid-level) provided by multi-bank trading platforms at the point of execution. That said, in the case of illiquid bonds, comparisons are not always meaningful. The low number of market-makers in a given instrument at any given point in time can make the electronic composite price (that is normally made up of a large number of dealer pricing indications) irrelevant.
The final challenge we face is that far more trades are done over the telephone in fixed-income than in equities, especially in corporate bonds. In order to get the most reliable analysis for bond transactions and to input all those transactions into the TCA tool, you need discipline from the traders, who have to get all the post-trade data into the OMS as quickly as possible.
A truly multi-asset TCA
TCA is connected to all trading regardless of asset class. It is a tool that promises an effective best-execution process; it helps you analyse your trading activity, the costliest trades and the performances of brokers vs. execution benchmarks.
If you again compare asset classes, there is common ground between equity TCA and fixed-income TCA in the construction phase. The TCA construction process consists of extracting trade history from the OMS (which is the structural backbone for TCA), then combining that data with independent market pricing, sourced (in the case of fixed-income) from any of the multi-dealer platforms and (in the case of equities) from consolidated order books.
There is, however, a clear distinction between that construction phase and its finalisation. The second phase differs between bonds and equities because, with bonds, you have to determine and analyse more categories, more sub-categories and “liquidity buckets”. In equities, there are many more order types and execution benchmarks. Today, a TCA tool in equities compares trading results against different execution metrics (arrival price, VWAP, % of volume, etc.) across a limited number of categories while a TCA tool in fixed-income compares execution against a composite price across a wider range of categories and sub-categories.
Developing the system
A key consideration when developing a TCA system in fixed-income is to be aware of market structure and the role played by broker-dealers. The market structure in fixed-income is driven by principal trading, not agency trading, so the way bonds are traded is often “all or nothing”. The agency model will gradually progress in fixed-income but this will take time and we will need to keep a flexible model for trading much of our business.
That’s why an efficient post-trade analysis system in fixed-income should go beyond the cost aspect, display who your top counterparties or top liquidity providers are across various categories of instruments, help you trade better and find more liquidity. Liquidity discovery is the natural continuity of TCA in fixed-income. At the Candriam trading desk, we have incorporated a search engine connected to our trade history database into our TCA tool, so we can find our top five counterparties for specific instruments or segments. This tool has been designed to broaden any search and to select the issuer, so we can sometimes get five or ten different issues from the same issuer. This can include correlated or similar issues, and it is very important that the tool is able to give us that information.
TCA for fixed-income is quite a new area in Europe, so our preference initially has been to develop and test our own system. It has taken several months to construct our TCA tool, but it has not been a linear process. Traders have spent time working outside normal business hours and speaking with portfolio managers. The creation of a TCA tool not only gives us greater control, it also enables us to share appropriate solutions for end-users with our OMS provider and TCA vendors.
The long-term future of fixed-income TCA is closely related to OMS sophistication because today, the OMS is the backbone and, technologically speaking, it is becoming further advanced all the time. The OMS will become more integrated, further standardised and provide increased access to crucial areas such as pre-trade and post-trade functionality. It also involves cooperating with TCA vendors, who are developing peer-data and peer-group analysis.
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The Role Of Associations In Regulation

GlobalTrading

January 10, 2016

With Christian Krohn, Managing Director, Head of Equities, AFME, and Matthew Coupe, Director Market Structure, Barclays and FIX Trading Community EMEA Regulatory Subcommittee Co-chair.
Christian: It’s certainly been the case for MiFID II that there has been a lengthy process of negotiation between the European parliamentarians and the member states as co-legislators on one side, the commission on another, and then ESMA and the regulatory community all trying to have a key stake in the shape of that regulation. It’s almost inevitable that the process has become deeply politicised because it’s such an important piece of regulation. It really does govern how Europe’s capital markets are going to function in years to come.
But that’s not to say there isn’t a need for efforts to standardise what we can, where provisions have become settled as a matter of politics or where the politicians have agreed and policy makers in general have agreed about what they want the regime to achieve. Then it’s up to practitioners and standardisation bodies such as the FIX Trading Community to help policy makers operationalise that policy and to make sure that the regime actually works.
Matt: Obviously there’s a lot of work going on engaging those various stakeholders while the policy and political aspects are still very active. But the standards need to be built into that process from the ground up, because if we don’t have standardisation, we’re not going to achieve one of the core goals of MiFID II, which is to enable a much greater level of understanding as to the transactions that are occurring in the marketplace.
The FIX Trading Community is a standards organisation, and we’re promoting free and open standards across the financial service industry. We know that there are a number of trade associations engaged in this space, but FIX is quite unique in the sense that we operate downstream to many other trade associations and we get much more heavily involved in the nitty-gritty implementation of the regulation because it comes from a much more technical perspective. A classic examples of that is the fact that FIX is the owner of the FIX messaging standard and the MMT standard.
However, it goes a step beyond this as well because if we don’t have a standard set of engagement rules and standards in how we interact with the market and each other, it falls away. Collaboration with AFME adds a business policy perspective and understanding from a higher level in terms of what the impact will be, and establishing an industry position.
The depth of collaboration
Christian: The primary role of trade associations is to develop policy positions, initially, often at a high level, but as regulatory regimes are developed, at an increasing level of detail, including quite nitty-gritty policy positions on the interpretation of the evolving legislation. Whereas in contrast, the role of standardisation bodies like FIX is to step in once the position has been settled among policy-makers and work closely with market participants to decide how it’s going to be operationalised.
The collaboration is very close across the various industry bodies. There’s even a joint trade association group here in London where FIX sits as well alongside all the major sell- and buy-side trade associations.
Matt: It is definitely wrong to think that the trade associations don’t intercommunicate or correlate. While FIX generally sits further downstream to the other associations, all the associations have a very close interoperation in terms of communication. This is not necessarily just between sell-side organisations, but also buy-side organisations. We need to be able to address this regulation and if we don’t address it as an industry, it’s going to create issues. Everyone is actively working together to try and deliver a very large chunk of requirements that need to be operated on across the whole spectrum. This also applies to the venues and the vendors as well, who play important roles. All of the associations have a role in that engagement, in pulling all those different viewpoints together.
Christian: One of the reasons why this collaboration between organisations that each have a different focus is becoming increasingly important is the sheer size and scale of the task.
Matt: The scope of MiFID II is across a number of massive asset classes, and this needs to be divided up but also correlated and coordinated because some of the themes fit across asset classes. This cooperation and collaboration is only going to further deepen as we go through the process.
The future
Christian: The immediate focus is to try and identify members’ key policy areas where surgery is still required on the RTS. Those policy changes must then be advocated to the commission, the parliament, the council as well to other stakeholders.
This coming period is about engaging with policy makers to make sure that the Level 2 measures, be they in the RTS or delegated acts are fit for purpose.
Matt: From a FIX Trading Community perspective, right now, we’ve got further detail but a definite lack of cemented detail. We’re leveraging that further detail to try and put the plans in action to try and respond to this regulation within the timeframes that have been laid out. With more details, the more we can do to try and harmonise industry standards and enable an effective implementation for the industry.
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Data And Trust

GlobalTrading

December 30, 2015

Joe Kassel, Head of Global Dealing and Exposure Management, AMP Capital examines the changing role of data and technology, and the impact on trust.
My responsibilities at AMP Capital include relationship management, providing best execution, ensuring that we have proper regimes in place to conduct TCA and that we have a good risk framework in terms of where and how we route, who we are routing with, and who is giving us the best prices across asset classes.
In certain jurisdictions there is increasing pressure on the buy-side to have a deeper and closer understanding of the algos being used when we are going straight to market and certifying our knowledge of those algos. Of course, knowing exactly how our orders are handled is not new to institutional traders but fragmentation of liquidity pools and electronification has led to new considerations such as the participants and toxicity within dark pools and, more recently, the conduct of dark pool operators themselves. From a buy-side point of view, as the microstructure of markets becomes more sophisticated so too does the requirement to be resourced properly to police our counterparties’ behaviour. As a result, more than ever, trust and transparency are the primary drivers of our interactions and relationships with brokers and banks.
Managing data
There is a tremendous opportunity for the buy-side to manage and analyse our own data. With regard to TCA, there are many different brokers with a multitude of ways of calculating reports and there are a number of forms of data standardisation.
Currently, we engage third party experts to analyse our data and provide independent review and insights into our trading activity, patterns and cost outcomes. But to a greater extent, there is the opportunity now for us to analyse that data ourselves, which is something that we are starting to do more of from a TCA point of view.
Consequently, in terms of that third party position however, the focus is moving more towards real time decision support, TCA in terms of destination selection and performance of various dark pools and how SORs work, etc.
We do need to ensure that the wider basis for analysing costs does not get lost in the more granular analysis of real time decision support. Ultimately this wider area is where we are going to find our biggest savings on decisions that should not have been made in the first place from a trading point of view. This is where we will find those ‘holes’ in terms of market access and our ability to access liquidity quickly and globally. The data now available to us is at a peak level across all our activity – across all asset classes. Our data has that information embedded in it, as well as the information that we can extract in terms of the historical behaviour of counterparties and the historical outcomes across the markets. However, there is still much to be learned in order to better analyse those wider trends in behaviour.
We do require decision support, whether it is software or real time analytics, and it could be something that we develop ourselves or alternatively have our counterparties provide for us. And that decision support helps inform how we route our orders, where we execute and with whom we execute. Ultimately however, the outcome of that trade from a whole cost analysis point of view will be revealed in the longer time frame analysis.
Cross asset standardisation
We are still finding that many of the processes and relationships across asset classes are still relatively siloed. From my perspective the evolution of TCA and 3rd party information systems in equity markets is a very good reference point for the evolving regimes in other asset classes. In particular we can easily transfer equity market principles to futures, which are traded on an agency basis. And that is one step away from FX that is executed versus price benchmarks.
In terms of translating that into fixed income, currently the situation is to compare against prevailing market levels and stored RFQs, and refer to historical data in terms of ‘the trade relative to pricing’. However, this is evolving in terms of our ability to store the data, and then to reference the execution process against the prevailing historical tick data.
Impact on sell-side relationships
The buy-side is not trying to drive spreads to zero, because that is in no one’s interest. But before we get to that point there is still some margin compression to happen. It is not our role to preserve margins for our counterparties, but it is certainly not our role to make them go away either.
Our role is to know what the marginal cost of dealing is, and to assess where it is reasonable. And we can compare that in a number of ways. A long as there are sufficient providers of services with sufficient margin in their businesses then we will continue to have the means to deal where we need to be dealing.
We also have a duty to trade on a best execution basis. Our position is to ensure that we are properly set up to access liquidity wherever we can find it. We need to verify on a trade-by-trade basis that we are dealing at the right price and a necessary part of that role is to be able to confirm that those are the right prices.
Regulatory impact on trust
The impact of regulation is definitely driving some of our concerns. An example of this is the ongoing discussion about commission rates and what client commissions can be used for. One point that has been missed by many is how the market has responded to this concern of commissions over time, and the fact is that it has responded quite successfully.
We conducted some internal analysis to look at our equity commission rates in the Australian markets over the last 25 years. Broadly speaking, the result was that over the last 25 years, our equity commission rates in Australia have fallen by 1 basis point per year. This is a very good outcome and is a real reflection of how seriously we take our responsibility to manage our clients’ money effectively. It is also a satisfactory response in the Australian market to the perception of regulators in some jurisdictions that managers of institutional investors are failing to ensure that that they are not paying too much of their clients’ money towards execution and research.
Our ability to analyse our own activities is getting more sophisticated, as is our ability to analyse peak data in the market, to connect to liquidity pools, to understand who the market’s participants are and how they behave, and how to navigate our way around misbehaviours using minimum acceptable quantities, and avoiding certain dark pools with high levels of toxicity. Ultimately we do rely on third parties to act as agents for us which means that they must act in our interest in an ethical and proper manner. So it comes back to trust, which cannot be regulated or processed or technologised away.
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Buy-Side Execution: Fad Or The Real Deal?

tom_kingsley

December 19, 2015

By Tom Kingsley of Bloomberg Tradebook recounts the successes of buy-side execution and the market forces sustaining it.
After trials in Canada, buy-side execution has increased among Australia’s superannuation funds. The challenge is for buy-side traders to keep up the pace to offer competitive best execution for their portfolio managers.
We have definitely noticed an uptick in certain markets of pension funds and superannuation funds bringing their trading in-house. These firms are evaluating their algorithms and getting more sophisticated in their electronic trading. It is a great benefit that these firms are starting to take execution in-house. Whenever you start educating traders, everyone benefits, particularly when it comes time to trade.
Now, a trader who might not have been familiar with the challenges of trading electronically, has a nuanced appreciation for opportunity costs, capturing spread, pre- and post-trade checks as well as TCA analysis. There is a learning curve for in-house traders, but because they already understand communicating trades over voice, they are hungry to learn electronic trading.
In these meetings, the first question is often what primary benchmark their desk uses. Is it trade out last or market on close? Do you participate in the auctions and take advantage of the significant liquidity in the auctions? Drilling down into their pre- and post-trade metrics helps them define how they approach a trade, which is always a benefit.
To take it a step further, when you understand their sense of urgency in executing a trade, you can help them understand much easier what algorithms are appropriate and not appropriate.
Technology, market structure decide longevity
When a trading strategy proves successful for the buy-side in Australia or in Canada, it is fair to assume the buy-side will be talking to each other about it. Whether at global conferences or informally, validation amongst peers is very common.
If something is working for a large fund, they will communicate it. If someone feels a competitor is benefiting from a certain strategy, others will try it. It seems natural that in-house trading will continue to grow.
The challenge, however, is for buy-side trading desks to compete with the sell-side in terms of technology investment. Technology is faster. Information is faster and market impact from news is quicker so the markets have changed. Asian exchanges will continue to change, continue to get lower latency environments and continue to improve their market structure.
Asian markets are likely to homogenize further because there is so much competition that opportunity costs are everywhere in the trading world. The 15 most-liquid Asian markets are already communicating much more than they ever have, whether they are competing for liquidity or looking at opportunities to cross list. There will be challenges with currency and harmonizing regulations, but Asian markets will start to look much more alike in the next few years.
The pressure is already on brokers to change with the markets. Buy-side trading desks’ ability to withstand the same pressure, adapting to the changes in structure and speed, will also shape the longevity of this in-house trading trend.
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Out with the old… Lynn Strongin Dodds

Lynn Strongin Dodds

December 18, 2015

OUT WITH THE OLD…

There is no doubt that 2015 was a year full of twists and turns. Few would have predicted Greece almost falling off a cliff or the Chinese stock market crashing in the summer. Worse still were the unspeakable and horrific events in Paris. They all left indelible marks on asset prices although the terrorist attacks were also a reminder of the fragility of life.

The irony though is despite the unexpected events, there are several issues that we have covered in 2015 that will still be plodding along in 2016 and beyond. MiFID II is a case in point, having just been delayed to 2018. It may give everyone more breathing room but only the brave would put this on the backburner as time goes quickly. This means not only focusing on the IT infrastructure required but also the amendments to dark pool trading, meeting best execution and the unbundling of research.

Collateral management will be an even bigger theme as a date has finally been put in the diary – June 2016 – for the clearing of OTC derivatives under the European Market Infrastructure Regulation. Views still vary as to the shortfall but firms will have to ensure that their systems and processes are in place to meet the deadline. Once an instrument is at the clearing starting gate it will be the European Markets and Security Authority’s (Esma) turn to develop technical standards for MiFID to determine the class of derivatives subject to the trading obligation and the launch date.

Although Europe seems to be finally getting its regulatory act together, this does not seem to be the case between the region and the US, who are still wrangling over the finer points of clearing. Aligning their regimes was never going to be an easy task but few thought it would take this long. It is unclear whether 2016 will be the year where they can put their differences aside and reach an accord.

Uncertainty is also lingering over Britain’s place in the European Union. The referendum to leave, or Brexit, could take place in 2016 or 2017 but it has not been factored into equity prices and analysts believe that it would pose a big shock because few take the possibility seriously outside the UK. This is perhaps because they don’t believe the population would seriously consider a Brexit. Little do they know and let’s hope the yes campaign can convince them of the merits of staying in despite the many problems.

Looking ahead is always difficult and last year’s crystal balls are no doubt cracked. However, the one thing that is certain is that the regulatory saga will continue having a profound impact on the financial service community.

Wishing all our readers a happy holiday and New Year.

Lynn Strongin Dodds
Managing Editor

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