SmartStream : Collateral Management Solutions : Philippe Chambadal

April 26, 2015

IN THE RIGHT PLACE, AT THE RIGHT TIME.

By Philippe Chambadal, CEO, SmartStream

SmartStream, the global software and managed services provider can boast more than 1,500 customers, including more than 70 of the world’s top 100 banks alongside the world’s leading asset managers, custodians and broker dealers. In this presentation SmartStream outlines both the acquisition and implementation of a collateral management solution into their suite of services.

In February, SmartStream acquired Algorithmics’ Collateral assets from IBM, enabling it to address funding and counterparty risk issues for customers from within its own post-trade software suite.

The Algorithmics Collateral package, which has been rebranded TLM Collateral Management, offers collateral lifecycle automation for our 1,500+ buy- and sell-side institutions, custodians and asset servicing customers. It will be integrated with the company’s own post-trade suite of services for cash and intraday liquidity management, corporate actions, reconciliations, data management and exception management.

I believe the integration will give customers a clearer picture of the true exposure of their equities, bonds and derivatives as well as their ability to mitigate counterparty risk and to respond to market changes in real-time. It provides a comprehensive and centralised view across a firm’s front- and back-office as well inventory and various other levels of exposure. I believe that having a consistent definition that both parties can agree to is a ‘must have’. I would add, that in addition to this, one needs to handle corporate actions properly due to the impact it can have on collateral management.

Although the deal may have happened quickly, a move into collateral management had been on the radar for a long time. We knew the product well, so when we were approached we completed the deal in very short order. We were very fortunate to be able to add a best-of-breed product with an impressive client base that was a natural fit with our existing solutions.

Looking ahead, I believe that collateral management is going to be a major utility in the post-trade world along with reference data management and fees and invoice management. The whole process is about managing different counterparties’ collateral, therefore the data and the processing should sit in the middle. This makes it an ideal candidate for a shared service utility and it is hard to imagine how efficiencies and cost reduction for the industry could be achieved if firms undertook the task by building their own, in-house solutions.

As this acquisition and that of Credit Suisse’s proprietary commission fees and expense management software last December show, we are committed to continuously searching for new solutions to develop or acquire, all in an effort to enhance our offerings in the marketplace and to better serve our clients.

[divider_line]©BestExecution 2015

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KDPW : The Polish financial sector : Dr Iwona Sroka

Ian Rycott

April 26, 2015

AT THE LEADING EDGE.

Be24_KDPW_IwonaSroka

Iwona Sroka, PhD, President & CEO of KDPW and KDPW_CCP.

Poland can be proud of its achievements in the financial sector û a branch of the Polish economy which was built up almost from nothing in the 25 years of transformation. During this period, phenomenal progress has been made that enabled the Polish financial sector to achieve a significant position in comparison with other European and global markets and become an undisputed leader in certain innovative arrangements, notably in the area of retail payment systems.

Over the past 25 years everything has changed. Poland went from state ownership to private companies. From having no capital market, payment clearing systems, independent central bank or proper supervision, to having a modern financial market infrastructure.

The Polish financial market nowadays can be describe as innovative, compliant with internationally recognised standards and secure, and is also a safe location for investments.

Looking at the financial market and its infrastructure it is really important to notice how the KDPW Group built Central Europe’s leading clearing and settlement infrastructure. Thanks to services offered by KDPW (the Polish CSD) and KDPW_CCP (the clearing house) the quality and safety of the Polish financial market and its attractiveness to international investors have been greatly improved. KDPW Group offers the services of an authorised CCP, a registered Trade Repository, a Global Numbering Agency (ISIN, LEI) and is also preparing for CSD authorisation.

In 2011, KDPW separated its clearinghouse from its central securities depository to create a more robust distinction between its two lines of business. KDPW now has 65 participants, while KDPW_CCP has 38. In April 2014, KDPW_CCP became the third clearinghouse in the European Union to be authorised to clear OTC derivatives under the European Market Infrastructure Regulation. Our services are provided for the most dynamic economy in the region but we are interested in attracting more market participants, not only domestic but also foreign, to build economic scale.

Thanks to the right policies, regulations and supervisory standards, the Polish financial sector made it safely through the crisis, none of the banks defaulted and, importantly, the sector grew.

And the Polish economy? According to European Union forecasts, Poland ranks third in expected GDP growth in 2014-2019 among all EU member states. This is a result of the expected faster economic growth in Poland, as well as the economic growth of Germany, Poland’s main trade partner. The optimistic forecast is also driven by the anticipated increase of foreign investments.

OTC clearing in KDPW_CCP

The Polish Financial Supervision Authority (KNF) has authorised the clearinghouse KDPW_CCP on 8 April 2014, confirming that it fulfils all requirements for such institutions under the EU Regulation EMIR. KDPW_CCP is equipped with a state-of-the-art risk management system (based on the SPAN methodology for organised trading and Value at risk model for OTC clearing), a multi-tier clearing guarantee system (cash and derivatives market margins, clearing fund, own capital of the CCP). KDPW_CCP’s own capital is currently c. EUR 52m (PLN 228m). The EU authorisation allows KDPW_CCP to operate as CCP across the European Union including the addition of the OTC derivatives market to the authorised scope of the clearinghouse’s services. Along with the authorisation application, the clearing house has filed the list of OTC instruments to be cleared, which are derivatives cleared in PLN. KDPW_CCP clears trades in instruments denominated in PLN, including the following OTC trades: Forward Rate Agreements, Interest Rate Swaps, Overnight Index Swaps, Basis Swaps, REPO. KDPW_CCP is now expecting the authorisation of euro OTC derivatives.

Trade reporting to KDPW_TR

KDPW_TR offers its services to all companies obligated to report, not only in Poland, but in the whole of Europe. The registration application covered the reporting of all types of contracts under the reporting obligation (commodities, credit, foreign exchange, equity, interest rates and others û irrespective of whether the contracts are traded on or off exchange).

Parties required to report contracts may report them directly to the trade repository in KDPW, for which they must be KDPW_TR participants (Ordinary Reporting Participant or General Reporting Participant), or fulfil the obligation through another reporting participant of KDPW_TR. According to EU regulations, the reporting obligation may be delegated to a central counterparty: on the Polish market, to KDPW_CCP.

KDPW_CCP does not charge any fees for intermediary services; consequently, reporting of derivatives contracts by KDPW_CCP on behalf of a clearing member or its clients does not involve any additional costs to clearing members other than fees charged by KDPW (for reporting a trade to the repository and for maintaining contract details in the repository).

LEI Assigning: KDPW_LEI

Every entity that is required to report trade details, either directly or through an intermediary, must have an LEI number which identifies it as a counterparty. Only LOUs (pre-LOUs) are authorised to issue LEIs.

On 19 August 2013, the Central Securities Depository of Poland was assigned a prefix (2594) necessary to assign legal entity identifiers (LEIs). The Central Securities Depository of Poland has been awarded the pre-LOU status on 27 December 2013. The ROC’s decision confirms that as a numbering agency, KDPW conforms to the global standards of LEI assignment. Identifiers assigned by KDPW are universally accepted and recognised around the world.

Services for international investors

As the Polish market has grown, it has begun to attract foreign investors, who currently account for half of all trading on the Warsaw Stock Exchange. They provide additional liquidity and capital, which in turn helps fuel IPOs. Not far behind foreign investors, come foreign members of its infrastructure institutions û first to the exchange, later to the CCP and CSD. This is a sign that the market is becoming more mature, that it meets the exacting standards of Western financial institutions and that it inspires confidence in the future. This is true for the Polish market as well. The increased interest of foreign investors and intermediaries is the result of efforts by the whole Polish market to promote the attractiveness of domestic companies, their growth perspectives, a diversified range of traded instruments and an efficient and well-developed post-trade infrastructure.

The KDPW Group has for many years been implementing a range of projects in response to the changing, more globalised nature of the markets. In April 2013 we introduced a service for foreign financial institutions to be able to open omnibus securities accounts directly at the level of the CSD in Poland.

[divider_line]©BestExecution 2015

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Using Technology To Drive Transparency

GlobalTrading

April 25, 2015

With AXA IM’s Paul Squires, Head of Trading, Lee Sanders, Head of Fixed Income and FX Dealing, and Yann Couellan, Head of Fixed Income Execution.
Paul: I suspect by the time we’ve finished this discussion you’ll realise that we’re big supporters of technology. That said, people are much more important than technology because experience remains a very valuable asset. Technology can only enable you to execute what the market allows you to, whereas human experience adds value in deciding how to execute with that technology.
Within a fixed income environment, it comes down to which part of the fixed income market you are trading. You expect a lot more transparency in government bonds; pricing transparency, more insight into the macro, what kind of cost you are expected to pay to implement a trade. And a lot of that obviously benefits from technology, both internally and externally. When you move down the liquidity waterfall into EM/high yield, you expect less transparency. You expect to be taking a surrounding position, access pricing information on the bond. It’s very much tailored to which part of the world that you are trading.
Lee: We have segregated the areas that we trade and assign orders according to those areas of expertise. Orders in European debt will predominantly be traded in Paris, sterling will be traded in London, and then EM and high yield orders traded in London, and non-euros, anything around the edges is traded in London. Co-ordination by us for the fund managers is key. If the index-linked fund manager in London wants to place a trade with a euro or dollar leg, they will tell us and we’ll talk to our specialists and coordinate the trade to make sure the trade is executed correctly.
Paul: The underlying principle is: the narrower the focus, the better the expertise and resulting execution. We have people dedicated to particular bond types even within fixed income. That said, building out to a multi-asset conversation, we have a lot of shared technology to harmonise where each clients’ needs are more efficiently taken into consideration.
Build vs buy
Yann: We need to extend our fixed income trading applications globally to Hong Kong and also the US. I think it would be fair to say that the international state in pre- and post-trade is slightly lagging. We will all benefit if we maximise efficiency on the pre- and post-trade information available on new issues and also the secondary market. The buy side community and the market globally demands more transparency on the primary and the secondary market in fixed income.
Many buy-side firms are at different stages of development with regard to their technology. Some do not invest very much and others often underestimate the size of the job that developing their own solutions can really amount to. You need big investment in terms of time and resource to develop proprietary trading tools.
Paul: Our parent and largest client is a very large insurance company and therefore, fixed income is our primary asset class. Yann is responsible for a very large amount of that fixed income trading which means we benefit from his expertise in deploying the budget. This allows us to continuously develop our platform for fixed income trading and stay at the forefront of our peers in terms of fixed income trading.
Most asset management trading desks that have an order management system tend to be off-the-shelf. Proprietary work is often done to extend that limited platform to give you trading functionality. With regard to multi-asset trading requirements, our OMS covers all asset classes but we also use an EMS for equity trading. In FX we also have an EMS functionality for some of our FX trades. For fixed income by contrast, it’s all been proprietary development under Yann’s leadership. Ultimately, it’s a question for each individual asset manager and their trading desk how to get the best return from the money that they want to invest.
Lee: We still don’t really know exactly how best to set any desk up for the regulatory impact that we’ve got coming down the road. Although with time, as that day approaches, we get a better idea of how the market is going to trade and what we need to trade in that environment. There’s a lot of consensus across the industry. The debate, and the way these topics are discussed at conferences, is very informative for all of us, but now everybody’s playing catch up. We need to see how the market structure is going to change and be part of that debate, and then set ourselves up in a way in which we can take advantage of those changes to put us at the front.
Yann rolled out an internal TCA which gives us immediate credibility, both internally and externally in terms of what we’re trying to achieve. Whether you put that at the beginning of what you’re doing or at the end will depend on the process in the middle. That process is all about trying to write a ticket at the best price possible.
The implications of this for us as a business is that more orders will be fragmented. We won’t necessarily be able to fill the order with one liquidity provider, but it will differentiate venues that we’re pointed to by using smarter technology which will be the coalface of our operation.
Yann: Benchmarking is something we continuously look at and extend year after year. As we gain expertise and make it much more efficient we increase our credibility both internally and externally. Due diligence conversations are more common, because clients are more demanding in how they check the cost of implementing a portfolio and all positions. Now, when we participate externally in these conversations, based on the analysis we’ve got and using our TCA we have minimum cost and maximum saving. This also allows us a way to profile a bank and also for traders to see where we can trade and benefit from that data.
Industry initiatives
Paul: Adam Conn of Barings, co-chair of the Buy-side Working Group of the FIX Trading Community, has led the initiative on the IPO project. The simplistic objective is to lessen the existing gap around operational risks that a lack of access to relevant technology creates. The new issue process still doesn’t use the latest tools. This creates operational risks when trying to coordinate interest from multiple fund managers and then transmitting that interest to brokers who are syndicating primary deals.
To have that operation transmitted by FIX for example, is immediately a positive step. We are already more advanced than most of our peer group in that we already have some automation around the IPO process. But on equities we still don’t have the same technology that Yann’s introduced in fixed income. The operational risks are therefore higher and regulators may come in and challenge you on that process because there are many different ways that interest can manifest itself: price sensitivity, interest indicated via value or number of shares or just different ways of approaching it by different clients.
Fixed income technology has suddenly opened up to a lot of innovation. Technology gets replicated quite quickly and then the challenge is to make yourself different again by innovating further. It’s going to sound a little bit philanthropic, but we have taken the view that there is a bigger picture out there and that the industry benefits as a whole from this universal access. Even though it will reduce our competitive advantage purely on execution of fixed income against our peers, we think it’s for the greater good. And that’s why Lee has invested a lot of time getting Project Neptune off the ground, not only by being another buy-side involved in the process, but intermediating with the sell-side to drive this paradigm shift for an asset class which has reaped very lucrative revenues for the big investment banks over the years. If you look at why the buy-side fixed income desk is getting involved in the initiative, it’s possibly because they had previously written off technology in this asset class. The thought process is as an OTC market, you can’t have that STP environment. The problem is, that a lot of people on the buy-side and sell-side use that as an excuse to not do anything. If it then becomes more feasible to develop a platform where they can develop that type of connectivity then they start to take more interest.
People’s ideas of how to be agile in the bond market vary greatly from institution to institution. It does however seem that now everyone’s working out how we can overcome the hurdles ahead of us. It’s been a real privilege to have been in the position to be involved in this.
Lee: Going out and giving people options around a solution, educating them on the advances being made and aligning that with the banks is the key to Neptune’s success. I think we have established some really solid foundations.
Through conversation, contact, conferences, and association with trade organisations we are working out what’s best for all of us. We’re not necessarily looking out for ourselves here. We’re looking out for the banks and we’re looking out for our peers because we need to have an effective and fair fixed income market for all to participate in. That’s what we are trying, as an industry, to achieve. Equity is not going to change that much, but in this context of industry-led change, fixed income is really where it’s going to change a lot.

Converging Technical And Regulatory Changes

GlobalTrading

April 24, 2015

Kim Man Li, Head of Japan Institutional Electronic Trading, Bank of America Merrill Lynch, looks at ongoing microstructure and buy-side trader behaviour changes in Japan.
In recent months, we have seen several changes to Japanese tick sizes that have been gradually introduced to the market. Whilst these individual changes have been implemented incrementally, the collective milestones should not be overlooked as they have fundamentally altered the behaviour and usage of Japan’s favourite benchmark algorithm, Volume Weighted Average Price (VWAP).
Japan has a long history of small and measured changes to its environment. Each is seemingly compact, potentially trivial, but collectively all these measured changes are part of a very long-term vision or plan to help maintain Japan as a reputable investment centre to the global investment client base.
It has been nearly nine years since the fated Livedoor incident that caused a deluge of order flow causing the Tokyo Stock Exchange (TSE) to shut its doors early and subsequently re-evaluate its approach to the operational needs of its investors. Since this incident, the TSE has embarked on a multi-year, calculated and steady approach to rebuild its systems and reputation. In some respects, adopting a more measured approach allowed the TSE to be flexible with its incremental short-term plans. This strategy, coupled with relatively light-handed regulatory oversight, has allowed the TSE to evolve whilst adapting to additional financial shocks along the way, modifying its plans to accommodate the emergence of technically demanding businesses such as HFT trading, co-location participants, competition from technically superior PTS and alternative venues, increased data demands from algorithm trading and market data processing. We must not forget that this was also done with the backdrop of several releases of trading systems and a merger with the Osaka Stock Exchange to create the JPX along the way.
Considering these factors and some other more recent regulatory induced products, including the new JPX400 Index with strong in-built corporate governance metrics for its constituents, Japan’s future trading environment looks favourable.
Looking back specifically at the most recent changes, we correctly predicted that the latest tick size changes would cause some fundamental changes to the trading landscape.
Overview of TSE Tick Size Reduction:
Two changes occurred in Japan last year: Phase One in January 2014, which considered stocks where the price was over JPY3000 and the subsequent Phase Two in July 2014, which focused on stocks that were below JPY5000. In both cases the aim was to reduce the prevailing tick sizes to substantially smaller sizes in absolute terms. The combined result of these two phases amounted to changing the tick sizes for names which collectively made up to 50 percent of the TSE market turnover.
Traditionally, the desire to have the smallest tick size possible allows for less frictional cost when buying and selling shares. Where stocks had previously had large minimum ticks, the bid/offer queues were subsequently long as buyers and sellers refrained from crossing the bid/offer spread to pay an expensive price. With minimised ticks, the cost to taking liquidity is reduced and ultimately these cost savings are passed onto the ultimate investor, be it direct retail, or retail via institutional vehicles such as mutual funds or other investment strategies. It would also be fair to say that this was a competitive reaction to alternative PTS venues which already had capability to trade these names at the smaller tick sizes and had been offering these savings for some time.

The ability for the TSE to do this, however, was only possible due to the technical advances it had made over time. Whilst decreasing the minimum tick size leads to savings for the end client, it comes at cost for the exchange which will now see the available liquidity distributed more finely across the order book. Finer minimum tick sizes ultimately means an increase in total number of (smaller) orders, which in turn leads to more market data requirements and potentially more work from the exchange participants to cope with the demands of the increased data requirements. If you consider that in 2006, the TSE had to shut early when it neared then capacity of 4.5 million transactions, to the current day where we saw peaks of 30+ million orders back in Q1 2014, you can get a sense of the how much the systems have grown.
In terms of how the market microstructure has affected participants we see that for stocks with a tick size reduction, the following is true:
• Reduced spread (from 10.4 to 4.3bps)
• Reduced available liquidity at the bid/offer (from 590k to 33.5k)
• Reduced trade size and queue time which sho ws how long you must wait before being able to make your transaction
• Increased spread from 1.3 (at old large tick size) to 2.2 (at new small tick size)
• Increased trade frequency (in correlation to smaller trade sizes)

VWAP Algo Performance of Affected Names:
Algorithm providers have also needed to enhance their abilities in-line with the exchange’s microstructure changes. Some providers will have had experience trading on the PTS venues. Regardless of trading experience, given the larger trading volumes on the TSE, all brokers will have needed to ensure that they can process the increased market data given the more granular tick sizes. Additionally, it is important that algorithms can also read market data that are more than just a few levels below/above the current bid/offer. Given the ticks can be up to 1/10th of the original tick size, in order to see the same amount of liquidity you would potentially need to read 10 times the depth of book. Algorithm systems that may not be able to react to the increased data demands and read this level of depth in real-time will ultimately pay for this in loss of execution quality.
Narrowing of tick sizes have ultimately led to both improvements in interval-VWAP (IVWAP) performance, as well as performance versus arrival price. For IVWAP it’s simply the ability to trade at more granular levels. For arrival price, given that liquidity is distributed across smaller ticks, the ability to complete execution at less than the previous full-sized tick also leads to an improvement to this arrival price benchmark. If we look at the distribution of trade volume pre and post tick size change and adjusted to old tick size, we can see that more volume executes in a narrower band post change, i.e. orders are able to complete more quickly at more favourable prices.

To conclude, the TSE and indeed all exchanges continue to evolve their technology and structure to compete with their peers and ensure they deliver the trading functionality that investors demand. Brokers must continually invest to ensure that they keep in step with the regulatory and technological changes. Whilst each incremental change may seem small in isolation, the amount of technical investment needed by participant brokers can be very high. It is imperative that brokers continue to invest in-line with the market developments to ensure that they advance in step with the market and continue to provide optimal execution for their clients.

New Trading Communications Technology: Voice is Still Sweet Music to Our Ears

neil_gray

April 24, 2015

By Neil Gray, Vice President, Enhanced Services, IPC
Classical, jazz or techno. Creating a new song or piece of music hasn’t changed much over the years. But what has changed is how music is produced and delivered. Vinyl to tape to digital. Record players to boom boxes to iPods and iPhones. I suppose much the same can be said about trade execution, too.
A new song is still started by an individual’s idea, and then enhanced through collaboration with trusted colleagues – usually voice discussions on what lyric changes or melodies could make it better. But when it comes to recording and distribution, new technologies make the process faster, better, less expensive and enabled from and to all corners of the globe – almost instantaneously.
New technologies have also dramatically changed trading and trading communications. And looking forward, driven by the need for more efficient information flow and ever-greater productivity, we can pretty much count on more change leading to:

Smaller systems – perhaps virtualized, available 100-percent of the time. Equipment for trading communications systems used to fill entire rooms – sometimes even floors – of banks and trading firms. Today, it’s just a soft switch – usually compact and energy efficient.
Improved end user productivity and accessibility – through a proliferation of custom applications, intelligent interworking and other systems. Sales people, traders, their support teams and their capital markets counterparties will trade at anytime from anywhere with the utmost in capabilities, reliability and speed. Getting intellectual capital on line to close a deal anytime, anywhere is competitive advantage.
Less human capital to manage and configure – sophisticated software and communication tools will continue to reduce the number of people required to effectively implement, maintain and monitor trading communications networks and systems. The ability to manage and make changes remotely or to make global changes from a central location is a huge savings in costs, time and resources. Taking advantage of self-service/self-provisioning tools and customer portals means tasks that required 40 people or more, now only need a handful or less.
Real-time compliance oversight – with policy engines determining who can talk to whom, about what, and when. Today’s business intelligence can manage the more complex requirements and increasing number of variables/requirements of who and how and when any member of a trading organization can communicate with customers and counterparties throughout the capital markets while maintaining Chinese walls, highlighting conflicts of interests or flagging front running.

These technology advances will be interesting and exciting, but it all brings us back to music and the one thing that won’t change: Voice and the need for it. As new ideas develop for innovative financial instruments or enterprising trades, like creating a new song, voice is needed to communicate and collaborate. Only voice can convey the emotion, empathy and sentiments that are part of every trade. Human interaction will continue to drive markets, increase trust and enhance relationships.
As new technologies develop and accelerate the pace of change, both trading floor to back office and capital markets connectivity for voice communications becomes ever more critical. Like the music industry, we will continue to do much of what we do even faster, better, more electronically. But neither industry will be doing much of anything without the continuation of voice.

Buyside Focus : TCA

Ian Rycott

April 20, 2015

Be28_KAMES_AdrianFitzpatrick_375x489 — Adrian Fitzpatrick, Kames Capital

BUYSIDE LOOKS INHOUSE FOR SOLUTION.

Sam Shaw looks at how asset managers are developing their own tools.

Multi-faceted regulatory pressure combined with heightened competitiveness is prompting the buyside to look further afield for its transaction cost analysis (TCA). However, in some cases, looking ‘further’ actually means looking inward, as asset managers are honing their own solutions.

Pure reliance on the sellside could beg questions over an asset manager’s credibility as well as become more onerous at a time when TCA needs to be more prevalent, detailed, accurate and immediate. The need for real-time instruction and analysis form the backbone of this argument, although in a more complex landscape, blended solutions may be a better route as the landscape changes.

There is no doubt TCA is evolving. Put simply, what was once pre-trade analysis of what might happen, used retrospectively by compliance departments is morphing into a real-time, dynamic process of trade monitoring with an impact on trading behaviour, consequently informing better judgments, or such is the view of Simon Maugham, head of operations at OTAS Technologies.

Creating the analysis to do this effectively though is both time-consuming and expensive and to date, neither buy nor sellside firms have led the charge. Yossi Brandes, EMEA managing director, ITG Analytics explains, “The asset managers are looking for third parties because it is harder to aggregate and standardise across 15 different brokers, methodologies and datasets – it is a nightmare to compare otherwise. The TCA vendors offer a form of standardisation across brokers, from an independent perspective.”

As well as the practicalities, there is a fairness argument for introducing an independent view. Despite the FCA’s recent thematic review on best execution focusing on sellside obligations, it highlights the need for all parties to take greater responsibility to ensure optimum trading conditions, with MiFID II and its various aspects a key driver.

According to the Investment Association, a trend is emerging of asset managers hiring dedicated personnel acting as liaison between TCA vendors, sellside and internal stakeholders, demonstrating the fund manager’s commitment to the cause.

The trade body notes that greater emphasis on TCA means asset managers are not only more focused on achieving best execution but are demonstrating to clients they are enforcing a policy that is signed off by senior management, effectively monitored and backed by supporting data.

Sabine Toulson, managing director at LiquidMetrix, says regulation has propelled impartiality up the buyside’s list of priorities. “In the last year and a half we have been approached far more by the buyside, which has been more interested in independent analysis,” she adds. “They want to be able to compare their brokers in a more standardised way rather than getting individual reports, which may not contain the same benchmarks and cannot be compared on a like-for-like basis.”

While a broker report might provide in-depth examination of trading activity, it only offers a single perspective. LiquidMetrix notes the growing penetration of its reports across the buyside allow an interrogation of all the brokers, their chosen venues, algorithms and performance comparison.

While MiFID and the FCA can be blamed – or rather, thanked – for shining their light, the media also has a role to play, according to Toulson.

She says the publication of the Michael Lewis book ‘Flash Boys’ and stories around high frequency trading as well as arguments over venue toxicity, and coverage of the various dark pools under investigation in the US have collectively driven TCA up the agenda.

Beyond equities

As the industry shifts away from just high-level TCA measures around order routing, implementation shortfall, volume-weighted average price (VWAP) and post-order price reversion towards more granularity, MiFID II is also expanding its reach beyond equities.

Fund managers are happy with the broader view. For example, while Investec Asset Management recognises the maturity of equity market TCA, drawing on a broad church of benchmarks and analytics, Mark Denny, its head of dealing, global markets sees the need for “meaningful execution analysis across all asset classes”.

Denny adds that while foreign exchange TCA may now be established in the major currencies, it is not the case in the emerging markets space, which holds greater importance for the South African based fund manager. Further, as bond TCA progresses in the more liquid and regularly traded markets he says it also struggles to find relevant benchmarks in less liquid instruments.

At BNY Mellon subsidiary Newton, head of dealing Tony Russell is also keen to branch out and says he has been working with long-term TCA provider ITG to roll out FX this year, with fixed income capability to follow. However, he concedes data accuracy and availability is difficult.

“We need to get to the point where the fixed income data gives a true representation of the marketplace but at the moment there is not enough data and it is not clean enough. It is a challenge for a number of reasons – liquidity is an issue as well as price transparency – the investment banks hold less than 10% of the liquidity in the market, which is why there are huge calls for buyside to buyside trading platforms to aid clearer price formation, to help improve transparency and liquidity.”

Counting the costs

While the explicit costs – commissions, counterparty trade novation data, data around venues – can be sought externally, implicit and opportunity costs are harder to measure. As such, asset managers might be better conducting some, if not all, of their TCA internally.

Robert Henry, director at GFT, says more common is the bifurcation of solutions – combining the critical information found internally and externally. “It is very hard for them to assess opportunity costs – the time between the fund manager’s decision to trade and executing that trade comes at a cost that needs to be assessed.”

He believes there is value in both options. “While the widely held view is that third parties provide the best chance for independent analysis of trades, the issue is they cannot provide pre-trade or real-time intraday market activity that is critical for TCA.”

Kames Capital’s head of investment trading Adrian Fitzpatrick goes even further, saying external TCA is too backward looking. He has turned away from third-party TCA altogether, favouring proprietary tools such as execution management systems, which negate the need for external provision and improve the real-time capability.

“At Kames we no longer take third-party TCA because we utilise other metrics including our EMS to monitor trades as we are actually trading them,” he adds.

“If I do a trade and it is incorrect I can see if a broker is trading it today, so if I give various parameters, such as I want to be 15% of the volume and they are only 5%, I can get them to adjust it to make sure they are in line with my instructions.”

Ultimately the primary objective of using TCA is to ascertain the impact of various trading practices on investment returns, and asset managers – especially the ones delivering quantitative strategies – are increasingly well-informed. More data, plugged into independent analysis, and used to complement the sellside may well create an optimal solution.

“We now see more and more trends into understanding the effect on fund returns; more from quant side fund managers trying to understand the associated costs and what percentage of return is lost due to the implementation of investment ideas,” says ITG’s Brandes.

“You will never know how much the processes hurt your fund unless you measure it.”

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Trading in Dark Pools – An Asset Manager’s Perspective

GlobalTrading

April 18, 2015

Øyvind G. Schanke, CIO and Simon Emrich, Lead Analyst at Norges Bank Investment Management examine the rise of dark pools and highlight issues of concern to large longterm global investors.
Off-exchange trading has evolved and increased in importance in recent years. This is partially driven by the increased ‘institutionalisation’ of asset management. At the same time, the advent of computer-based trading and the emergence of new forms of liquidity providers such as high-frequency traders in an increasingly fragmented market has changed the nature of equity trading¹.
‘Dark Pools’ have been in the news recently, and are often seen as one of the potential problem areas of modern market microstructure – no doubt due in part to their somewhat unfortunate name. As a large participant in asset markets globally, NBIM has a more differentiated view. ‘Dark pools’ cover a wide range of trading venues that are utilized at different stages of the investment process, either directly by the investor, or by a broker employed as an agent. The impact of dark pools on market quality needs to be analysed based on these different uses.
Do dark pools contribute to well-functioning markets?
For present purposes, we define this as supporting a market structure that maximizes natural liquidity (long-term, natural buyers and sellers can find each other with high probability) while minimizing cost (rent extraction by intermediaries such as high-frequency traders, exchanges and broker/dealers should not be excessive). Several dark pool characteristics can help in achieving these objectives:
• they can efficiently facilitate direct block trading between institutional investors,
• they can serve as competitive checks on exchange monopoly power, and
• they can be tailored to specific market participant requirements, and innovate rapidly.
These benefits have to be weighed against the potential efficiency drag that dark pools can introduce to the price discovery process. Dark pools operate without pre-trade transparency. This means that the residual volume that is traded on ‘lit’ exchanges becomes more informative. This can increase instantaneous volatility and the cost of price discovery.
Dark trading venues can be classified in a number of different ways – Butler (2007) segments 24 US dark pools into 16 different types, for example². A classification by the stage of the investment process in which a venue is used is particularly useful. Some dark pools focus on direct block crossing, and typically appear early in an investor’s execution plan. These pools show large average trade size and low fill rates. Other dark pools – most of those operated by broker/dealers, as well as independents and HFT ping destinations – have smaller trade sizes (comparable to those in lit exchanges) and higher fill rates. These pools typically appear later in an investor’s execution plan, after the investor has delegated execution to a broker.
Block crossing venues are the modern-day equivalent of ‘upstairs trading’, which is probably as old as exchanges. Their potential utility has increased as global asset markets have become increasingly ‘institutionalized’³. Institutional liquidity demand is likely to be ultimately satisfied by the contra liquidity demand of another institutional manager. Block crossing venues serve to efficiently facilitate such trades. Ready (2013) shows that these venues account for between 5 and 8% of US large cap institutional flow⁴. One area of interest for us is whether this percentage can be increased.
For the remaining institutional flow, a broker is typically tasked with sourcing liquidity, with the understanding that this will lead to market impact. Typically, this involves a trading algorithm, which will break up a ‘parent order’ into small, sequential ‘child orders’. At this point, the number of venues that may be accessed increases significantly. In addition to traditional exchanges, these include the second type of dark pools described above. Trade sizes across these trading venues are typically comparable. However, the venues differ in probability of fill (from near-certainty for market orders sent to exchanges, to very low for most HFT ping destinations), toxicity (information leakage) and cost.
Subject to a broker’s best execution obligations, their algorithms’ venue routing decision will be driven by economics. This includes explicit access costs for the broker, as well as competitive considerations which can lead to excessive fragmentation. This increased competition is effective in limiting rent extraction by exchanges and liquidity providers. However, execution quality considerations mean the investor has to direct the broker on permissible venues and trading strategies. Execution benchmarks are an important tool, but in our experience more explicit venue selection criteria are also necessary. For example, we do not believe that the liquidity from HFT ping destinations is worth the information leakage costs. For other venues, as well as exchange-operated hidden books, the picture is more nuanced and requires constant monitoring of execution quality.
We believe that both block crossing venues and other dark pools can play an important role in ensuring well-functioning markets. In particular, they are useful in limiting rent extraction by intermediaries. Recent letters from US exchanges to brokers and investors indicate the effectiveness of this; however, we believe that there has to be a broader discussion on exchange costs – especially around data fees.
At the same time, transparency around the operating procedures of many dark trading venues is needed. Publication of Reg ATS forms by many of our US brokers is a useful first step; we are in favour of further transparency about operating procedures and available order types, particularly if they differ by client. If we do not feel we have sufficient transparency in a given trading venue, it will not be on our whitelist of permitted trading venues for our brokers.
We are also actively working on establishing and strengthening direct block crossing venues. We believe these trading venues should have greater prominence in today’s equity markets, and are a better reflection of the reality of ever-increasing institutionalisation of asset markets.
Dark pools are a valuable complement to exchanges, and are an essential part of today’s market structure. However, they can introduce avenues for novel forms of rent extraction through insufficient transparency. This is also not a new phenomenon – as always, it requires vigilance and a proactive approach by asset owners and managers.

Reforming The Regulation

GlobalTrading

April 18, 2015

Jim Toes of the US Security Traders Association discusses the role of public comment in forming US regulation as well as its effects on other asset classes and international markets.
US equity market structure endured criticism in recent years, raising questions about its functionality. Yet, US equity markets remain the most liquid in the world, with the tightest spreads. It would appear, investors do not share the same level of concern as the financial press.
In considering market structure and the role of regulation, a balance must be struck. Regulation should allow market participants to compete among themselves like, one broker dealer with other broker dealers and then, to a certain degree, between themselves like broker dealers competing with other participants for example exchanges.
While the regulator and market participants differ, in that regulators and participants have fundamentally different roles to play, the discussion must move to procedures and policies. It is the responsibility of regulators to be in touch with the marketplace and decide whether more feedback is needed via a review or a concept release, after which, new rules can be introduced with comment periods.
All market participants are able to comment on SEC concepts, releases and rule proposals. Regardless of whether ideas start from public discourse and the SEC takes them into consideration or the SEC pens a proposal and submits it to the public for comments, ideas and the responses they engender, do circulate in a transparent manner.
To facilitate more accurate regulation, the SEC has taken great strides in its ability to capture data through its Market Information Data and Analytics System (MIDAS). The SEC’s Office of Analytics and Research, comments on its interpretation of the data via its website, which enables market participants to comment on the process.
So they have the ability to pull in data through their MIDAS system, they have the ability to interpret it through their department of economists. They’re being transparent in how they are interpreting it and through the website, which is their outreach program to market participants, and which enables people to look and comment.
The SEC’s transparency has reassured traders, and its transparency dramatically increased the SEC’s industry credibility. Increased reliance on data may also encourage regulators to prioritise standardisation of infrastructure to facilitate more efficient supervision.
Competing visons
Similar companies, with similar business models could be expected to think, well, similarly. The proposals from BATS and NYSE, however, appear to disagree on fundamentals, or at least priorities.
HFT has created a virtual exchange where liquidity can flow rapidly from one asset class to another, yet there is a natural friction from pressing different asset class’ trading infrastructures into one model. Now there is pressure amongst the two competitors to homogenise trading infrastructures across assets so liquidity can flow even more easily.
The rise of ETFs as a widespread investment vehicle are an obvious source of this pressure, given their need for electronic access to different assets.
Global disharmony
Regulatory harmonisation, a central thrust of financial regulators’ response to the global financial crisis is beginning to lose steam. There was a time when the SEC would make a market structure rule and other countries would replicate it. As markets globalise, however, a number of larger markets are making decisions based upon what they deem best for their participants.
Having said that, liquidity continues to course around the world. Global money flows pressure regulators’ decisions because the wrong decision could very easily see liquidity leave their nation. Traders in far flung jurisdictions depend on their domestic regulators’ tacit cooperation with US counterparts.
FINRA’s Trade Reporting and Compliance Engine in the US obviously had a major impact on fixed income and benefited investors, but market participants need to realise that transparency has a cost. That cost can be explicit, through the operational costs of providing added transparency to investors, or implicit through the way existing participants change their behaviour.
In the next three to five years, non-equity asset classes will go through a review as to how it would work on an equity-style market structure platform. Just as FX went from an over-the-counter market in the 1980s to the equity-style market we have today, the pattern will repeat.

Unbundling revisited : Lynn Stronging Dodds

Lynn Strongin Dodds

April 14, 2015

Unbundling revisited

Ever since the Myners report in 2001, the unbundling of research from execution has been a hotly debated topic. However, it has never seemed to be placed that high on the asset managers’ agenda until now. European regulators are forcing their collective hand but as with so much of the legislation flowing through the pipeline, there will be an initial wave of confusion before a clearer picture emerges.

At the moment, Europe’s national regulators have different views of the European Securities and Markets Authority (ESMA) vision of MiFID II, which comes into force in 2017. The UK’s Financial Conduct Authority is among those advocating for an outright ban on charging investors for research out of share dealing commissions while its French counterpart, AMF (Autorité des Marchés Financiers) is against such a move.

This wrangling between European local authorities is hampering progress, according to a new report – The Changing Face of Equity Trading: Paying for Research by Rebecca Healey, a principal and senior equity analyst at TABB Group. The study which canvassed 44 long-only asset management firms and seven hedge funds, managing €25.5 trn in assets under management found, that 38% of UK firms and 30% of all firms are now sitting on the side lines, unsure of what to do next.

One potential solution to break the regulatory deadlock for over 90% of the respondents is mandated commission sharing arrangements (CSAs) although this also includes 20% who recognise they are only part of the answer in generating greater transparency over fees. The UK has been leading the charge in not only increasing their use of CSAs but also in valuing third party research and separating research from execution costs.

There will be a limit to the activity though as the Investment Association expects asset managers to delay negotiations with pension fund clients until the European Commission officially adopts ESMA’s recommendations, which is expected in the second quarter of this year.

As with many changes, it could be the smaller firms, particularly those on the continent, that suffer the most. These concerns are borne out in the TABB study which showed that nearly 80% believe this group could face a greater disadvantage and may struggle to afford to pay for external research. This is because only those with deep pockets will be able to afford the breadth of research provided by large as well as regional and specialist brokers.

The UK firms are not as worried with 35% seeing a flight to quality research and not an outright drop, which is in sharp contrast to the 86% of the firms across Continental European which expect a more severe decline. Although it is hard to predict the actual outcome, all agree that the cosy world of bundled commissions will be broken up to a large degree.

Lynn Strongin Dodds
Managing Editor

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Liquidity And Transparency: Not Necessarily Two Sides Of The Same Coin

GlobalTrading

April 10, 2015

Brett Chappell, Head of Fixed Income Trading at Nordea Investment Management examines the changing dynamic of European fixed income, and how the answers may not be as simple as they first seem.
Liquidity is making the rounds as the top buzz-word of 2015 in the fixed income universe. Everyone bemoans the lack of it, and points to the heady days of a decade ago when it was abundant. In the run up to the crisis, there was in fact a liquidity bubble, one which led to a somewhat overzealous use of balance sheet by certain market players. When RBS filed its 6-K with the SEC on August 3rd, 2007 it stated “Total assets were £1,011.3 billion at June 30 2007.” To put that in perspective, this roughly equates to the 2007 annual GDP of the Republic of Italy.
Today things are very different, and the pressures being exerted on the flow of secondary market trading have reached boiling point. In certain asset classes, such as European Credit Bonds, it is becoming close to impossible to move wholesale sizes in the market without causing a ruckus. Banks are being told to swim with handcuffs on – the regulation is both onerous and in certain cases contradictory. A deluge of acronyms: COFIA, CRD IV, CRR, CVA, etc. is causing alphabet soup-induced indigestion among front office and compliance personnel alike.
It is abundantly clear that banks are displaying greater reticence in using their balance sheets in providing two-way liquidity to the market. The cost of capital is at a premium, and many banks’ market operations are reevaluating their business models. Is it economically viable to allocate resources and balance sheet to this business? Bank trading desks are changing their modus operandi from a principal-based to agency-based approach. “We can work an order for you…” is a rather clichéd response we receive on many queries when we seek to move any size superior to 5 million EUR in the market.
Transparency Liquidity
ESMA (the European Securities and Markets Authority) issued a behemoth of a consultation paper concerning MiFID II on December 19th, 2014 http://www.esma.europa.eu/system/files/2014-1570_cp_mifid_ii.pdf , which asks participants to revert with their input before March 2nd, 2015. There is a very small window for stakeholders to read, analyse, and formulate a coherent response.

Two topics which the technical paper discusses in depth are the definitions of instrument liquidity and transparency. The latter is not a solution to the former.
Moreover, superimposing an equity market template on a fixed income market which has more granular and diversified maturity profiles would make no sense.

The United States introduced TRACE in the United States in the 00’s in an effort to increase transparency in the bond market. The OTC European bond market is less deep and more heterogeneous than that of the United States. There seems to be a current mood to introduce an even stricter transparency regime in Europe in both the pre- and post-trade levels. Transparency in and by itself sounds like a good thing, however the application of it may have a detrimental effect on a smooth functioning of the European financial system.
If a bank must make “professional counterparty” prices available prior to trading a given security, then chances are that the market-makers’ bid-offer spread will widen.
Post-trade reporting will open the door for faster-moving hedge funds and less scrupulous brokers to effectively front-run the interest of a larger asset manager who is incrementally attempting to take-on or off-load a wholesale position. Deferral times should be sufficiently long for market-makers to square positions, otherwise they may find themselves unwilling to provide markets in given bonds. ESMA is proposing to set up standards for a liquidity classification on an ISIN by ISIN basis per instrument (covered, credit, etc.) with classifications such as SSTI (Specfic Size to the Instrument) and LIS (Large in Scale). Deferral rules and waivers will apply on an individual basis.
Experience shows, especially in times of market stress, that the European corporate bond market is by its very nature illiquid. Some insurers, for example, with very specific accounting rules in place, will buy a well-rated benchmark bond and hold it for an extended period of time. In an ideal situation with no major swings in investment strategy or issue ratings, this bond will be held until maturity or at least the point when it reaches a short enough tenor to be reclassified and sold off to money market portfolios. CSDR (central securities depositories and securities settlement regulation) legislation in the EU will introduce forced buy-ins, which may reduce banks’ willingness to provide offers in a market where the bonds are simply squeezed in the repo and difficult to procure. Market-makers may have to reevaluate their willingness to provide two-way prices in the bond markets.
Dude, where’s my liquidity?
We at Nordea Investment Management wish to have as many viable trading counterparties as possible for access to greater liquidity. We speak to bulge-bracket and niche players who endeavour to provide us with good research, prices, and liquidity when we need it. To this effect we must ensure that our counterparties are solid entities on whom we should rely. The KYC process is very thorough, as it is important that we deliver the best returns to our clients whether they are retail or institutional investors.
Trading
Most outstanding European debt is no longer on the traders’ books, and the bottleneck to access the market in RFQ format is currently dysfunctional. Many initiatives are underway for various trading platforms to enter the fray to challenge incumbents Bloomberg, MarketAxess and Tradeweb. The technology is there, and MiFID II requirements can be programmed in. The three majors are all introducing more developed platforms along with nimble entrants who can tailor-make solutions to the needs of 2015. Examples of the latter include Algomi, BondCube, TradingScreen and Liquidnet. These new solutions are meant to supplement, not replace, existing relationships with sell-side counterparties.
Inventory
Technical projects further upstream from trade execution, such as Project Neptune, will create the nuts-and-bolts of pre-order delivery of bank inventory to the buy-side through a FIX API standard. This is supplemented by receiving Excel spreadsheets from brokers, on-line services such as B2Scan, and pure data mining on Bloomberg.
It’s NOT equity
When financial laymen ask what I do, and I reply finance, I usually receive hostile stares. Often people will ask me what stocks to buy but I have to come clean and tell them I work with bonds. Explaining debt maturity profiles, coverage ratios and Basel III capital requirements is a sure-fire way to kill a dinner party. The equity market is easier to grasp – there are one or two instruments to choose from in general, not in some cases several hundred ISIN codes from which to choose. Dealing in debt requires great patience as the general illiquidity of the instruments makes it very difficult to trade at levels seen on screen. A typical European Bloomberg ALLQ is simply a two-way indication of 1 million x 1 million EUR. Our experience shows that circa 50% of the time, the prices are purely indications, and even small queries to the tune of 250,000 EUR can lead to a bank pulling back its offer by 15 cents in an investment grade bond. When the size tends to be larger, say in excess of 10 million EUR, we on the trading desk have to very carefully consider how, where, whom and when to best to approach the market lest we sweep the rug right out from under us.
L’UNION FAIT LA FORCE / EENDRACHT MAAKT MACHT
The drivers for this European innovation seem to be based at the termini of the Eurostar: Paris and London. However, the asset management community is of course spread out throughout Europe from Lisbon to Helsinki. These players are in constant dialogue with the local regulator, but need to be aware of the changes afoot and to openly discuss the matters at hand. The changing landscape will have very large consequences for the asset management community. Since many European banks are becoming less willing to lend to the real economy due to capital restraints, it is the investor community, which is now in the driver’s seat providing funding for companies, infrastructure, and other projects that promote growth and employment.
European Commission President, Jean-Claude Juncker has proclaimed his support for a Capital Markets Union http://ec.europa.eu/priorities/docs/pg_en.pdf This is a lofty goal, but the devil is in the details. It is of paramount importance that ESMA gets this right. Finance is already the most regulated industry in Europe. Decisions taken in the coming months will have a resounding effect on the business and repercussions beyond the trading floors.
Ultimately it becomes a question of how end-investors can efficiently provide financing for the firms that make up the real economy. The approach must ideally be backed by both a broad representation of buy-side and sell-side to put forward as much as a common front as possible given what is at stake. Unity makes strength, and it is important that the rules are set right from the beginning. It’s not just good for the clients’ investments at risk, but Europe as a whole.

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IN THE RIGHT PLACE, AT THE RIGHT TIME.

By Philippe Chambadal, CEO, SmartStream

AT THE LEADING EDGE.

Iwona Sroka, PhD, President & CEO of KDPW and KDPW_CCP.

BUYSIDE LOOKS INHOUSE FOR SOLUTION.

Sam Shaw looks at how asset managers are developing their own tools.

Unbundling revisited

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