Adam Conn, Head of Dealing, Baring Asset Management looks at the FIX Trading Community’s IPO Automation Project
At the 2014 FIX Trading Community conference at Old Billingsgate in London, Michele Patron of Alliance Bernstein and I spoke on a panel to discuss initiatives such as the standardisation of Execution Venue codes and the use of FIX in electronic trading of Fixed Income.
We were there in our roles as two of the three co-chairs of the EMEA Investment Management Working Group, along with Paul Squires of AXA Investment Managers.
We also set out our vision of a world where we as traders could create an STP Process for the electronic transmission of new issue orders from an asset manager’s Order Management System through to the Deal Managers and receipt of allocations back to it.
The primary driver behind such a process would be mitigation of risk by digitising a manual process. Current market practice is for applications (orders) for new issues such as IPOs to be placed manually. The idea is to try and eliminate the risk of error in the transmission or the possible misinterpretation by the receiver of these placed orders by trying to replicate the electronic order placing process in the secondary market.
Automation would also address other problems with the status quo, namely speed, reliability and the integration of this workflow into wider systems: part of the on-going trend of ‘Straight Through Processing’ from front to back. It would essentially upgrade the existing methodology whereby some of the largest single orders an asset manager may give are manually placed with each manager in a book-building syndicate. The electronic communication of new issue applications and receipt back of allocations (quantity filled/executed) seems a natural extension of the existing integration between the Buy-Side OMS and Broker.
At that conference I met with Scott Atwell of American Century, who had discussed a similar aspiration with other members of the US Buy-Side group. After discussion within FIX Trading Community, a Global Buy-Side Working party was established to devise a set of best practice guidelines that would work for both Buy and Sell-Sides.
The multinational approach arising from the global nature of the working group has allowed us to draw on each other’s experiences in different jurisdictions and create a process that should fit regional nuances. The advantage of doing this through the framework of the FIX Trading Community is its neutrality, allowing us to engage with a variety of enterprises to create this new process mindful of the need to standardise disparate processes between markets, participants and systems.
To facilitate this workflow, many factors have been identified for consideration, starting with the need to ensure official stock identifiers are available well in advance of the closing date of an offer. It is crucial that these standard identifiers are used by all parties. The London Stock Exchange has been very supportive, working with us to ensure that global SEDOL codes may, subject to the permission of the Lead Deal Manager, be released when a deal is made public. We have also had similar positive conversations with CUSIP, which also releases its symbology in good time and Bloomberg, as a leading data provider, which confirmed that when this data is released it is immediately made available to its users.
The focus has been on equity IPOs given there is a more significant time period between when an application is made and the deal potentially closing, but the intention is that this process will equally lend itself to Fixed Income new issues, provided ISIN stock identifiers are made available. The move towards single access to all fixed income electronic platforms and the innovative changes we are starting to see in book building should both benefit from the move towards greater automation in order generation and receipt of allocations.
Whilst the FIX Trading Community remains strictly vendor neutral, there have been some detailed conversations to understand the proposed workflow with the leading providers of Book-Build software to the Brokers, which are looking to offer their software to the Buy-Side and with other technology and FIX network providers.
There must of course be two ends to a connection and the next stage of the evolutionary cycle will be to work through the feasibility of this project with the Syndication Managers who, in early conversations have expressed support for this initiative.
Finally, we are all aware that paradigms shift and today’s norm may not be the same as tomorrow’s. The Global Buy-Side working group is mindful to progress this initiative in a manner that lends itself to the future of the book building process, in whatever direction that takes. Whilst ensuring there is no impediment to future direction, we believe risk mitigation is a step in the right direction. This is an industry initiative for the industry. Whilst there is no directive pushing this change, we hope our colleagues who want this new world will join us in making this successful.
Driving IPOs
Technical Implementation
By Scott Atwell, Manager FIX Trading and Connectivity, American Century Investments
Leveraging the FIX Protocol to electronically communicate IPO order-related information is a natural extension to the existing FIX-based integration buy-side Order Management Systems already have in place with their brokers. FIX’s Global Buy-side IPO Working Group was able to bring together a number of buy-side firms with similar needs, and we were able to specify how firms can easily use existing FIX messages to support IPOs.
The working group’s recently released IPO Recommended Practice/Guidelines document identifies two workflow models. The first model describes “Point-to-Point”, whereby a buy-side firm communicates directly with the sell-side firm who is acting as the IPO’s “Booking and Billing Agent”.
That sell-side firm would then be responsible to communicate the buy-side firm’s intentions to the other sell-side firms within the syndicate. The second model describes “Multi-broker Deal Hub”, in which the buy-side firm communicates via a single session to a multi-broker deal hub platform – without specifying a specific target broker – where the hub integrates connectivity to all of the relevant sell-side firms.
The most complex orderflow scenario is “Stepping (Multiple Limit Orders)”, used when a buy-side firm is willing to buy one amount at one price, and more at a better price, in which case multiple FIX limit orders will need to be sent – each one exclusive of the others. FIX’s Global Buy-side IPO Working Group believes that the industry can significantly reduce risk and enhance efficiency and accuracy by leveraging the FIX Protocol for IPOs. Fortunately, several key sell-side firms and deal hub platforms have already expressed interest in working with the buy-side firms to adopt FIX for IPOs.
A New Model For Changing Markets
By Stephen H. McGoldrick, Project Director, Plato Partnership.
The institutional equity markets are a complex ecosystem. In recent years the fragile balance of that system has been challenged by compromised stewardship and new regulations. It could be argued that since demutualisation, exchanges have been focused on driving value for their shareholders and the pricing power they exercise in relation to market data costs, trading fees and ancillary services has led them to tip the balance toward their own revenues. Similarly, while regulators have an imperative to ensure the security of the market, they also seek to balance that with maintaining the appeal of equities as an investment class. In recent debates the regulators have been poorly served by venues and participants who have supplied scant data. These failings are threatening the attractiveness of the equities, both for investors in the secondary market and for potential primary issuers seeking financing.
What is Plato?
In light of this environment, a consortium of market participants from the asset management and broker dealer community are collaborating to create a not-for-profit trading utility in Europe. Its governance structure recognises the traditional symbiosis and demarcations in the relationship of the buy-side with sell-side while updating that old model to reflect the significant increases we have seen in the sophistication of the buy-side approach to execution. By remutualising participant involvement in market design, the proposed governance model would allow Plato’s members to focus on driving improvements in the market without some of the challenges created by the conflicts inherent in current venues.
Integral to the vision for the platform is an academic research fund. This should produce independent research and analytics, open to peer review, and aimed at seeking out ways in which participants can collectively build a better financial ecosystem, as well as helping to inform and support the regulators’ market structure debate. This research will be funded by revenue generated from Plato’s trading utility.
In terms of its governance structure, the platform will have the participation of both buy- and sell-side firms. This is important since the success of the venue can only be guaranteed if it works for both sides. A Trust-like structure will be employed to ensure that our core principles will not be compromised over time.
Plato’s founding members include Deutsche Asset and Wealth Management, Norges Bank Investment Management, UBS, Barclays, Citi, Deutsche Bank, Goldman Sachs, JP Morgan and Morgan Stanley, along with others yet to be named. Significantly, this is the first time that this range of organisations have worked together in this manner, which we believe makes this a very exciting and unique proposition.
MiFID: A Catalyst for Positive Change
For large investors, well-functioning markets are essential, and over recent years, a number of changes to markets, regulations and participant profiles have altered the buy-side’s experience of trading in size. The forces shaping the market have led to dramatically declining average trade sizes, and with the ever-increasing prevalence of high frequency strategies, block trading has become increasingly more difficult to transact.
Plato is embracing the changes that are explicit and implicit in the regulator’s direction to the market, specifically around increasing the size of trades done in the dark. We believe that MiFID II, due to be implemented in January 2017, can become the catalyst for positive change to this ecosystem. Today, dark trading under MiFID typically utilises the Reference Price Waiver (RPW) for public non-displayed midpoint trading of child/algo orders.
However, MiFIR Article 5 imposes a cap on such trading at 8% of trades transacted under the RPW and certain Negotiated Trades in aggregate. This, together with new Trading Obligations (MiFIR Art. 23) will limit how and where trades are executed, moving more activity onto lit exchanges that are ill-equipped to serve the entirety needs of large asset managers. In the absence of a market response, this will have a material impact on the market, altering the European trading landscape significantly, especially for larger wholesale funds as well as for less smaller listed stocks.
Rehabilitating Equity Markets
There are a large number of processes and data flows ancillary to executions where we pay too much or where I don’t believe it helps any one firm if another one does them badly. What actually suffers is the equity market efficiency or external stakeholders’ views of the fairness of the market – something which the financial services industry has certainly had to deal with in recent years. It is relatively easy to identify the areas where a collective approach should produce a better outcome for less expenditure but the economics of tackling those issues are challenging if you have to create a new vehicle to do it each time.
Plato could play a vital role in helping to build fair and robust future markets through the neutral governance it is answerable to and its combined research arm.
Disintermediation? Don’t Bank On It.
By James Cooper, Head of Execution, Troy Asset Management.
There is a creeping fear among banks and some brokers that they are destined to be squeezed out of the execution chain by the exchanges on one hand and the buy-side community on the other.
The three-way relationship has been a mainstay of execution since the days of the Buttonwood Tree and the London coffee houses. The broking community, originally banished to the coffee houses from the Royal Exchange for their rowdy behaviour, has always been expert in bringing buyers and sellers together; they have continually innovated the hard technology and new commercial initiatives whilst maintaining (in nearly all cases) a reputation for trustworthiness and discretion.
Traditional exchanges meanwhile have provided not just a safe environment in which to transact but have always helped to form the rules of engagement well before regulators were even dreamt of. Since Thomas Gresham founded the Royal Exchange in 1571, there have been clear rules and exchanges remained broadly self-regulated until June 1985 when the forerunner of the FCA, the SIB, was created. Indeed self-regulation of the exchanges only really came to an end following the collapse of Barings in the 1990s. From the rules applied in the original London or New York coffee houses, to the circuit breakers and randomised electronic auctions of the present, public exchanges have provided a robust infrastructure upon which to transact.
The relationship, however, hasn’t always been cosy and the past few years have been especially tense.
Since the liberalisation of exchanges under Markets of Financial Instruments Directive I (MiFID I), the incumbent exchanges have been buffeted by heightened competition that has occasionally threatened their very existence and very often their own independence. Initially the broking community didn’t compete directly with the exchanges on their own patch, preferring to leave that to either competing foreign exchanges or start-up technology outfits. However, the development of Broker Crossing Networks (BCNs), originally envisaged as a means to allow the brokers’ institutional clients to cross large blocks discretely, soon offered a means for the brokers to apply even greater pressure on the exchanges.
At the same time, brokers have been raided by the buy-side for both their human capital and their technology. The buy-side has felt the regulatory pressure to deliver better and more transparent execution and much of the required expertise have come from the sell-side. Demoralised brokers have moved to the buy-side to develop the dealing desks and help develop the in-house, direct-to-exchange routers that were first pioneered by the sell-side.
Finally, both sell-side and buy-side have felt let down by the exchanges on two counts of late. The first has been their apparent reluctance to lower data charges and the second has been their perceived kowtowing to the high-frequency traders (HFT) at the expense of the “real investors”. The exchanges and their shareholders have benefitted greatly over the past ten years from the volumes traded by the HFT – as indeed have many of the banks. Institutional clients have felt that their ability to transact large blocks effectively has been made much more difficult. Many buy-siders have become so frustrated by these perceived conflicts of interests that radical initiatives are often threatened. Occasional flashpoints highlight the tension in the three-way relationship. Most recently the lobbying of EU parliamentarians and regulators by the exchanges and the brokers about the dangers or otherwise of “dark liquidity” and “off exchange” transactions has cut some particularly deep scars that will take time to heal.
But heal they will
As we enter the second half of the decade, and as the various stakeholders think about the shape of the industry post-MiFID, there are signs that the industry is rediscovering the value of the three-way partnership.
I was fortunate enough to be involved recently in the development of the Turquoise Block Discovery Service (BDS). The buy-side working group for BDS felt strongly that transactions should take place on a public exchange and that the service should be broker neutral. Some of us were worried that the broking community might be cautious of such an initiative. The reality has been the opposite: the brokers have understood the value of the service, have helped police it and have been instrumental in making it available to all. At the same time, the stock exchange involved in the BDS project, showed how adept it could be at implementing the buy-side’s specific requests. Although exchanges have tried to become more commercial in recent years and have tried to understand the buy-side’s requirements more comprehensively, they will always remain a long way behind the brokers in understanding investors’ all-round needs and guessing how they might improve their service. Brokers will always own the nexus bringing clients together especially for the purpose of large block transactions.
As the industry faces the end of BCNs and tighter regulation on dark pools, both sell-side and buy-side are appreciating how difficult it is to create the scale and integrity needed for a successful trading venue. Importantly, the public censure and fines received by Barclays and Goldman Sachs for the failings of their own venues combined with the sometimes sensationalist allegations made in “Flash Boys” by Michael Lewis, mean that politicians and the public may find it hard to ever trust bank-owned venues. Public exchanges have the expertise embedded deep within and have earned a valuable reputation for neutrality and competence. The current attempts to influence the shape of European trading ahead of MiFID II implementation and beyond have revealed that recent tensions between the actors have been a cause for positive change. Recent spats have helped to clarify where the role of one party ends and that of another begins.
It is true that there is a surfeit of European trading venues currently, but sensible regulation and market forces are gradually reversing this. True, also, that brokers are finding it hard to earn a decent risk-adjusted return on agency execution. But again, market forces and a growing reluctance to subsidise loss-making execution platforms are both correcting this.
It is clearer than ever, that exchanges are required in the system for their neutrality and their technical heritage. Brokers meanwhile are vital for their skill in bringing buyers and sellers together in a discrete and ever more efficient manner.
For its part, the buy-side has two distinct roles in the game. Firstly, it should focus on its core competence of managing other people’s money and not on building buy-side to buy-side venues from scratch. Secondly, it should visibly support and promote this three-way partnership that continues to provide the best possible structure for long term savers.
Man vs machine – the Schroders story
By Jacqueline Loh, Head of Asia Trading, Schroders.
Schroders Asia first started using direct market access tools and algorithms for trade execution in 2006. Since then, the proportion of trades carried out via electronic execution has grown significantly in terms of volume of traded turnover. This would not have been possible without the increased sophistication of algos and refinement of TCA (transactions costs analysis) analytic tools to measure trading performance. In line with Schroders’ best execution policy of implementing trades with minimal total impact costs to clients, electronic trading was initially introduced to help traders minimise impact costs by gaining better overall control of their trades. It was not a conscious effort to pay less commission, although that later turned out to be one of the indirect results.
The journey over the past few years has been a very profitable and enlightening one. We made new discoveries every day, such as which broker provides the most hardy algos, which algos work best in which Asian markets, which ones were particularly suited for volatile markets. We continuously monitor the quality of our low touch and high touch execution, and the relative proportions of these to ensure that we are making optimal use of all the execution venues available to us.
The past few years have spawned a myriad of DMA and algo providers for Asia electronic trading, accompanied by a vast array of algorithms. It therefore made sense to try to differentiate between the algos as well as determine whether we were utilising algos in ways that added value.
Objective of the study: To determine if there are any significant differences in trading performance, measured against two benchmarks (arrival price and VWAP), between results achieved using fully automated algos and semi-automated algorithms.
Methodology
Using data for all of 2014, we classified all the trading strategies used by the Asia trading desk into the following two categories:
– Automated
– Semi-automated algos
Definition of automated algos: All auto schedule, auto participant type algos.
Definition of semi-automated algos: Algos with a high degree of trader input such as picking price levels and market timing.
The performance of all these algos were compared against two benchmarks – arrival price and VWAP.
Results
These are the results obtained from our two algo providers.
From the above graphs, it is clear that semi-automated algos outperform automated ones against both benchmarks – arrival price and VWAP. Divergence in performance is increasing with difficulty of trades, as represented by high ADV trades.
Singapore Roundtable: Maximising Your Data
By Peter Waters, Managing Editor, GlobalTrading.
On the 3rd December 2014 GlobalTrading hosted a roundtable discussion to examine one of the key challenges for market operators; how to better capture, analyse and use data to generate revenue.
Getting the data and viewing the data are two very different challenges, and both need addressing before a market operator can use the data both as a strategic asset for internal purposes and as a revenue generating asset.
Our roundtable, moderated by long-time market operator expert Ned Phillips, developed around numerous key themes; one of which is the idea that firms need to constantly adapt to the changing nature of data itself. Market operators need to be constantly incorporating new data sources as well as the existing types of data which can be structured, semi-structured and unstructured. And most importantly, all of this data needs to be captured and analysed in a comparable way.
A significant area for development, in Asia and globally, is the division between regulatory data and that which can be used and sold as a marketable commodity. The room discussed the consequences of the fact that in Asia especially, different regulatory regimes determine at what point data can be released and to whom, and so market operators need to be aware of their obligations. The other side of this debate is around data standards, and what standards, if any, exist in terms of capturing data, time-stamping, formatting, and storage. These questions need to be addressed before an exchange can fully appreciate just what freedom it has to monetise the data.
Data is one of the major areas where exchanges now realise they can generate increasing revenues. For firms looking to provide those services to exchanges, the key is to capture and analyse all of the available data, and let clients decide what is useful, rather than deciding for them. One differentiating factor to consider is the divide between institutional and retail clients, and the big difference in demands and needs that they have. The different exchanges present each offered their own views on their precise retail/institutional mix, and how it had affected their decisions.
Institutional clients are constantly searching to benchmark themselves against their peers and competitors, whereas retail defines their data needs differently, with the potential for data piracy being a concern. The levels of service and price sensitivity need to be flexible enough to allow each recipient of the data to tailor their services. However the point was made that simply by charging for a given asset, it ascribes value to it, so giving away certain datasets for free might not be the best use of that data.
The progression reflected in the way exchanges deal with data ties into the wider theme of exchanges adopting behaviour from the sell-side – a recurring theme throughout the roundtable. Exchanges are increasingly going to clients with products and looking to generate revenue more directly and actively. This trend will continue to grow as market operators realise that they need to be more proactive, both in offerings to clients, and reacting to client needs before those clients realise the need themselves. The holistic dataset that exchanges have, once properly analysed and visualised, can go a long way to drive sales.
The biggest subsequent question from market operators is then their own peer comparison; “What are the other regional exchanges doing?” which goes into how market operators also view themselves – what are their own core competencies and competitive advantages, and how can new datasets and visualisations maximise that? These questions are not simple, and each of the exchanges in the room had a slightly different interpretation of exactly what the best mix for their customers was, the common factor being using the data to better analyse the options available.
An Emerging Middle East
Ahmed Tabaqchali, CIO of Iraq Investments, Asia Frontier Capital looks at the economic history of, and changing market conditions in the Middle East
When people think of the Middle East, they think of it as one homogenous place. The Middle East should be looked at as broad, distinct areas with different dynamics regarding populations, history, especially recent history, and other factors. On the one hand there is the Gulf Cooperation Council (GCC) which comprises Kuwait, Saudi Arabia, UAE, Qatar, Oman and Bahrain. They are incredibly rich nations; rich in oil and resource, but relative newcomers to the world stage. They also have very small populations.
On the other hand you have Egypt, with a massive population but poor resources; similarly lacking in resources are Jordan and Syria. Countries such as Iraq and Iran fall between the two; they were established well before the oil boom with a long history of urban development and share the incredible oil wealth that the GCC has.
In stock market terms, most of the Middle East is retail driven, where retail accounts for around 80% of the market in some places. The occupation of Iraq in 2003 saw rapid growth in western interest in Middle Eastern markets as the Iraq risk premium was mostly removed. If you examine the stock charts, you’ll see from 2004 onward, enormous growth in the Saudi market in terms of market capitalisation. Kuwait and the UAE were similar. Eventually they all peaked at about 2006 after the strong bull markets.
Now they are a major asset class, with Egypt, the UAE and Qatar as part of the emerging market index. And the frontier market index also has major regional representation. The GCC is one of the biggest components in the MSCI frontier market.
A False Economy?
Within the Middle East, the real economy is not well represented in the stock markets. The GCC’s biggest driver is oil and petrochemicals. Now, with the exception of Saudi Arabia, none of the other markets i.e. Kuwait, UAE, Qatar, have an oil company represented on their markets because the oil companies are government owned.
Saudi Arabia is an exception because Saudi Aramco is majority government owned but is listed. It is one of the biggest components in the index, but still nowhere near a true representation of the of the oil sector in the economy. The Middle East is primarily made up of family businesses which are massive players in the economy but very few are listed in the market. The markets are composed mostly of banks, telecoms and real estate.
Market technology
In terms of technology, most of the exchanges use modern systems. NASDAQ-OMX systems are widespread across much of the region. Egypt was one of the first to use NASDAQ with the UAE and Qatar having the same technology. Kuwait moved to NASDAQ-OMX latest system Xtreme in 2012 and Iraq converted in October of last year.
In the Middle East every investor has a unique National Investor Number, whether an individual investor or institutional investor. In the case of an institutional investor the NIN is attributable to the individual fund/account; for example, in a typical asset management firm the Growth Fund or the Small Cap Fund for example will each have a separate NIN.
Furthermore, trading is done in the NIN’s name; for example, a trader cannot aggregate orders and offer 20,000 shares for sale for four people and allocate afterwards. A firm has to put in the four separate orders at the same time using the individual account NIN number for each order. Moreover, each NIN number is linked to a unique settlement account.
At an institutional level this becomes very difficult; for example, where an institution has ten funds and one is a growth fund, one is a pension fund, etc. If the firm wants to buy a million shares of Alpha Beta Gama Company for instance, the order has to be placed/traded individually, X in this account, Y that account which complicates the execution process.
The other element which differentiates the Middle East stock markets is that there isn’t a specialist or market making function. There is no specialist book, all orders in the order book are customer orders and as such volatility can be high as there is no specialist/market maker to ensure a fair and orderly market. This is especially the case when a larger order is placed; it can take out all offers or hit all bids and as such the price can swing a great deal.
For all these and other reasons that complicate trading systems in the Middle East, technology firms have to think “outside the box” when developing new technology for the region.
Iraq focus
Using Iraq as an example as it is my focus; as a major economy with estimated 2014 GDP of USD 230 billion, the economy will only contract by half a percent this year despite ISIS occupation and plunging oil prices according the IMF’s latest figures. The stock market, as a percentage of the economy is less than 4% of GDP. The region as a whole is in the 50s and in more developed stock markets, that figure is substantially higher.
If you believe the estimates, based on the latest available full IMF figures (Jan 2015) Iraq will start growing again by 2.5% in 2015 and by over 7% until 2018. These figures haven’t factored in future lower prices. However, Iraq will still likely grow strongly paced by increased oil production. A stock market at under 4% of GDP is unsustainable with this economy and with such growth.
The major obstacle facing the great majority of institutional investors entering Iraq is the lack of a global custodian. Iraq has custody laws and infrastructure to allow the entry of a global custodian, however, a major obstacle is the size of the market. The whole market cap right now is USD 8 billion with an average daily trading of USD 1 million which doesn’t leave room for any custodian to operate profitably. And without global custody most foreign funds cannot operate.
The wider future
There is much talk of the need for unity across the the region’s stock markets. Finally the preparations are underway about opening up the Saudi market to foreign investors, and I believe they will use the Indian system of the qualified investors.
In terms of international institutional presence, the UAE has the largest because it has been open earlier and easier. It’s a fast growing region. The companies are developing pretty quickly. There is enormous potential for growth in the markets.
Most of the regulators see themselves as comparable to other emerging markets, but technology is a constantly changing challenge that pushes their ability to catch up. The speed of technology advances and the speed of the transformation of the economy is outstripping the capacity of regulators and the law to catch up. That is where the opportunity is because these markets as they develop will become major global markets.
With a long term average oil price of USD 70 per barrel, the GCC will be a significant force. Quite a few countries in the region need to diversify their economies, and they’re using the sovereign wealth funds to build assets overseas, but they are also using them to develop their local economies.
A lot of the family businesses will come to the stock market because like all family businesses, when they reach the second or third generation, family members who either want to monetise their assets or start their own projects, move to listings. That’s how almost all major international family companies became public companies.
As that happens the markets will start to resemble the real economy, and they will start to move from frontier to emerging and they will be major asset classes.
One of the major drivers for uniformity in the Western markets is the growth of institutional investors as a force in the market i.e. other pension funds, insurance funds and ultimately down the road, mutual funds. In the Middle East, that is at a very small scale and almost non-existent. For example, insurance companies are not players in the stock market. Most of their assets are in fixed income and even the fixed income markets of the GCC are hardly developed. So there is not that big force which is needed to drive the market: retail is non-homogenous in behaviour and driving needs.
These markets are developing very rapidly in terms of technology, lifestyle, influence, institutions etc. in line with a society chasing technological and social economic developments. The system itself has to catch up with all of that: how the markets work and how the investment culture and business culture develop, will ultimately drive this region. It will either make or break these markets.
European Equities: How We Got Where We Are Today
Robert Barnes, CEO, Turquoise looks at the progression of European equities to date, and what the future might hold.
Modern equity market mega trends include global passive indexation and the desire to outperform benchmarks by trading block liquidity, increasingly in mid and small caps, diversified by geography. Today European real returns are near zero, so the focus is on efficiency of trading clearing and settlement at instant of investment to minimise slippage cost to enhance long term returns.
In 2001, The Committee of Wise Men on the Regulation of European Securities Markets1 noted that returns on assets over a period of time were growing faster in the US than in Europe. With rising population demographics and an increasing reliance on private sector pensions, European capital markets needed to be competitive for meaningful long term investment returns.
At the time, Europe featured an exchange landscape comprised of single country monopolies. While there were some advantages, this model did not serve well an increasing demand by the user community for nimbleness on fees and functionalities as equity volumes grew world wide. Europe as a ‘single market’ was underperforming its potential. Among contributing factors were higher costs of trading, clearing and settlement. The regulatory tool to address frictional costs was competitive entry.
The findings of the Wise Men report led to the European framework that became the Markets in Financial Instruments Directive (MiFID) which encouraged competition, transparency and investor protection. Best execution was redefined as a process to deliver best possible result on a continuous basis. What followed was a raft of new market entrants, of which some took hold and continue today. Competition reduced exchange fees for cash equities. Innovations driven by the private sector within the regulatory framework included introduction of single order books that could admit for trading securities from multiple countries via a single connection. Complementing these new ‘lit’ order books were broker crossing and external venue ‘dark pools’ where price and size is not displayed until after a trade. In an automated MiFID framework, post-trade transparency is like pre-trade transparency for the next trade.
Post-trade clearing and settlement
With competitive new entry, there was more customer choice and greater efficiency of execution venues, but this required more sophisticated tools and methods to manage. The next major innovation arose from addressing the challenges of clearing in that fragmented environment and the consequence of electronic order books: the trend of shrinking trade size.
In 1999, the average trade size on London Stock Exchange was £64,000. By 2008, this had fallen to below £10,000 per trade. Interestingly, the overall order book value traded from 1999 to 2008 had grown by six times for UK equities but due to the shrinking trade size, the number of tickets had grown by 35 times. Because clearing and settlement costs tend to correlate with the number of tickets, if nothing was done to address this post trade trend, then the overall cost of processing the same value of trades would grow year on year.
This was one of the catalysts encouraging introduction of interoperability of clearing, whereby customers of certain trade venues can choose a single CCP to consolidate their respective trades. Competitive scalable volume discounts drove reduced clearing fees.
Consolidating clearing into a single CCP of choice also offered significant settlement savings. Prior to the introduction of CCP interoperability, if one was trading, for example, Vodafone shares on multiple trading platforms, then, shares via London Stock Exchange would be cleared through LCH. Clearnet or SIX x-clear while trades executed on Chi-X or Turquoise would have be cleared through EMCF and EuroCCP respectively. As a consequence there would be at least three net settlement messages and three net settlement fees per stock per day. Today, that same member can save two-thirds in one step by directing each of those trades into the single clearing house of choice.
Block trading adds further benefit regarding post-trade costs. Let’s say a stock’s average trade size is ten thousand Euros with unit clearing fees charged per ticket. If one can trade a block of a million Euros, in one step, the clearing fee is one hundred times less than trading the equivalent value in 100 trades x the average trade size.
Block trading on order book
The bigger prize of block trading is to match size at a price while avoiding market impact. As buy side dealers often explain, there are a number of channels through which they may direct an order. Channel one might be the high touch sales trader, channel two might be the algorithmic smart order router slicing up and dicing small size into multiple order books, but there is a new channel appearing: the anonymous order book mechanism that can rest larger orders safely until finding another side to match in block size without informing the market until after the trade.
A feature of MiFID II that’s often discussed in cash equities is the potential spectre of the dark pool double caps that can prevent a stock trading for 6 months via a relevant ‘dark’ mechanism. The caps are, on a rolling 12 month average, matches of 4% of turnover on a single dark venue or, if that single stock trades across multiple venues, more than 8%.
MiFIR Article 4(1)(c) allows authorities to waive the obligation for orders that are large in scale (LIS) compared with normal market size. Currently, ESMA defines LIS bandings that reflect average daily trading values for stocks over 50 million a day for blue chip companies to micro-caps matching less than 500 thousand a day. MiFID II will add more bands.
Innovation will drive the future of European equities defined by client demand, buy and sell side, for market structures that comply with regulations, lower costs, and generate revenues. The opportunities are for those delivering the highest standards. It will be a fascinating year ahead.
1. http://ec.europa.eu/internal_market/securities/docs/lamfalussy/wisemen/final-report-wise-men_en.pdf
The Power of the Cloud: Thinking Beyond TCO
By Brian Ross, CEO, FIX Flyer
There’s been much hype about the Cloud and Managed Services recently, and for good reason. The prevalence of outsourcing has been primarily a story of the Total Cost of Ownership (TCO) and cost controls. And of course cost savings continue to be a major driver of the movement to the Cloud. But the promise of the Cloud and specialised managed services moves the discussion beyond economics to other strategic considerations. The Cloud enables firms to do more, faster and better. In today’s complex landscape of evolving regulation and fast-changing market opportunities, the Cloud offers the potential for true competitive advantage.
Virtually all industries have benefited from widely available cloud-based applications such as Salesforce, Dropbox and Slack. These tools have become ubiquitous not only because of the attractive on-demand pricing model, but also because they simply work better than what was available before. The Cloud offers turn-key deployment, headache-free management, universal access from inside and outside the company’s network, and ultimately engenders a radical degree of collaboration and sharing. These same benefits are driving a watershed shift in solution implementation and deployment for financial services applications, from FIX connectivity and OMSs to monitoring and reporting.
Cloud-based offerings are becoming mature at an apt time. Today’s financial services firms are under pressure to fulfill increasingly complex and demanding regulatory requirements. Depending on your region and corner of the industry, RegNMS, MiFID, Reg SCI, Sarbanes-Oxley, Dodd-Frank and more may have something to say about what you do and how your track it. More data needs to be stored, it has to be transparent and accessible across systems and departments, and it must be digested and reported on frequently. Often monitoring and reporting solutions must be independent of core trading platforms to provide an independent and untainted view of the underlying data.
Historically, many financial services firms have avoided the Cloud out of concerns around security and privacy. Technology has caught up, and today there is a range of platforms and services designed to meet the specific needs of the industry. Major cloud vendors including VMware, IBM, Microsoft and Amazon offer cloud infrastructure solutions engineered with robust encryption and security features. The stage is set for the industry to adopt the Cloud in a big way. TCO is a fundamental part of the story, but there are other strategic benefits firms can realise.
Strategic Benefit 1: Division of Expertise
Even modest IT projects require a deep and varied skill set; networking, fault tolerance, redundancy, system administration, intrusion detection, performance optimisation, and so forth. Technologies in each of these areas are evolving quickly, putting a burden on firms to acquire deep expertise across skill sets to implement robust solutions.
Cloud and managed service solutions allow firms to capitalise on the best-in-class skills and practices of highly specialised vendors, embodied as turn-key products. Infrastructure-as-a-Service (IaaS) vendors specialise in data availability and server optimisation. Platform-as-a-Service (PaaS) vendors provide besto-f-breed security and application management. And higher up the solution stack, FIX-as-a-Service like FIX Flyer are experts in platform integration, connectivity management, on-boarding and certification.
Consider how the on-demand market data service from Xignite is solving a challenge that many firms face. Xignite provides Data-as-a-Service (DaaS) including normalised security definitions, corporate actions, pricing, market listings, and other information. Accurate and timely security master data is a requirement of many financial applications. Maintaining this data is complicated and expensive. At the same time, the data is essentially a commodity that does not itself create competitive advantage. It makes sense for firms to subscribe to this data within the Cloud and apply their own resources to more value-creating activities.
Division of expertise is straight from a page of Business 101 – focus on what you do best, and let others do the rest. Concentrating resources and management attention on activities that add core value ultimately make a firm more innovative and competitive.
Strategic Benefit 2: Leverage the Ecosystem
The Cloud is not a single “thing” – it is a paradigm of service delivery that allows firms to pick and choose the right components for each part of a solution. PaaS solutions productise the operating platform for your applications, from virtual servers and storage up through the operating system. IaaS solutions commoditise the provisioning of hardware, data storage, and network connectivity. Now, Software-as-a-Service vendors are increasingly offering cloud-enabled applications like Order and Execution Management Systems, Managed FIX Services, Trade Surveillance, Trade Reporting, Security Master and Market Data.
Like any network, the Cloud becomes stronger and more useful as more connections are formed and more applications become available. For instance, as Apple sells more iPhones more developers invest resources in developing iOS apps – which then encourages consumers to buy more iPhones. Today the roots of such an ecosystem have taken hold in the financial services industry.
One example of such an ecosystem is the Cloud Exchange offering from the data center provider Equinix. Their community cloud platform integrates with PaaS providers such as Amazon Web Services (AWS) and Microsoft Azure, but is hosted in a data center with other cloud participants just a cross-connect away. This proximity and seamless connectivity between various cloud providers allows participating firms to essentially create a hybrid cloud model with private and ultra-fast connectivity to various flavoured counter parties including those in the electronic trading ecosystem. As more firms join the cloud, this creates growing opportunities to cross-connect to one another for different solutions within a data center or scaled amongst geo-diverse sites.
Specialised cloud technologies such as these are specifically designed to address the unique needs of the industry. Comprehensive security, entitlement and auditing capabilities are now becoming commonplace. These solutions are built ground up with InfoSec compliance built in, making it easy to clear what was once a major hurdle for any IT project.
Strategic Benefit 3: Business Agility
Ultimately, leveraging cloud services allows a firm to deploy solutions faster and with fewer resources. And then after the solutions are operational, cloud and managed services allow them to scale flexibly and operate more efficiently. In today’s competitive market, speed and agility are critical sources of competitive advantage.
Regulations and compliance requirements frequently impose new demands on firms, such as increased trade reporting and data transparency. Growing business opportunities lead to more counterparty integrations, FIX connections and drop copy destinations. A cloud strategy provides the foundation for growth and scale without heavy up-front investment of time or resources.
One way the Cloud makes firms more agile is by facilitating on-demand managed service relationships. Managed FIX vendors operate FIX infrastructure on a shared cloud environment. These vendors can manage FIX sessions, on-board clients, monitor connections, perform conformance testing services, and provide a host of other services. Under this model, firms are freed up to work on initiatives that are in line with their core competencies.
The Cloud also enables an agile build-and-deploy model. Consider the situation where a firm needs to conduct a proof-of-concept ahead of making a buy decision, for instance the deployment of a new FIX monitoring tool. Because the data is in the Cloud, a vendor can easily deploy a new environment, much like buying an app from an app store. Then, if all goes well, readying the system for production is much easier and faster than it would be with a self-managed platform: InfoSec, High-Availability, Disaster Recovery, additional compute power and more bandwidth are all essentially services that already exist within the IaaS / PaaS environment.
Agility is a competitive differentiator for firms of all sizes. For smaller firms, a cloud strategy provides instant access to resources and technologies that allow them to keep up with the bigger players. And for larger firms, on-demand cloud technologies simplify projects and greatly compress go-to-market timelines, leading to better responsiveness to market needs.
An ongoing expansion
A cloud strategy is about more than keeping costs down. It enables firms to leverage productised platform solutions that radically simplify complex technology projects. It leads to an ecosystem that allows simpler and faster connections to counter parties, and simple integration with vendor services and applications. And it drives agility and velocity so firms can be more nimble and reactive.
As cloud adoption expands, we can expect these benefits to compound. Mature cloud platforms in more consumer-oriented spaces such as Salesforce and Amazon Web Services (AWS) provide good indications of where things will go. As more financial services firms are in the Cloud, vendors will develop more capabilities for the Cloud. Evaluating and deploying sophisticated and specialised financial services applications and resources will be as simple as buying an app from an app store. Firms will have instant access to market data, order routing services, risk management tools, trade support applications, and everything else we can imagine.
Technology: There Is No End Game
With Paul Collins, Head of Trading EMEA, Franklin Templeton
As we enter 2015, the main focus for our industry participants has been on MiFID II and the ramifications for Europe and beyond.
In my mind the attention is two-fold; a focus on the impact that MiFID II has in terms of the use of client commissions to pay for research, and the emphasis on better execution.
From the research perspective the industry across Europe may be forced to truly unbundle research from the execution process. We have talked about it for long enough, but MiFID II will most certainly encourage this to happen.
The buy-side and the sell-side may be forced to put a monetary value on research. The sell-side will have to come up with a form of pricing and the buy-side will need to show that the research it consumes has value. This change will certainly overhaul the industry especially given the length of time the industry has been paying for research in this way.
As the industry in Europe continues to be driven towards unbundling, differences will emerge between Europe and the US in terms of commissions and research payments. There could be a significant contrast between these two regions and it will be interesting to see how they come together.
Best execution is also very much to the fore for the buy-side in MiFID II, this follows the FCA’s recent thematic review. While the focus of the FCA’s review was on the sell-side, there is no doubt that the emphasis will fall equally on both (buy- and sell-side) to prove we are achieving ‘best execution’, especially given ESMA’s latest comments late in 2014.
Technology
We have been fortunate at Franklin Templeton to invest in key resources from a technology perspective, which has allowed us to pursue best execution practices across all our markets.
We have a proprietary OMS, providing us the ability to be more agile and make changes in a timely fashion without having to wait on an external provider. We can readily, adapt and update our OMS by utilising our team of programmers that are focused primarily on maintaining and enhancing this trading technology.
The build versus buy debate for technology is a perennial one, across the whole of our technology platform. We do have a number of systems that we have built and are maintained internally, but we also leverage products off-the-shelf or collaborate with outside vendors to help build exactly what we’re trying to achieve. It really depends on the specifics we require and the competitive advantage it will derive.
Technology has always been the focal point of what we’ve done on the trading side ever since Mat Gulley joined Franklin Templeton almost 20 years ago. Mat, then as Global Head of Trading and Bill Stephenson who took on Mat’s role last year, have always recognised technology as an advantage to our desk as markets evolved and changed.
It is not just about technology, our global trading platform with experts on 12 desks around the world bring their own unique expertise. This provides unique insights which we apply to execution and drives how we collaborate with our investment teams around the world. For example, we have a trading desk in Dubai with a focus on the Middle East and Africa. The desk provides us with market knowledge and expertise which is applied to both the execution and investment process. Having local expertise on the ground, local relationships plus this knowledge is invaluable when you’re trading in less penetrable markets.
Technology that is co-ordinated globally further enhances the execution process. Sitting in Edinburgh, I can see every trade that’s happening live around the world. If there was a disaster recovery situation in Hong Kong and we need to pick up trading for them, we can do so seamlessly. Some initiatives we undertook were order and execution audit trail projects. We looked at market structure and recognised what was happening in the markets in terms of algorithmic trading and high frequency trading and decided to be proactive in how we leverage both our technology and execution processes globally.
We realised the need to have more transparency, so we crafted the project to require the execution and order data needed to understand exactly what was happening with our orders in the market: where are we having the most impact, what algos are performing the best, what venues are performing better, and why does one broker favour a certain venue over another.
We have been able to use that data to approach brokers and trading venues as a conversation point for a two way discussion on the mechanics of their algos and matching logics, to the point of highlighting where they may not be working as well as we would expect. MiFID II will not only drive greater transparency around order flow, but it will also increase the onus on the buy-side to ensure we understand what is happening to our orders. In terms of best execution, the two key elements we are looking at are the technology that the brokers provide in terms of SOR, and the execution decision – how are we going to trade this stock? The evidence that we’ve got: the technology, skill-sets, processes, and outlook will be a key focus to determine this decision. We are also up-streaming through collaboration with the portfolio managers, which will become more important as we look to enhance the wider investment process through execution.
The more electronic trading we do the more we have to rely on our own team and the technology that supports it. We are now able to do more analysis on the pre-trade, post-trade, and intra-trade; real time processes that look at trades as they happen.
Transparency
When MiFID I was initiated and the market opened up to competition, it was fragmented and there was a tendency to just accept what the brokers were giving us because we weren’t building our own algorithms or SORs. As we have gone through this whole process and built out the tools, the brokers have become much more collaborative.
Going forward brokers, exchanges, and other trading venues, will have to be much more transparent, and so will we. We have to be prepared to be asked questions by our clients and be able to demonstrate that we understand our processes as well as what happens to client orders once they interact with a broker’s algos.
We are going to have to be in a good position to provide evidence that we are achieving the best execution for our clients. Whether it’s electronic trading, which continues to increase, or via a traditional broker, the execution decision itself lies with us.
However, there remains an objective for best execution that brokers need to ensure they’re fulfilling. The assurance that they’re getting us the best price, and that they’re going to the best venue under the circumstances.
At the micro-level when we are trading and something happens to the stock outside of its normal parameters, i.e. when a stock is outperforming/ underperforming its peers, the spread widens or tightens significantly or volumes increase significantly; we want our traders to have access from a live perspective to these intra-day signals. Traders need to be able to recognise what’s happening to their order flow and react in real time and change their execution decision process.
We compliment this information with proprietary technology – our Investment Dashboard and internal idea generation systems coupled with the external signaling tools enable the traders to separate meaningful signals from all the noise, and efficiently interact and collaborate with our investment professionals.
There is a lot that technology can do, and we continue to progress down this electronic route to ensure that the traders have the tools and the knowledge in real-time needed to be able to react. Once you bring all that together, it changes the traditional dynamics between buy and sell-side.
The future
There is always a little bit of debate around whether regulation is going to stifle technological innovation and development. From our perspective, we continue to develop our electronic trading capabilities and know how, to ensure constant innovation in our trading processes.
So what’s next? More disruptive technology, social media, and new technologies that will impact how we trade, gather and manage our data technology which will continue to move as we do.
