Buyside challenges : Trading : Block trading

November 21, 2014

Block and tackle

Mark Goodman, head of European quantitative electronic services at Société Générale discusses solutions to navigate a crowded marketplace.

According to recent research from TABB Group – buyside firms have continued to value block trading in equities. However there has been a significant gap between what could trade as a block, the amount the buyside wants to trade in blocks and the actual block numbers – a gap that has persisted despite a number of efforts to “crack the code”, each with inherent limits. Do you agree with this and what other problems do you think there are?

Whilst trading blocks is not the only challenge facing the buyside it is certainly one of the topics we find is raised most frequently. This is partly a function of the changing market structure but it also seems to be self-perpetuating: if everyone else is splitting their trades into smaller and smaller sizes then you are going to follow the crowd rather than post a block.

So whilst the market structure is important there is a behavioural issue here. If what one wants is blocks why do you divide your orders into small sizes, whether explicitly when submitting to dark pools through an ‘aggregator-type’ solution, or implicitly when sending it to a broker’s algorithm?

The overwhelming response was that as the buyside trader does not know who might be trading against them in a particular venue, the right thing to do is to be cautious. In short, the lack of certainty in terms of outcome means people shy away from committing themselves in block size.

The TABB report noted that the industry needs to resolve multiple requirements often at odds with one another, including: enabling trusted counterparties and allowing for anonymity; sourcing liquidity and paying for services; quick-matching engines and seamless workflow integration; and, marrying electronic messaging with traditional sales trading. Does PartnerY provide a solution and how does it address other issues?

The key area we have tried to address in terms of the above is how to enable trusted counterparties yet still allow for anonymity. The issue around an uncertain outcome stems very much from not knowing who is there. PartnerY – by allowing clients to construct a group of counterparties in a pool with whom they wish to interact – ensures that the potential outcome of a cross is much more predictable. However, we retain the notion that at the point of execution the counterparty remains anonymous. Whilst you know who you exposed the order to out of a universe of selected counterparties, you do not know specifically who you crossed your order with at the time of execution. So you retain anonymity at the point of trade.

To some extent this becomes similar to working with a sales trader in order to source a block for you. The sales trader by using their knowledge of your objectives and of the holdings and objectives of potential counterparts will selectively try to match buyers with sellers whilst trying to ensure that anonymity is maintained. PartnerY offers a complementary electronic solution to this more traditional service.

In terms of sourcing liquidity and paying for services we see a very clear approach from the buyside. Even bundled clients will step outside their broker list where a service or provider can really add value in terms of differentiated liquidity.

Some buyside firms have become disillusioned with information leakage and falling order fill sizes in (some) dark pools although they like the anonymity. Do you see PartnerY as a substitute or add on?

We see PartnerY as an addition to the choices already available to the buyside when sourcing liquidity from dark pools. Whilst we do not believe that all liquidity is good all of the time, all liquidity is good some of the time.

If we look at what is already available in the market we would agree that the majority offer trade sizes equivalent to that in ‘lit’ venues and there is clear evidence from our own analysis of information leakage. However, if your order contains significant short-term alpha, and immediacy of execution overrides concerns around signalling risk then you would be happy to interact with these venues.

PartnerY, by nature of the fact that users will limit the number of counterparties they expose their orders to, offers less immediacy. But equally it can offer an environment into which clients feel comfortable in committing large size. And, that means it occupies a different end of the spectrum in terms of immediacy versus quality than a traditional dark pool.

In Europe generally market participants trade in small- and mid-cap stocks with the average order size around 55% of average daily volume (ADV) on a given stock. How does that compare with the wider market?

This has very much been the profile of the liquidity that we have seen in PartnerY. It is not something we dictated. It is a result of where the users have positioned PartnerY indicating that a venue, which can handle this type of stock and size, is what they were missing. Typically we have found that the platform is being used much more for small and mid-cap stocks rather than large caps.

What has been the reaction since the November launch and what are your plans for future development?

We feel we have really captured the attention of clients with the concept of passing control from the venue operator to the end user so that they can construct the venue(s) they want. We have a strong pipeline of mainly large long-only asset managers and are currently just north of thirty clients – adding probably around 3 to 4 new parties a month.

Clearly we need to turn this enthusiasm into material cross rates. This is challenging when you are focused on organic growth of participants and natural liquidity. However, fundamentally we do not want to try to accelerate this by adding marketmaking activity as this would effectively drive PartnerY towards the same scenario as existing offerings in the market, which is simply not differentiated.

This is a more challenging approach and requires patience. Yet we believe the end result is worth it and our existing partners have been very vocal in encouraging us to see this through. So our focus currently is on how to better assist our clients concentrate liquidity to capture crossing opportunities and we will continue to experiment with the offering in order to achieve that.

You say that a unique element of this service is that you are transferring control from the venue operator to the end user. How so?

We allow each participant to select those other partners they want to interact with and allow them to police their list – including or excluding – on demand. Our role is to operate the service and provide data that allows participants to make informed decisions on managing their group. Data reports are provided to clients to allow them to identify partners whose behaviour does not match their desired objectives – including quality indicators around reversion performance as well as frequency/size of trades and average resting time.

Future development is also managed in this way. Whilst we have some ideas we are very active in ensuring that we consult with existing participants and only make changes when we find consensus. Even more encouraging has been that we see examples of participants discussing issues directly with each other then coming to us with joint proposals. This is very much in the spirit of the approach and we believe differs from the more traditional approach of designing finished products and subsequently pushing them out to potential users.

That being the case, what control do you exercise and where is this likely to lead?

Outside of our obligations to manage the platform according to regulatory requirements we do not exercise any control over the type of participants or who should interact with whom. We offer the service to all clients of the firm without prejudice and equally offer all participants the option to interact, or not, at their discretion. We believe this is the best approach to ensuring that the evolution of PartnerY remains in line with the evolution of user needs – rather than short-term market share or revenue wins.

www.execution.socgen.com

FIX Trading Community Announces FIX Implementation Guide for Shanghai-Hong Kong Stock Connect Project

GlobalTrading

November 17, 2014

FIX Trading Community, the non-profit, industry-driven standards body at the heart of global financial trading, today announced the publication of an industry Implementation Guide for the Shanghai-Hong Kong Stock Connect project.
The Shanghai-Hong Kong Stock Connect project will allow global investors to trade Shanghai ‘A’ shares via the Hong Kong Stock Exchange while Chinese mainland investors will be able to trade Hong Kong ‘H’ shares via the Shanghai Stock Exchange for the first time.
In an effort to standardise implementation and educate on “early practices” and later “best practices” by participating firms, the Implementation Guide provides a number of suggested tags and their usages which are set out to provide the industry with a basis for messaging standardisation, relating them to the requirement to help understanding of the origination of the workflow. As this programme continues to develop, the FIX Trading Community will look to support the buy-side, sell-side and their vendors with constructive suggestions on how to implement the various regulatory requirements.
The guide has been developed by FIX Trading Community, in partnership with ASIFMA, representing the culmination of a series of working groups of sell-side, buy-side, vendors, and other market participants. Core market structure, risk checks, quota restrictions and technical implementation, across buy-sides, sell-sides and the vendor community were all considered.
Jessica Morrison, Head of APAC Market Structure, Deutsche Bank and Asia Pacific Exchange and Regulatory Subcommittee Co-Chair, FIX Trading Community commented, “The FIX Trading Community have produced these guidelines to give the industry some practical suggestions on how to communicate Shanghai-Hong Kong Stock Connect orders. We believe that standardisation will help bring efficiency to the market, reduce complexity and therefore help the buy-side, sell-side and vendors manage cost and operational risk. We hope market participants find it helps them participate in this historic opening of the China market.”
Michael Drake, Asia Regional Director, REDI Technologies and Asia Pacific Education & Marketing Co-Chair, FIX Trading Community added, “Once again, we have seen a great amount of support and collaboration from FIX member firms, neighboring industry groups, and market participants when presented with a new opportunity, in this case the Shanghai-Hong Kong Stock Connect. The participation leading up to the launch has been incredibly strong, and the continued collaboration will be invaluable as we share this initial blueprint, refine it going forward, and potentially leverage it in future cross-market initiatives.”
To access the Implementation Guide, please click here.

Not so happy bunnies : Lynn Strongin Dodds

Lynn Strongin Dodds

November 10, 2014

NOT SO HAPPY BUNNIES.

Despite the reams of regulation intended to safeguard the financial service industry and its participants from another meltdown, the soothsayers have begun to predict another financial crisis could be hovering on the horizon in the next 15 to 20 years. Not very reassuring if you are a policymaker who has spent the past seven years hammering out the finer details of the multitude of regulations.

The pessimism was deep-seated at last month’s Sibos conference in Boston with 74% of those attending a regulatory reform panel believing the risk was high compared to 26% who were not that worried. The main cause for concern was the lack of co-ordination between the regulatory bodies – both within the US and internationally – and that worry has only been exacerbated in the following weeks.

Take aggregate derivatives trade reporting. Commerzbank and the Depository Trust and Clearing Corporation (DTCC) have both raised the alarm over the piecemeal approach. The list of principles for financial market infrastructures (FMIs) published by the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) may be clear, but the implementation differs from jurisdiction to jurisdiction.

Divisions are also being drawn in the line over clearinghouses. Players such as CME Group Intercontinental Exchange (ICE) and LCH.Clearnet Group, are required to register with their home-country regulators in the US and Europe. Global watchdogs are working to establish a system to ensure that home-country rules are “largely equivalent” across borders, but so far European policy makers are resisting approving US clearing rules as comparable as they have done with Japan, Hong Kong, India and other countries with much smaller clearinghouses.

Some believe this could be payback for steps US officials took earlier this year, when the Commodity Futures Trading Commission (CFTC) declined to grant full equivalence to European trading platforms for certain swaps. In fact, Michel Barnier, the European Union’s financial-services chief, warned last year that Washington’s attempts to impose its rules overseas could spark “protectionist reaction” from other countries.

Although lessons could be learnt from past experience, the same ructions are likely to occur within the so called shadow banking sector which has grown to a significant $70 trn since 2007. This has not just been flagged as a main issue of concern at financial conferences but also recently by the International Monetary Fund. The fear is that activities that once took place within the confines of banks are now moving to unregulated institutions such as hedge funds and private equity. Regulators are hoping to tighten their grip but without a harmonised approach, there are bound to be institutions that fall through the cracks.

©BestExecution 2014

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Seeking Clarity In Bonds

GlobalTrading

November 10, 2014

With Trevor Leydon, Head of Investment Risk and Portfolio Construction, AVIVA Investors
Bond trading issues
We wouldn’t say there are problems with bond trading at present, rather there are things that we are acutely aware of, particularly as we are in summer and that is historically a period of lower liquidity. Many seasoned hands are discussing the risks around the hunt for yield pushing less cautious investors into spaces where greater or different risks can lie unseen unless you have suitable expertise or insight. The shrinking of yields to the current levels, the re-emergence of covenant ‘lite’ and the wall of less sticky money entering some areas of the bond market over the last few years are all examples of things which are featuring more prominently in people’s minds.
If corrections were to occur this could be a harsh lesson for some investors who are less well prepared. These challenges mean that the value of an asset manager like Aviva Investors to an underlying investor is even greater because we can have the capacity and capabilities to construct an investment portfolio which delivers against the outcomes that the clients talk to us about, be it income, capital growth or protection against inflation.
On the trading front the summer period in more recent years has seen the issue around lower capacity of market players to provide liquidity through warehousing inventory being exacerbated.
This combination of the absence of market participants and the consequences of various stakeholders altering the ability of the sell side to act as intermediaries adds risks to the system and could have unintended consequences. The traditional role of intermediaries along with other participants was and still is very important, as they could, at times, have acted as a mechanism to avoid markets gapping down.
We don’t believe that there are problems that are unique to the electronic markets, rather the migration from the phone based market to electronic platforms will take time: markets where there are less market participants, such as some emerging ones, these will not move as quickly as some of the developed markets such as G7 Gov’t bonds. This is because until there is enough liquidity in those markets participants are not comfortable showing their hand to the wider market. As these concerns fade through increased participation this will be less of an obstacle to markets going mainly electronic.
Regulation, market structure solutions, and new technology
There is always a balance between regulation and allowing the markets to provide solutions. That is a balancing act that can be incredibly difficult to achieve as rules that are designed with the best of intentions can have completely unintended consequences in the real world on investors. Likewise market provided solutions can take time where there are competing goals and objectives. Finding that optimal level of regulation in a market that evolves as quickly as the global electronic financial markets requires international co-operation between regulators and also the participants.
Technology can be transformational, it can lead to new and exciting developments but as we have seen with some electronic trading developments over recent years it is not without risk. In the reputational sphere, firms need to understand the changes, the challenges, the risks and also, the returns from these developments.
Transparency in trading and inventories?
The measuring of liquidity is proving to be a major challenge within the industry in general and amongst bond managers in particular. Recent regulatory changes such as attempting to quantify liquidity profiles of funds for investors is something that we strongly support. However we appreciate that it requires assumptions in modelling and ultimately using an element of professional judgment to supplement somewhat limited information. Anything which can assist the industry in this space is going to receive a lot of attention and support, pooling of anonymised information in terms of liquidity would allow investors greater transparency around whether they are being correctly compensated for liquidity or more importantly the lack of it. At Aviva Investors we are fortunate to have an array of expertise and talent which has devoted considerable efforts to developing measurement techniques in this area however, we still recognise that it is an areas where collectively as an industry we should seek to do more.

Changing The Question

GlobalTrading

November 3, 2014

Martin Ekers, EMEA Head of Dealing, Northern Trust looks at trading, benchmarking, technology and what the buy-side can do to keep themselves up to date.
Sharp practice on the trading floor
As a long only trader, I have concerns around some trading where illusory liquidity is being provided. Some short term trading behaviours are not conducive to optimal market structure, for instance the posting of liquidity in multiple venues with an immediate cancellation of orders in the majority of those locations, once one location is interacted with. They understandably have to post in all the venues to ensure they make the transaction, and that, in itself is obviously defensible. But I suspect what often happens is that, as well as cancelling the other orders, they then go and buy many more than the 100 shares they sold irrespective of whether it is a small loss, to position themselves in the market to be able to offer more stock at higher prices. This behaviour doesn’t help anyone other than the high frequency traders who are trying to make some money on the back of a perceived genuine order.
The free market side of me says that in an open market place if somebody buys something and sells something they take on risk and they make some money out of it. If they’re buying stock that I should have bought and selling it to me at a higher price because I am giving them the opportunity to do so by sending signals and behaving like an elephant in a china shop, there’s no shame on them but shame on me.
I also have concerns that the markets may trade for a longer period of time than is optimal; even the US market, which is open for six and a half hours a day, has significant lows in its trading patterns and yet London and most of Europe are trying to hang on to eight and a half hours a day. I would argue that the genuine order flow that is looking to trade on any given day would participate at a higher level in a reduced trading day, and actual liquidity would be improved significantly.
A decade ago people were speculating if we’d be able to trade 24/7. Now you can trade many things 24/7, but the price you have to pay in terms of impact and spread increases significantly. If you want an optimum market then you want all the buyers and all the sellers in the same place at the same time, it obviously makes sense to have that period to be relatively small.
The role of new technology
Clearly, we have to use technology to help us avoid being caught out. What you can’t do is legislate for other people’s behaviour. There is some behaviour that is clearly either illegal or certainly morally questionable. I think the regulators should continue to challenge and investigate the people with dubious short-term trading behaviours because they are the ones that are likely to be detrimental to market structure. What other investors need to do is to make sure that they are using the necessary tools to make sure they don’t leave themselves open to abuse.
We use technology to make sure that if we are going into a dark pool, we want a minimum order size. We might use limit prices more than we would otherwise, By way of example, if a stock is showing at 5/6 and you’re happy to buy at 6, by sending that order “at market” you risk buying 100 shares at 6 and the other 19,900 at 6½ or 7, due to someone with questionable ethics and some very smart technology spotting that you are starting to buy the 20,000 at 6. They then beat you to the venues offering the vast majority, and take them to their own account. This enables them to position in the market to sell them back to you at a fractionally higher price. So we will often use limits to ensure this doesn’t happen, on what might have previously been referred to as a market order. This in itself is sometimes fraught with difficulty, as if you’re unable to buy your 20,000 at 6, (because you put a limit over it), with the added pressure of the fund manager following up with “Did you manage to buy my stock at 6?”, you may have to admit, “Actually no, I got a hundred shares but now it is being offered at 9.” So clearly this approach has made the trader’s life more challenging, just for them to continue to execute, what you would have regarded as straightforward orders.
The differences between large and small buy-side firms
It’s always hard to know but I would imagine that a small asset manager almost certainly won’t have invested in a technology of his own, but uses tools that are available from the brokers and banks to empower them. There are a variety of broker neutral platforms out there that allow you to use their own algorithms or those from brokers. So you could be a relatively small asset manager with a relatively small trading team and provided you’ve looked at what’s available, you’ve pretty much got all the tools that you’ll ever need.
Benchmarking – the next challenge
One of the fascinating things to me about trading is the fact that it’s not so much the results you get or the performance number you produce. It’s not so much how did I do versus arrival point, or how did I do to close; the real question is, why are you trading to a particular benchmark? Why are you trading these to a closing benchmark, why are you trading VWAP, or why are you trading implementation shortfall?
The challenge should be around asking why somebody has chosen a particular benchmark and why it is a valid benchmark for that order. So the regulators might be better focused challenging not so much buy-side desks performance numbers but challenging their strategies and their benchmarks. It’s so easy to say you averaged the same as everyone else did today, but the question should be asked why were you buying them over a day when you could have done it in 5 minutes or an hour? People spend a lot of time trying to tell me that their algorithm is better than somebody else’s and I always say that I think the differences between one person’s shortfall algorithm and another person’s shortfall algorithm is so negligible as to not matter. The key is why you were using a shortfall algorithm or volume participation algorithm or a closed algorithm or alternative.
The unintended consequences of regulation
The biggest challenge for the regulator is the unintended consequences of regulation, but I think that they’ve learnt lessons from previous actions. By way of example, we can look at commission unbundling and the FCA crack down on managers’ use of commission dollars to pay for research and pay for corporate access. Active managers may decide actually that they don’t need to be taking anywhere near the amount of research that they have been taking.
I don’t think the buy-side can fix these problems, all we can do is make sure we are not leaving ourselves open to abuse. You’re always going to have challenges in any market place of any nature where people are trying to make money. A consolidated tape would definitely be a benefit. However regulators have to be very careful. To illustrate this point, the US regulator wanted a consolidated tape in place and to some extent, they have it. But it’s practically meaningless due to the sheer amount of data, and the regulator’s insistence that market participants interact with the best price. This is irrespective of the size and quality of the order and the location of the venue. The potential information leakage from venues, has meant that, in the US’s very fragmented environment, it’s actually become harder to trade in any meaningful block size in the US.
Considering where I would like Europe to be: all the buyers and all the sellers in the same place at the same time, with that exchange not being a profit entity but being effectively owned by its users. The more money the entity makes, the cheaper it becomes to transact on it.It may even be that the profits generated there are paid out to users would be a perfect scenario. I can’t think of a way we would get back there, but if the community all decided from the 1st of September we were all going to instruct our brokers to only place our orders on one venue(and everyone did it) that would work! The alternative venues would dry up and it would then seem to be a very efficient market with everyone resting on the same place. The risks are that the one venue you go to starts abusing their monopoly, or that participants break ranks and post elsewhere “just in case” This would creates pockets of activity elsewhere that you feel you have to interact with because you don’t want to miss out. Let’s just say it’s a tough one.

Measuring Change To Find A New Path

GlobalTrading

November 3, 2014

By Ben Jefferys, Head of Trading Solutions, IRESS
Whether you look at it from a global, regional or local perspective, markets have changed a lot in recent times. A lot of this is to do with newer regulatory requirements but in markets where more than one exchange competes there has been a lot of competitive innovation too. With no sign of the rate of change slowing anytime soon could there be a better way for the industry to move forward? To explore this we first take a look at the effects of recent regulatory change on trading volumes and patterns.
Despite slight increases in overall market volume, the value of share trading today is averaging lower than where it was a year ago. Some brief periods of increased volatility supported higher volumes but relatively speaking markets remain quiet. Still the number of transactions across the board continues to rise as the markets further fragment. We now have well over a year of trading since the Australian regulator ASIC made changes to off-market transactions relating to price improvement and block sized trades.

Message rates on the Australian exchanges have remained stable for 2014. By looking at the number of create, amend and cancel messages on each exchange we see both ASX and Chi-X exchanges are following a similar level of activity this year. Even though the ASX is effectively a busier exchange in terms of the headline number of messages it looks a little different when we compare it to the actual amount of volume transacted on each exchange.

Here we can look back a bit further to the start of 2013 and see that the total Chi-X volume has been slowly increasing whilst the total ASX volume even though being more volatile is slowly decreasing. Overall Chi-X still trails ASX in terms of market share but the message rate on Chi-X relative to its traded volume is higher than the ASX giving it a higher order to trade ratio. What we see here in Australia is really no different to what we see in other markets around the world where newer alternative exchanges are competing with the incumbent exchange. The newer alternative exchanges need market makers passively resting in their order books at the same or better prices than the incumbent so that broker smart order routers will target these exchanges. As prices move around on the incumbent exchange the market makers tend to move in sync on the alternative exchange adding to its ‘busyness’ whilst not transacting as much volume.
Because the messaging rate has remained reasonably stable whilst the volume on Chi-X is slowly growing it is a positive result for those supporting competition. The market is becoming more confident in trading away from the incumbent exchange. Market makers are supplying more liquidity by sitting passively with more volume. At the same time sell side brokers are also happy to post liquidity into these exchanges driven primarily by cheaper execution costs and a reduced queue time for stocks where this counts.
But these last 12 months have also been interesting from a post regulatory change point of view. In May 2013 ASIC changes regarding off market crossings for dark liquidity took effect. ASIC have recently made public comment on these changes in “Report 394 – Review of recent rule changes affecting dark liquidity”. A lot of focus has been put into trading around the new block special tiers but it is equally interesting to look at the effect on trades below block size that are now referred to as trades “with meaningful price improvement”.
ASIC were concerned with the amount of off market trading taking place away from the lit exchanges of ASX and Chi-X and for amongst other reasons its effect on price formation. Previously below block size crossings could take place at the best bid/offer and within the spread. The rule changes sought to address the situation and protect market quality by limiting what can be done off market and encouraging brokers to post liquidity back onto the lit exchanges. Nowadays these off market crossings below block size can only trade within the spread and offer a meaningful price improvement.
Looking at some sample data helps illustrate just what the effect has been. Telstra is a great example to use because it is well fragmented not only due to its size but also because of the way it trades. Telstra is a “queue stock” where establishing priority for passive orders is important.

Prior to the rule changes vast amounts of Telstra traded via NX crossings that could be done at the bid or offer. Brokers would always try and establish queue priority but then jump the queue and cross with an opposing order when the opportunity arose. The immediate effect of the rule change was a sharp drop in the number of below block size crossings. In fact these ‘NX’ crossings were down +60% the following month. Since then the number of NX crossings has remained fairly stable. It’s worth noting that in this example we don’t include what were known as ASX Priority Crossings that would extend the effect of the change as some broker crossing engines still used this order type at the time.

Towards An Efficient Back Office

GlobalTrading

October 27, 2014

By Brian Godins, Global Head Equities Operations, HSBC
For at least ten years there has been debate around the manual nature of processing client side business. The ‘operating model triangle’ – where executing brokers (EBs), buy-side participants and custodians all work towards same day affirmation (SDA) – might more appropriately be called the ‘Bermuda Triangle’, given its inefficiencies. Lethargy in communication between the participants; a lack of protocols and standards in the matching model; and a general lack of consistent and quality data result in many trades going far past T0 for matching, affirmation, confirmation and/or allocation. The trade date process is then further complicated by third-party buy-side middle office outsourcing, and the prime broker dynamic.
On specific asset classes, derivatives have actually seen more progress towards efficiency in SDA than more vanilla securities such as equities and bonds. This is thanks to increased scrutiny from regulators on derivatives, and an industry-led push towards new market solutions which facilitate SDA and lifecycle management. While complex derivatives products still need attention, with more protocols and solutions (like FIX) to follow, most agree that vanilla securities lag behind on SDA. This is perhaps testament to the power of formal regulation in creating focus, maturity and a rapid pace of product development.
T+2 is a step towards an SDA model which is more efficient and lower risk, although the regulatory focus is currently on implementing T+2 on the sell-side, exchange and MTF/OTF trades. While buy-side and OTC client transactions are expected to follow suit and move to T+2, it is not a given. Dialogue within the market, and between broker dealers and buy-side participants, must be constructive and continue to focus on the negative implications of not settling the client side T+2, to make sure it does happen.
There are also an ever-increasing number of vendor solutions emerging to help insulate broker dealers from ‘manual client processing’. Most large players are now using industry solutions such as CTM, SWIFT GETC and FIX to facilitate SDA and ensure all allocations are booked and agreed on trade date. There is however a ‘tail’ of manual clients which continues to provide trade information by more antiquated means – spreadsheets, CSVs, PDFs and even free format e-mail. Helpfully, some vendor solutions provide a technology outsourcing capability that translates these into a standard sell-side format (usually FIX). This gives broker dealers straight through processing (STP) and helps them to interact more smoothly with that ‘tail’ of clients.
There are still a few questions around these solutions, such as, who should ultimately pick up the cost? Will broker dealers get their correctly formatted message in a timely manner? Do these solutions really get to the heart of the challenge at buy-side firms? Do they help improve STP from point of execution or will there still be many hands touching these trades through the process? We’re solving a problem, but are we solving the root of the problem? It will be interesting to see whether these questions develop into broader concerns.
Either way, we are certainly seeing steps forward, and we should encourage these types of solutions on buy-side transactions, to enhance the SDA rate where uptake of industry standards and protocol is not forthcoming. As regulators’ expectations around SDA become clearer, and perhaps more prescriptive, we may see a more forced change in approach. Until then, it is clearly in the industry’s interest to move beyond the old model of manual trade processing, for the sake of a more efficient marketplace.

Post-Trade Processing: Updating The Long Tail

GlobalTrading

October 27, 2014

With David Pearson, Strategic Business Architect, Fidessa
One key area of concern is that there are a large number of smaller asset managers whose traditional technology footprint is quite light and whose appetite to invest in technology has traditionally been limited. By continuing to operate a manual process after the point of order distribution, they are a real challenge for the brokers because they represent a disproportionate operational cost. By supplying their allocation instructions on spreadsheets or emails they don’t see the need at the buy-side end to sort out a problem that they don’t have.
There is a concern around this because in a T+2 environment there is less time to sort out a manual process; this process represents one particular area where the procedure could go wrong simply because you’re spending too much time on what ought to be a fairly straightforward operational area.
Can the buy-side get up to speed?
This time last year some of the exchanges said they would do T+2 in October 2014 rather than the deadline in 2015 and initially people said “we already do it for some markets, like Germany, so it could be rolled out” but as organisations have put their process under the microscope they realise that there are areas where they could see difficulties. The regular day to day stuff that is happening now will continue to be done, but it is the unusual trades around the edges that will suffer – unusual currencies, markets, and investors in distant time-zones are all areas where T+2 could be a real problem.
There are multiple focal points here – the sell-sides are starting to recognise some of those problems, but for some investment managers where you have third party admin going on, where firms are the buy-side for their own funds and for third parties, they have a problem with this administration. I think that the sell-side recognises that they might have to step in to improve the process – some smaller buy-side firms still think the problems lie with the sell-side; but they will start to understand this change should they see their costs rise because of higher levels of settlement failures as the sell-side has to push back on manual processing – if they hurt someone in their pockets the buy-side has to react, and it might take that to get them to upgrade and improve their processes.
How do the deadlines and timelines impact development?
These firms almost need to feel the pain to see what they could possibly gain – when people get to T+2 and they see the reality of where additional operational manual processes are rapidly having to be put together to cope with difficult scenarios. I think we’ll see the right kind of solutions being developed to help firms overcome that. What we’ve tried to do is build the cornerstone framework for processing, and as other areas come to light we’ll be in a good place to help solve the problems of those businesses. But we need to get to October 8th to see where those conversations become more real.
Operational staff have shown themselves very adept at getting things sorted but potentially in a relatively inefficient way. The business will be done and trades will be settled, but the cost will be inefficiency in manpower and time, and this is where solutions can make a difference.
Regulatory pressure has focused the industry on ensuring that it can efficiently handle the post trade workflow in a T+2 environment. We’re seeing now in Europe and the US, innovation coming through from operators and vendors alike. Building on the agreed standards laid out by bodies such as the FIX Trading Community, Fidessa has its new AMS service specifically to provide that kind of affirmation processing that actually ought to enable asset managers , big and small, to take control of technology where they were unwilling to make that investment and where they seek to improve their business process. That innovation will roll through, building on those industry-agreed standards.
Are firms still separating front from back in their thought process?
Many of the smaller businesses outsource the back office function, and one thing revealed to us is that no one really identifies a middle office on the buy-side . Many of those firms will outsource part or all of the client servicing and settlement process, and there is a very strong division put in between front office and the rest. There is a growing realisation of the need to integrate these things together, so front and middle become more seamless enabling better trade processing that will benefit the back office as well. Innovative vendor software will help bridge that gap and help the smaller fund managers, and through the outsourcers they will see the benefit of more integrated post-trade processing. The outsource providers have a significant throughput and reducing costs improves their value within that business – a collective shared cost of ownership across their clients.
It is interesting when you start to discuss certain issues with the larger fund managers. Issues like the creation of a middle office function for post-trade pre-settlement, making better use of that data that is now available and that information that you are storing in that middle office function. This may help these firms deal with other issues, particularly on the regulatory side. Firms looking at what they have to do in terms of upcoming regulation recognise the opportunity that a middle office solution addresses to solve problems that are still being analysed.

Hong Kong Conference: Buy-side Follow-Up

GlobalTrading

October 27, 2014

With Emma Quinn, Head of Asia Pacific, AllianceBernstein, and Sam Kim, Head of Trading & Liquidity Strategies Asia Pacific, BlackRock
Dark Pools
Emma: I expect dark pools to remain for any broker who wishes to offer a full service model. I also expect to see them move away from being mainly used as an internaliser for algorithmic flow to block trading pools.
The Onus for Best Execution: Buy-side or Sell-side?
Emma: We have always taken our duty to put our clients’ interests first very seriously. This has not changed. What has changed is the expectation that we can demonstrate this. Given this has not changed we do not believe the value that sell-side trading brings to the buy-side trader to diminish. The role of the sell-side is to ensure that the value that they are providing stays relevant.
Sam: The onus for best ex has always been with the buy-side. We are a fiduciary to our clients and are held to ensure we achieve the best outcome for them. The role of the sell-side has been to help us achieve best execution, whether that’s through providing market insight and colour, finding natural liquidity or building better tools. Based on the market and conditions in those markets and depending on our needs, the value of any one of those areas will increase or decrease.
Liquidity in Asian Markets
Emma: Liquidity is a factor we consider in all markets and is not just limited to Asian markets – you can have liquidity issues in small cap stocks in developed markets. We have a dedicated internal quantitative trading team who constantly review our transaction costs across all markets.
Sam: Any framework for evaluating best ex will need to take into account liquidity conditions for a given market. We constantly look at our t-cost models to ensure that our models are accurately predicting our actual trading costs.
The Changing Role of the Sell-Side
Emma: I believe that the recent years have forced the sell-side to review their business models. Whether it is certain asset classes, markets or division of roles. Each firm will need to make the decision that suits the majority of their client base and understand that the days of being all things to all people are behind us. I certainly expect to see sales traders needing to provide a more rounded service than just matching VWAP orders.
Sam: We believe that there will be a convergence of skillsets for the various types of execution roles. Different firms will structure their execution offering differently based on their business models, but we anticipate more firms will look to cross-train their salespeople across the different types of execution roles.
Fragmentation in Asia
Emma: In Asia we can see the benefits of a little fragmentation. In some markets the mere threat of competition saw the incumbent exchange innovate and lower costs. This is great for our clients. I do not expect to see the level of fragmentation that we see in the US or EMEA: however I would like to see monopolies disappear via some healthy competition.
Sam: We believe that a certain amount of fragmentation is beneficial as it introduces competition into the marketplace. However, fragmentation for the sake of complexity is an unnecessary development and does not benefit our clients.

Regulation vs. Market Solutions

GlobalTrading

October 20, 2014

With Bernie Bozzelli, Director of Trade Management, Teacher Retirement System of Texas
Fragmentation in the US markets
With over 50 potential venues (exchanges, dark pools, and electronic communication networks) available to execute US stocks, it’s reasonable to suggest markets are too fragmented and are due for some consolidation. However, I think it’s important to point out that in our experience, trading costs (both explicit and implicit) in US equities have generally been declining over the last several years and compare very favourably with the rest of global developed markets so we should not lose sight of the realised benefits from increased competition.
Market Solutions or Regulation?
While I believe US markets are among the most efficient markets in the world, there is definitely room for improvement and I believe that improvement should probably be led by a combination of regulatory changes and market solutions. The Investor’s Exchange (IEX) team has shown that market based solutions do work and can affect change to improve market structure but the pace of change can be slow. The benefit of an enhanced regulatory environment is it can be applied to the entire market structure and the change happens almost instantaneously. For instance, I believe the markets would immediately benefit if the SEC would mandate that exchanges provide market data to participants at the same time and mandate that exchanges remove High Frequency Trading (HFT) friendly order types. (I fully understand this is much easier said than done so this is not a criticism of the SEC.) As institutional traders who are primarily concerned with best execution and the efficient flow of capital from one investor to another, my team only needs a few simple order types to get the job done effectively.
I think regulators are doing the best they can to better understand markets. The SEC and others have very limited resources and the impact of HFT is not the only item they are trying to address. It’s somewhat disingenuous to use the power of hindsight to criticise regulators for the unintended consequences of prior regulatory changes. I don’t recall anyone citing these risks as Reg. National Market System (NMS) was being approved.
Market Structure
We are a global, multi-asset class trading desk at Teacher Retirement System of Texas which means we have experience in several markets that present some type of obstacle to us, however, as US equity markets are very efficient when compared to the rest of the world so I don’t consider US market structure an obstacle.
Processes and Strategies
We are constantly evaluating and enhancing our internal processes to ensure that we are delivering on our best execution mandate. Even before HFTs became a concern, we were dealing with predatory type practices from other market participants such as specialists, broker dealers and fast money hedge funds. One of the most beneficial changes we made several years ago was to decouple research from execution by using a Commission Sharing Agreement (CSA) structure to pay for research. Prior to this change, we used trade execution to pay for research which meant we had to trade with the firm that provided the research. That did not always result in best execution. Under our current structure we only trade with firms that have demonstrated an ability to provide best execution.
We currently use three different external Transaction Cost Analysis (TCA) providers to evaluate the quality of our execution. For example, we use TCA providers to help us evaluate how efficiently our traders and our brokers are able to source liquidity across multiple venues. We also use TCA to identify price action patterns associated with our different portfolio managers. This allows us to then develop optimal execution strategies specific to individual portfolio managers and strategies. Finally, we use TCA to compare our execution quality vs. a peer universe of similar funds.
Technology is also crucial. Currently, we use Bloomberg as our Execution Management System (EMS) provider because it provides most of the analytics we need and it can accommodate all the asset classes we trade on the desk; however, we are constantly evaluating competing EMS products to ensure we are using the right technology.
As far as specific trading techniques designed to mitigate cost associated with HFTs, it’s important to fully understand the logic behind the smart order routers and algorithms we use on the desk. Also, we need to not be predictable. If we were to use just one strategy over a day to execute an order, chances are an HFT or other predator firm would sniff it out and run ahead of us so it’s important to change strategies and back out of the market at certain times. Also, sometimes simple is better. Instead of using a dark aggregator or algo that sends indications to multiple destinations, use a simple Direct Market Access (DMA) strategy with a limit price.

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Block and tackle

Mark Goodman, head of European quantitative electronic services at Société Générale discusses solutions to navigate a crowded marketplace.

NOT SO HAPPY BUNNIES.

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