By Scott Atwell, Manager FIX Trading and Connectivity, American Century Investments.
The benefits of increasing the use of FIX for allocations and confirmations include efficiency gains, improved straight-through processing, and quicker identification of issues, all of which provide significant risk reduction and cost savings.
We have approximately 20 brokers that support this. The key measuring stick for us is, of all the confirms that we have, what percentage of those have moved to this automated matching solution. For American Century, we have had over 75% of our confirm flow via FIX during the last eight months.
If you are a buy-side firm thinking about trying to implement this flow, you can be successful, because all the major sell-side firms support this. And because they have already implemented this, they are eager to use and provide that for other buy-side firms.
FIX For Allocations And Confirmations
FCA’s yellow card : Lynn Strongin Dodds
BEST EXECUTION – THE FCA’s YELLOW CARD.
There is no doubt that the Financial Conduct Authority’s (FCA) review of 36 retail banks, investment banks and wealth managers made for uncomfortable reading. Firms were not specifically named but the industry as a whole was shamed in its inability to meet their best execution obligations. Trading costs increased and returns reduced but material losses suffered were not quantified.
The FCA did show though that every basis point saved in all trading by all market participants could translate into £264 m in additional annual returns for customers. However, firms failed to make the grade due to their failure to grasp the key elements of best execution as well as incorrect implementation of policies. In fact, the review found that many firms frequently tried to limit their best execution obligations to clients with some using prohibited “carve-outs” or agreements in which customers allow firms to opt out of rules.
In addition, one group the FCA cited excluded all algorithmic trading from its best execution obligations while many still relied on single trading venues despite the fragmented European equities trading landscape. These results may be surprising given the reams of material, not to mention airtime, the original MiFID was given back in 2007. It was difficult to turn in the City at the time without bumping into a roundtable, seminar, White Paper or report discussing these shiny new best execution requirements.
There are many reasons that these practices fell through the net. Fear that customers would simply switch to a rival if they were unhappy is one but poor oversight and order execution were also blamed. The regulator pointedly noted that the monitoring not only missed all relevant asset classes but also did not reflect all of the execution factors which firms are required to assess or include adequate samples of transactions. Moreover, it was often unclear how monitoring was captured in management information and used to correct any deficiencies.
In addition, there didn’t seem to be anyone in charge plus reviews tended to focus on process rather than client outcomes, with insufficient input from the front office. Equally as worrying, firms were often unable to demonstrate how they managed conflicts of interest when using connected parties or internal systems to deliver best execution for their clients.
Given MiFID II’s 2017 deadline, firms could be lulled into a false sense of security of having plenty of time to rectify their mistakes. However, those firms who put their clients’ best execution interests high on their priority list will have the edge in not only restoring market integrity but also stealing a march on their competition.
Lynn Strongin Dodds
[divider_line]
To download the FCA report ‘Best Execution and Payment for Order Flow’ (TR14/13) click here
To download the FCA report ‘Best Execution and Payment for Order Flow’ (TR14/13) click here[divider_to_top]
Best Ex Report – Must do better : Roger Aitken
FCA’S THEMATIC REVIEW ON BEST EXECUTION DELIVERS SCATHING REPORT.
As thematic reviews from the Financial Conduct Authority (FCA) go the UK financial regulator’s latest, entitled ‘Best Execution and Payment for Order Flow’ (TR14/13), was probably not the weightiest at a mere 55 pages, but it still packed quite a punch.
One of the biggest issues with the term best execution, even since MiFID first tried to define it, is that it continues to mean different things to different constituents – be they buyside or sellside, retail or institutional. This inconsistency may well explain why the FCA’s review provided a scathing assessment of the financial industry adoption and application of their rules on best execution.
Against this backdrop TR14/13’s supervisory findings and conclusions ran to 26 pages and spanned five sections: (1) the scope of best execution; (2) monitoring of best execution; (3) executing internally or through connected parties; (4) accountability for delivering best execution; and, (5) payment for order flow (PFOF).
The review’s key findings were that very few firms were fully cognisant of their best execution obligations, were relying on use of prohibited carve-outs and frequently they had insufficient controls and lines of responsibility to ensure best execution was being provided to their end clients.
The FCA states that its document is “relevant to all firms that execute, receive and transmit or place orders for execution, including investment managers.” That said, whilst this review of 36 firms across five different business models did not include investment managers, “many of its conclusions will also be of interest to these firms, given their need to act in the best interests of their underlying clients,” the FCA said.
In terms of what follows next, the UK regulator will shortly write to all the firms in their thematic sample to provide individual feedback of the findings. A communiqué from the FCA stated: “We will require firms to take immediate action to address all relevant areas of our findings. As well as asking them to confirm they are no longer receiving PFOF, we will require confirmation that firms fully understand the scope of their best execution obligations to clients and the steps they are taking to reflect these obligations in their execution arrangements.”
In terms of preparation “all investment firms should review their arrangements for delivering best execution and ensure they are not receiving PFOF”, the regulatory authority said. Firms need to ensure that business practices are fit for purpose and that these are supported by what the regulator refers to as appropriate “second-line of defence controls”.
Furthermore, all firms also need to assess the risks and issues identified in TR14/13 in the context of future regulatory developments. Additional obligations in the recast MiFID II are intended to address some of the specific weaknesses observed in this work, especially relating to the adequacy of monitoring. “Firms need to improve their current systems and controls and be ready for the implementation of future policy change,” the UK regulator asserted. One might think though that firms had already had ample time.
by Roger Aitken ©BestExecution 2014[divider_line]
To download the FCA report ‘Best Execution and Payment for Order Flow’ (TR14/13) click here
[divider_line]
In the next issue of Best Execution this report’s findings will be covered in depth.[divider_to_top]
Canadian Regulator’s Best Execution Survey
By Wendy Rudd, IIROC Senior Vice President, Market Regulation and Policy
A number of IIROC dealer members have requested additional guidance on best execution compliance, given that changes in technology and market structure have increased order handling complexity in recent years.
By conducting an anonymous survey of all dealer members who execute secondary market trades for clients, IIROC was able to gather information quickly about current practices and learn how dealers are achieving best execution for their clients in a multi-marketplace environment.
IIROC focused the survey on considerations that affect best execution, including the use of smart order routers, order handling practices, governance and decision-making around best execution, access to lit and dark marketplaces, and how dealers treat marketplace fees and rebates. (Maker/taker marketplace fee models are prevalent in Canada.)
The survey is particularly important because the findings will help guide development of further IIROC rules, guidance and policies on best execution.
Certain survey results may lead us to focus on how dealers disclose information to their clients, especially information that could help investors better understand how their orders are handled by their dealer.
Also notable is that, despite the rules that are in place in Canada that would enable investors to receive price improvement when trading with dark liquidity, we found reluctance on the part of some dealers to consider opportunities to trade in dark pools.
Future policy work by IIROC may also include a focus on the level of supervision being undertaken by dealers to ensure best execution is being achieved.
Criteria Influencing Institutional Routing Strategy
Participants that are engaged in institutional trading and use a SOR (total of 55) were asked to rate on a scale of 1 to 10 the importance of selected criteria in influencing routing strategy for institutional orders entered during regular trading hours (9:30 a.m. to 4:00 p.m.).
The top tier of important factors included:
• current likelihood of execution (8.8/10 and 49% rating it a ‘10’); and
• price improvement opportunity (8.2 and 38%).
The second tier of important factors included:
• client preference (7.7 and 43% rating it a ‘10’);
• historically demonstrated liquidity in a security (7.5 and 25%);
• latency of execution (7.2 and 24%); and
• latency of data (7.0 and 22%).
The third tier of important factors included:
• potential crossing/internalization opportunities (5.5 and 12% rating it a ‘10’); and
• cost/opportunity to capture rebates (5.1 and 6%).
The least important factor was “a firm’s ownership or potential ownership of a marketplace (1.9 and 3%). “Order-to-trade ratio” was another reported minor factor influencing institutional routing strategy.
Hong Kong Regulation
With Emma Quinn, Head of Asia Pacific Trading, AllianceBernstein
How do the SFC Algo regs look six months on?
From a buy-side perspective it meant firms were minimising their administrative burden by reducing the number of brokers that they use. My personal view is that people will now start adding more brokers, if they haven’t already, now that they’re over the hump of the administration.
I’m not one of those people but I do think others will take that initiative.
Will people start innovating again?
No: I think people are going to pause and realise that they are quite happy with the more vanilla product that they’ve got. Responsible officers will want to make sure they understand every aspect of the algorithm that they use and are unlikely to want to do anything with more exotic algos and experimental technology.
SFC first or innovation already paused?
When people feel personally responsible for a spike in the market, for example, from a small change to an algo, it can scare you.
People should be responsible and know what they’re using; there’s no doubt about that. If you have 10 providers that each provide 10 algorithms, the chances of you understanding a hundred algorithms in enough depth is just not possible. No one can know it in that much detail. In my experience you find that traders tend to use a maximum of 10 anyway: from the general algo list you might use two IS ones that you like, and two sniper ones (and maybe an over the day algo as well), but at the end of the day you don’t need too many varieties.
Unintended consequences that the SFC may not have thought about?
I haven’t seen any unintended consequences that the SFC may not have thought about: I think the SFC intended people to be more responsible for their algorithms. The result has been that people taking responsibility for their own actions within the market. One aspect that may not have been considered fully is the implications for those trading out of Hong Kong into other jurisdictions that are captured by these rules.
And how does that feed into the current conversations around circuit breakers and closing auctions?
It’s interesting that there was only one party that was left out of the SFC algo regulations, and I would like to think that the Hong Kong stock exchange would do what most other developed markets in the world have done and introduce circuit breakers. The risk is that the buy-side do all the right things, the broker does all the right things and something happens between when the broker sends their message from their system to the exchange. The exchange is your last line of defence. There are four participants in the chain, including vendors, and one of those, the exchange, has been left out of this completely.
How does that feed into the dark pool regulations?
This has obviously got a lot more publicity after the “Flash Boys” book and the way exchanges would like volume to be 100% back on their markets, but it’s not an issue in Hong Kong. You only have to look at the numbers; not a huge percentage of the market is done in the dark.
How about retail flow going into the dark?
I don’t think that they will allow retail in there. If I was a retail person, I would of course like to improve my pricing with the use of dark pools. If trading at mid you’d always do better than the offer or better than the bid, depending on which side you’re on. With that being said, dark pools are more about block trading; they are not about the small orders. It is more for doing the big blocks in an anonymous form.
Monitoring Shanghai-Hong Kong Stock Connect Report
Monitoring Shanghai-Hong Kong Stock Connect
A viewpoint piece discussing the surveillance implications of cross-border equity trading between Hong Kong and Mainland China
The China Connect initiative between Hong Kong and Shanghai promises to further strengthen and increase attractiveness of China’s capital markets by transcending geographic borders. The opening of China’s capital markets represents an exciting business opportunity, but is your surveillance team prepared for the regulatory implications?
In this new whitepaper from NASDAQ OMX questions around the Shanghai-Hong Kong Connect and monitoring are examined.
Circuit Breakers And Closing Auctions: Reforming Hong Kong’s Marketplace
Andy Maynard, Global Head of Trading and Execution Services, CLSA, looks at the two major market structure changes facing Hong Kong
At the end of the day, the overriding premise of an exchange has to be the integrity of the market. Instilling confidence in the exchange is key, for market participants to trade on and invest in, and also to protect investors’ confidence and their assets when they go into the market outside the normal market dynamics of profit and loss. On the other hand, I do feel somewhat sympathetic to the view that stocks should rise and fall on their own merit as well.
Circuit breakers are, in some ways, a mechanism used to delay where a stock is going to end up eventually anyway; it just makes the change occur in a more orderly process. So, if you look across Asia, do the markets that have circuit breakers benefit from the fact that they have this extra protection? I would argue no. The reality of those markets is that everybody trades on the understanding that there are circuit breakers in place. I cannot say for sure that from an institutional point of view any of our clients look at those markets with extra confidence. As long as circuit breakers are done in a way that allows investors to also sell stock when they find there is adverse news on the name that is fine. If it is down 10% and they want to sell it down 10%, I feel that they should be able to do so, rather than being blocked from trading, only to watch it move down another 10%.
There is a very fine line between a free market and one that is constrained by circuit breakers. It’s going to be very difficult for any regulator to appear to have a foot in both camps. Do you profess that you’ve got a free and open market where stocks can do whatever they want to do based on the fundamentals of the stock, the geo-political scenario, the overall economic global scenario, and the local scenario, or do you say, no, stocks only move in the 5% range every day, and that’s it? I feel that Hong Kong will have to try to come to a common understanding about what’s right for the market; what’s right to attract investors into the market so people don’t feel that it’s a controlled environment, and at the same time, protect investor confidence. This seems to me to be a reaction as part of a wider trend of extra regulation for the market, which is really being driven from the US. Are we going to get to a point where Asian markets are over-regulating based not on what’s happening in their own markets, or even in their regions?
The Hong Kong stock exchange is a very different market to a venue like NASDAQ or NYSE. As long as circuit breakers are implemented in a way that protects investor confidence, no matter whether it is institutional or retail, I would have no problem working with them. Obviously I feel investors should also be able to sell stock that’s down 20% if the stock is moving down. There are plenty of examples of that across Hong Kong; where stocks have been in a free fall and never come back. Would circuit breakers stop that?
There are also many questions around the implementation of the breakers: is a 5% movement OK? What happens if it’s 5.1%? Does that mean that you can’t sell the stock? The high percentage of retail activity is also a key consideration.
In the 22 years I’ve been in Hong Kong, the exchange has worked almost perfectly. The Hong Kong stock exchange will suspend a stock very quickly if there’s enough adverse movement. To me, they already have some sort of delayed circuit breaker mechanism in place. Stocks get suspended a lot here. With the recent events around the Mainland exchange, the market had time to pause and time to analyse what was going on in the market and what was going on in the fundamentals of the relevant stocks. In that scenario, would a circuit breaker have stopped that event? No. Would it have exacerbated it? Potentially. I think stocks should be able to find their own level.
It is also good for the brokerage community to regulate their own parameters in terms of trading mechanism risk, and I think that should be done totally separately from a circuit breaker mechanism. You should have parameters and risk profiles set up, and you should have internal circuit breakers to stop the wrong button being pushed on your system. Similarly, when a DMA client flows in, you should have parameters set up. The counter argument is that this is fine for the bigger brokers because they have the technology spend to implement such controls, and I agree that as a result, it is difficult to appease everybody. However, we’ve potentially walked down a road of protecting the integrity of the market based on a reaction to something that hasn’t actually happened in Hong Kong.
Closing auction
The closing auction is something I feel Hong Kong desperately needs, and has needed from the outset. They have an opening auction, but no closing auction. You look at so many markets across Asia where a very significant amount of the overall trading volume is done on the close, without much price volatility, and we can’t find a mechanism that’s able to do that in Hong Kong.
Asset managers have a guaranteed benchmark set by a client, and they have to achieve it. There is more risk in Hong Kong because we don’t have an auction. This means we need to be more aggressive in the close, which means we are adding to volatility just so we don’t lose money. The closing mechanism as it is right now makes it more volatile because you can’t afford to be passive; you could be 20 basis points on one side and 30 basis points off the other side. You add that up across 100 stocks with the dollar size of these trades and you could end up with a very good day or a very bad day. Hence, I feel that the closing auction is necessary for a developed market.
Institutional clients base their whole performance and fund NAV on the closing price. Most countries have a mechanism to allow for the incorporation of that function. In order to promote investor confidence in the equity market, we need a closing auction. Rather than regulating HFT, everybody wants to know the closing price of stock. That helps everybody evaluate their investment.
Single-Stock Circuit Breakers: Expanding a Canadian Risk-Management Tool
By Deanna Dobrowsky, Vice-President Market Regulation Policy at IIROC
IIROC issued Final Guidance on July 10, 2014 to expand the single-stock circuit breaker (SSCB) program in Canada which has been in place since February 2012. The SSCB program targets rapid, significant and unexplained price movements and covers securities in the S&P/TSX Composite Index, as well as exchange-traded funds that are comprised principally of Canadian-listed securities. In IIROC’s view, applying SSCBs to securities in a broad-based index reduces extreme volatility in those securities and, by extension,
dampens the volatility in the index. Under the expansion, SSCBs will also cover securities that are considered to be “actively traded”.
An SSCB triggers when a security experiences a significant and unexplained price movement (generally measured as a price increase or decline of at least 10% and 20 trading increments) during a five-minute period, and results in a five-minute trading halt.
The securities that are covered by SSCBs account for a significant portion of total Canadian marketplace activity in terms of volume and value traded. Based on data from February 2013, under the expansion the SSCB program would cover securities that represent approximately 92% of the total value traded on Canadian equity marketplaces.
The SSCB Guidance, which takes effect February 2, 2015, expands the list of securities covered by SSCBs to include all securities that are considered “actively traded” and extends the times when they are active – SSCBs are now active from 9:30 a.m. to 3:30 p.m.
SSCBs are part of a series of IIROC reforms implemented to control risks arising from electronic trading. These measures include:
• requirements for participant controls to prevent the entry of orders that exceed certain thresholds and to address client order flow that is not intermediated by the participant, introduced through the electronic trading rules (March 2013) and third-party marketplace access rules (March 2014);
• a proposal for the introduction of marketplace thresholds (published for comment in April 2014);
• IIROC’s February 2013 update to market-wide circuit breakers to align with changes in the U.S.; and
• IIROC’s August 2012 clarification of its policies and procedures on erroneous and unreasonable trades.
To read the Final Guidance click here
Large Tick Assets: Implicit Spread and Optimal Tick Size
By Khalil Dayri, Antares Technologies and Mathieu Rosenbaum, Laboratory of Probability and Random Models, University Pierre and Marie Curie (Paris 6)
This paper is based on the article [1].
Abstract
We provide a framework linking microstructural properties of an asset to the tick value of the exchange. In particular, we bring to light a quantity, referred to as implicit spread, playing the role of spread for large tick assets, for which the effective spread is almost always equal to one tick. The relevance of this new parameter is shown both empirically and theoretically. This implicit spread allows us to quantify the tick sizes of large tick assets, to anticipate the consequences of a change in the tick value, and to define a notion of optimal tick size. In particular, our results allow us to forecast the behaviour of relevant market quantities after a change in the tick value and to give a way to modify it in order to reach an optimal tick size. Thus, we provide a crucial tool for regulators and trading platforms in the context of high frequency trading.
1) Tick value, tick size and spread
On a given market, the tick value of an asset is the smallest interval between two prices. It is a well-defined quantity, measured in euros, dollars, etc. However, when it comes to actual trading, the tick value is given little consideration. What is important is the so-called tick size. A trader considers that an asset has a small tick size when he “feels” it to be negligible, in other words, when he is not averse to price variations of the order of a single tick. In general then, the trader’s perception of the tick size is qualitative and empirical, and depends on many parameters such as the tick value, the price, the usual amounts traded in the asset and even his own trading strategy. Thus, the tick size is basically a subjective and ill-defined quantity. Nevertheless, we can still distinguish between small and large tick assets. Indeed, an asset is usually said to have a large tick when its bid-ask spread is almost always equal to one tick.
This work focuses on large tick assets and addresses the following questions:
- For small tick assets, the spread is a good proxy for the tick size. In the case of large tick assets, for which the spread is essentially equal to one tick, how to quantify the tick size?
- There exist some special relationships between the spread and some other market quantities. However, they are not valid for large tick assets since the spread is mechanically bounded from below by the tick value. How to extend these studies in the large tick case?
- When the tick value changes, what happens to the microstructure of the asset?
- Can we define an optimal tick value?
2) The spread-volatility relationship and its consequences
In general, for small tick assets, over a given time period, the average spread is proportional to the volatility per trade defined by σ / √ M, where σ² and M stand respectively for the cumulated price variance and the number of trades during the considered time period. From a theoretical point of view, this relationship can be well understood using a market makers / market takers dichotomy, see [2, 4]. Empirically, it is impressively well satisfied on data, see [2]. However, this relationship does not hold for large tick assets. Indeed, in this case, the spread is almost always equal to one tick and is therefore artificially bounded from below.
Implicit spread
We introduce a notion of implicit spread, playing the role of spread for large tick assets, for which the effective spread is almost always equal to one tick. This parameter arises from the model with uncertainty zones, see [3]. In this model, there is an underlying latent price, called efficient price, representing at any time some average opinion of market participants about the value of the asset. Depending on the position of the efficient price in the bid-ask spread, market orders are buy orders only, sell orders only, or can be of both types. The implicit spread is defined as the size of the interval where both buy and sell market orders can occur. Furthermore, it is shown to be equal to 2ηα, where α is the tick value and η is the microstructure parameter of the asset which summarizes all its microstructural features (high frequency volatility, correlations of the returns, …) see [3]. The parameter η lies between 0 et 1/2 and the larger η, the less intense the microstructure effects are. Furthermore , η can be very easily estimated from market data as follows:
η = Nc / 2Na,
where Nc is the number of continuations on the considered time period, that is the number of (last traded) price moves whose direction is the same as the one of the preceding move, and Na is the number of alternations, that is the number of price moves whose direction is opposite to the one of the preceding move.
On various large tick assets, listed on different exchanges, we show that the relationship between spread and volatility per trade still holds very well, provided that the conventional spread is replaced by the implicit spread 2ηα, see Figure 1.
The FIX Trading Community And MMT
By Jim Kaye, Co-Chair of the FIX Trading Community Global Steering Committee and Director of Execution Services, Bank of America Merrill Lynch
What are the principal consequences of MMT becoming a FIX standard?
There were two main drivers for this from an MMT perspective. One was to provide the opportunity to leverage the FIX Trading Community’s broad member base to assist with the ongoing development and adoption of the standard. The other was to move the MMT standard under the FPL Trust. This already covers the FIX Protocol and other FIX standards and basically ensures that the MMT standard will remain open and free to use for the entire industry.
How will this development feed into post-trade efforts around the consolidated tape?
It solves a long standing issue regarding the standardisation of classification of trade data. This issue has historically made data consolidation difficult and increased the likelihood that different implementations of a consolidated tape would come up with different data. This is clearly just one piece of the jigsaw but an important piece nevertheless.
Are there any implications for pre-trade as well?
We’ve discussed pre-trade and it’s certainly an area for consideration. Though the MMT in its current form is very much geared towards post-trade data, i.e. the classification of trades, there is an interest in similarly normalising the classification of quotes pre-trade. Aside from that though, there is significant overlap in terms of the business usage guidelines which are an important part of the standard. Many of the discussions and decisions around those in the post-trade area are relevant to the pre-trade space and we intend to leverage that as part of any pre-trade work.
