Fixed income trading focus : Best execution : Caroline Brotchie and Neil Murray

By

-

July 3, 2014

Be25_Algomi-C.Brotchie N.Murray — Caroline Brotchie & Neil Murray

CREDIT BEST EXECUTION.

aka “the block trade and the screen price fallacy”

Caroline Brotchie, Sales manager and Neil Murray, Head of European Sales at Algomi, discuss credit best execution.

The changing face of the credit markets has been discussed ad infinitum in recent years. Everyone recounts the good old days of 2005 when traders didn’t pass on a trade, and always stood up to a price. BWICS and OWICS with line items of EUR 5-10m barely caused a shrug. But times, have changed. The real risk takers no longer sit on sell side trading desks, they are the big institutional money managers. “Flow” products are increasingly tough to trade in any real size. Prices on the screen sometimes don’t work whichever side you try.

Against this backdrop, the trading process is under increasing scrutiny, and the need to prove best execution is hovering over every trade. This has underpinned the explosion of electronic trading in the past 5 years, where a dealer can demonstrate that the process and outcome of execution was indeed “best”. A number of competing quotes can be found and documented and account splits are automated. Best execution nirvana, if you will. Trustees, compliance, risk and regulators all sleep easy.

But of course every system has its limitations, and for eTrading, the most important limitation is size – the average ticket is sub EUR 1m. Proving best execution for voice trades – either larger size or less liquid ISINs – is more challenging, and the common solution has been the “three quote rule”, which works well for a sweet spot of bonds and sizes, say 3-5m in a decent percentage of the bond universe.

So far, so manageable. But here’s the rub. We know money managers own more of the bond universe than ever before. Logically that means they have more risk to move, and bigger sized trades to execute. And yet it has arguably only become harder to trade blocks and, more pertinently, to prove such trades were executed optimally. What does the price on the screen really represent? Runs are often stale or work in small size. How exactly can a dealer know where any given trade should or could be priced? In some cases, just knowing he can execute a trade at all is a shot in the dark.

Perhaps ironically, just as the economics at stake increase (through bigger size or bigger bid/offer) so does the difficulty in proving best execution.

The process of price discovery is in itself, fraught with danger. With banks unable to warehouse risk in the way they used to, their credit franchises have moved towards broker-like models, with desks looking for the other side of trades wherever possible. The risk of “noise” around a trade has increased exponentially, decreasing the chances of execution, let alone best execution. This naturally makes a dealer all the more wary of showing their hand where there is a block trade or illiquid name in play.

So if you have to tiptoe around the market to avoid making noise and there is no executable price – what exactly is there?

The starting point is still the two-way runs and balance sheet axes shared by market makers. Ostensibly the former represents the estimated current trading level of a bond in “market size” (which, as we know, is smaller than ever). In reality, runs and screen prices are often stale and serve as a marketing tool more than anything.

The “price” is not a real price. It is a shop window. It aims to inform clients that a trader is active in a bond, and invites him to press for further, “live”, information if he has something to do in that ISIN. That requires him to show his hand, with all of the danger that entails. Plus, let’s not forget there is very little in the way of verification of this data. Runs are littered with disclaimers aimed at reducing the litigation risk of any prices being pulled.

So a dealer’s situation is this: a block trade that can’t be traded electronically; that he can’t speak to multiple dealers about for risk of ruining his market; and screen or run prices that are at best workable for smaller size, and at worst, stale, irrelevant and unverifiable. If said dealer finds a price, how on earth can he practically assess whether that price is reasonable, and whether execution at that price would be “best”?

Bizarrely, given the paradigm shift in the regulation and balance sheet capacity, one thing has resolutely remained unchanged. The way banks market to their clients has barely changed in twenty years; two way runs, balance sheet axes and client relationships.

In the meantime other markets have transformed the way buyer and seller interact. Look at online retail: Amazon knows which books you might like to download onto your Kindle; Ocado understands you prefer your bananas green; and your phone can now show you the way home. But in fixed income, it’s still good old runs and axes.

So what can be done to bring fixed income markets into the 21^st century? The investment community need to be able to have a better understanding of the context of a bond. That context is about runs and axes, yes, but also knowing how to evaluate them. Which bank or broker has been in the flow? That might mean their runs are more solid. Who has printed or seen enquiry in the bond? Whose analyst has published on the name recently? What about the rest of the curve – have there been prints in similar bonds that might help price this one? This is about understanding a franchise’s ability and knowledge of a bond as a whole. It is recognizing that while the money managers are today’s market makers, banks and brokers still have the information to facilitate the movement of risk. It is just about time that data was used and communicated more effectively.

Once, and only once, a dealer can see the full context around a screen price, can it serve as a truly useful metric for evaluating execution for size.

[divider_to_top]

Viewpoint : Post-trade : CSDR Reform : Alex Merriman

By

Ian Rycott

-

July 3, 2014

SECURING THE FUTURE.

Europe prepares to harmonise its Central Securities Depositories. Alex Merriman, Head of Market Policy at SIX Securities, looks at the issues.

The primary driver of change in the financial services sector today is without doubt regulation. Since the financial crisis of 2008, regulators have sought to tighten processes, improve reporting and avoid any reproduction of the factors that led to the collapse of global financial institutions and brought the world´s financial markets to their knees. In Europe, many of the new regulations such as the European Market Infrastructure Regulation (EMIR) and the CSD Regulation (CSDR) have focused on introducing a more stringent regulatory regime for CCPs and CSDs. These measures, and infrastructural projects such as the ECB’s Target 2 Securities (T2S) Project, have also assisted in the harmonisation of post-trade activities across the continent in an effort to reinforce the stability of financial markets.

As we emerge from the crisis, post-trade reform has continued in Europe unabated. While reduction of systemic risk is still key, many are now looking to regulation to make Europe more competitive, especially in comparison to the US. Where US issuers and traders only have to deal with the DTCC for their clearing and settlement requirements, European trading activities can be, to some extent, routed through a number of post-trade operators. Having a settlement system with mainly domestic players, working under their own local jurisdiction and therefore following multiple sets of rules is not conducive to setting up a best-in-class, continent-wide financial market. As such, the European Union is now seeking to ensure harmony across the full value chain, so that trading partners can effectively compare benefits. Crucially, this harmonising process is also reinforcing risk management procedures, and thereby reassuring participants along the value chain.

Disciplining the markets

The Central Securities Depositories Regulation (CSDR) will be the next addition to the regulatory post-trade arsenal as it is due to be formally and finally adopted by European Institutions in July, notably at the new European Parliament´s Plenary session. This regulation takes aim at CSDs, which have only ever been subjected to national regulatory frameworks; the European Commission recognising that they have become a systemically important part of the post-trade infrastructure in the modern European securities markets.

In their role of overseeing the registration, safekeeping and settlement of securities in exchange for cash, CSDs ensure the efficient processing of securities transactions in financial markets, particularly as we have moved from paper-based trading to digital exchanges of securities that exist primarily in book entry form. As Europe moves to the full dematerialisation of securities by 2020, it will require a hyper-efficient post-trade infrastructure to match. In addition, because they are located at the end of the post-trade process, CSDs are unique witnesses to any failures that occur during the settlement period, making them a key element in the harmonisation of settlement discipline.

Levelling the playing field

For all firms along the value chain across Europe, the implementation of the CSDR will bring a range of benefits. By instigating a series of standardised rules, the regulation will level the post-trade playing field and generate a new wave of transparency. Companies will be able to compare prices for the first time, as services and risk management procedures are standardised. This trend will be enhanced by T2S, when it goes live in June 2015, when participants will be able to access T2S via a single connectivity point for all euro-denominated settlement. In addition, CSDs will have the onus of proving that their systems can deal with both market and operational risk. Best practice will be applied to governance as well, with the automation of participant consultation, the restructuring of boards of directors with new independent non-executive directors, and the implementation of mandatory user committees. CSDs will also be encouraged to openly define their goals and objectives, enabling market participants to get strong insight into the intentions and motives of their settlement partners.

Churning away

For these reasons, on the whole the CSDR can be regarded as positive for the stability of the financial system, despite the fact that it will increase burdens on CSDs such as enhanced capital requirements. It has been clear to many that the European Commission would have to introduce the CSD regulation at some point, now that they had already legislated in relation to trading venues, CCPs and Trade repositories. The CSDR is also important given other structural developments, such as T2S and the shortening of the settlement cycle to T+2. This will mean that collateral, which has become the lifeblood of the modern financial market, for instance in securing credit exposures, and providing initial and variation margin, will be freed up more quickly, potentially enabling firms to leverage it to their advantage.

The move to T+2 will in particular provide a real-time test of whether there is a sufficiency of collateral in the financial system, and this will be further tested when T2S goes live in June 2015.This will impact on what Manmohan Singh, ‎Senior Financial Economist at the International Monetary Fund, terms ‘collateral velocity’. If collateral velocity decreases, the markets are less liquid and are at risk of ‘seizing up’. The CSDR and T2S are therefore two of the primary drivers for market participants to improve their collateral management systems, which can handle both the heightened requirements for collateral and the higher rate of collateral churn – or turnover.

Battening down the hatches

Given recent media attention, for many market participants it may feel like the introduction of T2S will bring the project of harmonising the European post-trade infrastructure to a close. This is far from true, however, as it is generally recognised that the European market is still top heavy with post-trade infrastructures, both CCPs and CSDs.

Taken together, the creation of a single euro settlement platform, the shortening of the settlement cycle to T+2 and account handling changes will have a transformational impact along the whole value chain. Market participants will need to think carefully about the sorts of business benefits they can derive from the changes if they are to maintain a competitive advantage in servicing their own clients. For the CSD community itself, competition is intensifying but each will have its own approach. Crucially, the creation of a virtual collateral pool across European markets will help eliminate some of the inefficiencies in transferring securities across systems, hopefully making Europe a more competitive place to do business.

[divider_to_top]

Fixed Income Focus : Best Execution in Corporate Bonds : Russell Dinnage

By

Ian Rycott

-

July 3, 2014

BEST EXECUTION? IT DEPENDS ON YOUR DEFINITION.

In 2014, achieving best execution for over-the-counter trades in secondary corporate bonds is seemingly a logical non sequitur. The market for the securities is largely illiquid, and thus it does not lend itself easily to the benefits that technological innovations like algorithmic execution and transaction cost analysis are bringing to the sovereign bonds space. Russell Dinnage, Senior Consultant at GreySpark Partners discusses how a best execution-less reality for corporate bonds trading is not for want of trying on the part of broker-dealers and institutional investors alike.

RDinnage After successfully developing the first mass-produced automobiles of his time, industrialist Henry Ford famously said: “If I had asked people what they wanted, they would have said faster horses.” In 2014, Ford’s statement on the power of innovative thinking applies to the concept of best execution in the fixed income market, specifically in the now largely illiquid market for corporate bonds.

E-trading advances in recent years made price slippage – the loss of investor value on a trade through inefficient execution – a phenomenon of the past in markets for equities, futures and spot FX. In those markets, algorithmic execution and transaction cost analysis tools provide broker-dealers and buyside investors alike with copious amounts of quantitative measurements of the timing and effectiveness of point-of-transaction and settlement decision-making by traders.

This reality for a large portion of the capital markets universe of products thus begs the question: What does best execution look like for the illiquid corners of the market wherein e-trading solutions are limited by the technology of their time? In those corners of the market, e-trading solutions are not yet able to solve best execution-related problems because the final form of the solution has not yet been developed. Some fixed income market participants have attempted to bring their platform-based solutions to the fore in recent years, but all of those attempts have so far been met with only varying degrees of success.

Recently, GreySpark Partners surveyed 12 buyside firms asking them how they define best execution when seeking and consuming corporate bonds liquidity.

The survey found that 11 of the buyside firms have in place written, fixed income-specific best execution policies, but not all of those written policies contain specific practices and procedures for best execution. For all of the 12 firms, a formalised auditing program is in place to validate post-trade procedures on a regular basis in an effort to verify that an effort was made by the firm to provide best execution on client trades.

However, the survey also found that the buyside firms’ assessments of the application of best execution onto client trades are typically quantitative in nature. In not yet developing qualitative assessments to measure the quality of best execution protocols on client trades, the buyside firms surveyed said that, in illiquid instruments like off-the-run corporate bonds, best execution is typically based on the buyside firms’ long-standing knowledge of their counterparties’ ability to find liquidity at an attractive price. This means that, of the buyside firms surveyed by GreySpark, their knowledge of which counterparties typically provide fair pricing and which do not – within the spirit of best execution regulatory requirements – provides a better measure for the optimal outcome of a trade for a client over any quantitative tool to measure best execution available in the market in 2014.

In corporate bonds e-trading, most of the buyside firms surveyed said that three RFQs per order are sufficient for fulfilling best execution obligations. However, the quality of execution for every illiquid corporate bonds trade depends on the level of liquidity in the market for each type of bond security and the ability of the buyside firm to strip out speculators from lists of quotes. But, at only three RFQs per corporate bonds order, proving best execution is questionable at best for trades in the approximately 3,000 to 4,000 off-the-run corporate bonds that make up the highly illiquid tail of the credit market.

On the surface, it appears that buyside standards for corporate bonds best execution are still focused on the need for faster horses. But what good will faster horses do for buyside firms in the EU and US that now warehouse an estimated 96% to 99% of the USD 250bn of corporate bonds liquidity held by banks in the two regions in 2007?

Some electronic historical market data-centric solutions to the conundrum of the corporate bonds liquidity dilemma are emerging; Figure 1 (below), shows GreySpark’s informal assessment of the capabilities to-date of four of those solutions.

These ‘information management system’ solutions partially serve sellside and buyside needs for assistance in developing new corporate bonds trading models and accompanying analytics necessary for transitioning an illiquid market away from voice trading and more toward e-trading. But these systems do not automate trade execution methods, nor do they provide means for capturing best execution.

Enter HSBC – in October 2013, the bank launched* a corporate bonds block trading electronic order book called HSBC Credit Place. By segmenting the corporate bonds market into a venue wherein block trading alone is the goal, HSBC has used its clout as a flow house broker-dealer to create a platform on which the interests of all the counterparties interacting with one another there – either manually or automatically – are aligned. Theoretically, as the frequency of buyside corporate bond orders entered into HSBC Credit Place increases, so too does the statistical likelihood of achieving a match for that order, and the potential for success in ever-larger orders increases.

For now, overall volumes of corporate bonds trades done in fully automated, client-to-client matching execution electronic order book venues are low. The volumes are low because off-the-run corporate bonds liquidity streams rarely ever match up anyway in a precisely like-for-like manner, hence the predominantly voice-traded nature of the market for the securities, despite the recent emergence of numerous technology solutions designed to automate voice trading processes. Instead, ventures like HSBC Credit Place are suggestive of what the automobile-centric future of best execution in fixed income could look like – one in which technological advances would allow for the seamless crossing of illiquid corporate bonds flows.

In that future, the overall corporate bonds marketplace could then be siloed into specialized pools of liquidity – like large-size corporate bonds order pools, for example – that are governed by broker-dealers on behalf of willing client participants.

In such dealer-controlled environments, best execution in illiquid fixed income products of any ilk is more easily secured because both the interests of the venue’s stewards and its participants are aligned toward the idea of fair value, achieved in an efficient manner.

And while the buyside may not yet know precisely what their ideal standards for best execution for those products looks like, liquidity crossing venues like HSBC Credit Place that are governed by broker-dealer expressions of client imperatives are essential experiments on the road to designing the best execution automobile of the future.

*Ref Reuters article, “HSBC launches bond e-trading platform” by Christopher Whittall, March 18, 2014.

GreySpark Partners published two reports in June focusing on the uptake of e-commerce solutions in the fixed income market. Those reports are Trends in Fixed Income Trading 2014 and Fixed Income: Buyside Best Execution, both of which can be found at: https://research.greyspark.com/ ‘

[divider_to_top]

Market infrastructure : Case study : The Stock Exchange of Thailand

By

Ian Rycott

-

July 3, 2014

SET BOOSTS ITS FIREPOWER.

In 2010, the Stock Exchange of Thailand (SET) decided it was time to make a major improvement to its trading technology infrastructure. Best Execution spoke to Cinnober, the Swedish technology firm that won this challenging contract.

Operating in an increasingly competitive and fast-moving global market – and with its sights fixed on becoming the regional centre for the ASEAN capital markets – SET knew it required an upgraded trading platform to support the growth of the Thai Capital Market.

The exchange launched a five-year technology master plan to create an infrastructure capable of boosting the efficiency and vitality of the Thai capital market and supporting its long-term growth. Four years on, with its new state-of-the art trading system SET CONNECT now in place, it is a key mission accomplished.

Back in 2010, SET’s trading infrastructure was based on a mix of systems developed both in-house and by third parties, with cash equities and derivatives traded on different platforms. The goal was to replace its existing trading, market data dissemination and surveillance systems for both asset classes with a pioneering solution centred on a single platform.

The exchange needed an architecture capable of achieving higher levels of efficiency and throughput, lower latency and greater functionality. It also wanted to connect smoothly to the trading systems of foreign markets via standard industry interfaces in order to attract more liquidity, as well as reaching a higher level of compliance with international standards. With speed of the essence in global trading, SET was after a platform where new products and services could be introduced quickly and with the superior transaction times to support high-frequency and algorithmic trading.

First step in the process was to find a technology vendor with the expertise to deliver the core systems required. All the major exchange technology suppliers bid for the project, and the Swedish-firm Cinnober carried off the prize in June 2011 – marking the first time the company had undertaken a project in South East Asia.

What singled Cinnober out? “We were able to offer a complete and proven solution compliant with international standards and encompassing all SET’s needs on a single platform,” says Cinnober CEO, Veronica Augustsson.

In addition to multi-asset trading, SET was looking for an integrated index calculation engine, connected to the trading engine’s business logic so as to be able to calculate real-time indexes on their listed stocks, sophisticated data dissemination functionality, and multi-asset market surveillance.

“Our delivery project model offered a high degree of transparency, interaction, and flexibility, all of which was attractive to SET in implementing an internationally- recognised solution that would also meet the specific needs of the Thai market.”

Going live

Working in tandem with local brokerages, SET CONNECT was launched in two phases, reflecting the fact that the previous infrastructure consisted of two separate systems with different structures, memberships and member communities.

Cash equities went first, as the asset class with the most pressing need for an upgrade. Its new system launched in September 2012 and the derivatives market followed suit in May 2014. On the very first day of trading on the derivatives platform, SET experienced their second-highest daily number of contracts traded ever, and on June 10^th, the old record was beaten by as much as 19%.

The system is based on Cinnober’s high-performance TRADExpress Trading System, a multi-asset execution system that delivers powerful functionality, speed and throughput capacity, easily extendable and scaled up on demand. This runs alongside a new market dissemination system, TRADEexpress Information Manager, the TRADExpress Index Engine and Cinnober’s market surveillance system.

“For the first time, investors in SET can now trade both equities and derivatives on the same platform,” says Augustsson. “The new infrastructure enables multi-currency trading and, by incorporating the use of international industry standard interfaces (FIX 5), will attract the wider international trading community and is easy to link with other marketplaces to attract further liquidity to the Thai exchange.”

Accomplishing the migration to a global trading platform was always going to bring its own set of challenges. The deadline for the project was tight, particularly in the first phase, covering cash equities trading, index calculations, market surveillance and information dissemination services.

“It was a very ambitious target and in order to deliver, we had to quickly establish a very close working relationship with SET,” explains Augustsson. Client and supplier also had to manage a five hour time difference between their respective headquarters, something Cinnober is, however, used to, through its dealings with its large international client base.

“The majority of our project team was based in Stockholm, with some members also on site at SET. We focused on making partial deliveries to SET as early and frequently as possible to meet the timescale. SET had a highly skilled requirement and test organisation which tested the deliveries at every stage to confirm that we had understood and fulfilled their requirements. That close cooperation allowed us detect and solve any misunderstandings very early on, enabling us to deliver the various stages of the project at speed – in the case of the equities systems, in around ten months – and to meet all the specifications of the plan.”

Since implementing the new platform, SET has strengthened its market position in Asia. In October 2012, it became connected with the Bursa Malaysia and Singapore Exchange through the ASEAN Trading link, representing the first time investors have had a single entry point to three of the largest ASEAN equity markets. In Q3 2013, SET overtook the Singapore Exchange with about thirty five per cent higher trading volume and grown to have the highest trading volume in the region. In addition, SET has set out a plan to grow the market capitalization of listed companies and to enhance its product offerings to meet demands of both local and foreign investors.

“Markets everywhere today must be able to act quickly on changes and maintain their ability to shape their own destiny,” says Augustsson. “A trading venue’s technology is now more important than ever. Cinnober is proud to have worked in close partnership with SET to deliver SET CONNECT to the Thai capital market, enabling it to perform to the very highest standards at both regional and global level.”

[divider_to_top]

Market surveillance : Ancoa : Stefan Hendrickx

By

Ian Rycott

-

July 3, 2014

HELPING THE OVERSTRETCHED DATA SCIENTIST.

By Stefan Hendrickx, Founder and Executive Director at Ancoa.

Continuing from our article in the Spring issue “Market surveillance: From cost to value creation”, we move our focus to the analytics use cases of Ancoa, the market surveillance and monitoring platform. We describe how the platform is leveraged by our clients to execute specific data mining tasks, helping the front office gain real insight into both surveillance and risk.

So, how does market surveillance relate to quantitative analysis? As Kara Scannell described in the FT in May 2014 in her article “SEC: With the programme”: surveillance of Wall Street and the financial markets at large requires quant skills and high-tech tools in order to reveal market abuse concealed within huge amounts of transactional data. But these quantitative skills, and the data scientists who are able to do this analysis, are scarce and hardly affordable. Many firms, not only financial ones, want to make use of their precious data crunching skills. The goal is to maximise insight by optimising the workflow of your data scientists.

A number of quants/data scientists at sellside firms and exchanges looking to satisfy the increased need for analysis have worked with Ancoa. From this experience we have found that data scientists and quants often spend more than half of their time preparing data sets for analysis. This unfortunate reality makes it particularly difficult for them to find hidden correlations, which then leads to missed opportunities. Automation in data sampling or “scooping” boosts productivity, and this is where Ancoa can work with firms to help data scientists reach their potential. It is possible to scoop tens of thousands of specific data points out of hundreds of millions, and sometimes billions of transactions, with minimal effort.

Ultimately, the aim is to provide a single analytics environment which runs on top of a single data source. Creating a central data repository for market analytics, which stores both current and historical data on the market has several benefits. At a high level, businesses operating this kind of structure become more streamlined. Different departments learn to speak a common language through shared technology, and there is a reduction in IT overheads and duplication in data storage. Most importantly however, data scientists are able to apply fast and automated data scooping across back and front office. Within this framework, data and the associated analytics used for back office market surveillance and front line traders becomes a ubiquitous feature of an organisation’s structure.

Be25_Ancoa_Figure1.

Fig 1: Displays the order book for a security, rendered as a price-time priority queue, with filtering applied on market participants and order volumes to analyse relative positions in the order book over time. ©Ancoa Software 2014

There are implementation challenges in taking a ubiquitous approach to data and analytics. Essentially, it becomes necessary to apply the proper level of governance to ensure that individuals whose behaviour is being monitored do not have access to the alerts being analysed by those doing the monitoring. As a consequence, ensuring that the proper level of governance is put in place is essential in preventing the leakage of information. Nevertheless, the benefits of having a central data repository for analytics easily outweighs the implementation challenges which have to be managed.

A flavour of the types of analytics used by exchanges includes:

Studying market structure
Impact of rulebook changes and new connectivity services on behaviour across different groups (buyside, sellside, market makers) and individual market participants
Building order books from proprietary data
Effect of policies on liquidity, correlations
Effects of policies on market structure, network analytics
Behaviour of individual market participants, in relation to position in order book
Behaviour of groups or market participants’ (buyside, sellside, liquidity providers) relative positions in the order book for a specific security

A single data repository, at firm level, for analytics has additional benefits for a wide range of firms. Market makers are able to extract statistics on

the performance of individual algorithms. Buyside firms get statistics on different sellside venues, on execution quality and look for substantial trades in the market that are not their own. Sellside firms are easily able to measure performance between traders. Since the application of analytics is immensely diverse, and some of the insight that firms attempt to understand is proprietary, Ancoa has an application programming interface (API) that allows firms to develop their own metrics without disclosing them to third parties.

Ancoa’s key focus is contextual market surveillance. As the article attempts to illustrate, using a real-time system capable of capturing and analysing transactional data in a single repository, facilitates analytics and reports as a natural progression. Ancoa has addressed the corporate data governance issue by offering granular control of user rights and roles, and strong encryption practices. This enables best of breed practices of IT governance levels allowing members of staff to access only the appropriate types of data and applications and avoids inappropriate information diffusion across business functions.

ancoa.com

[divider_to_top]

News review : Equities

By

Ian Rycott

-

July 3, 2014

Content matters.

Despite the death knell being rung repeatedly for high touch services, the need for content and related services prevails in the US. A series of research reports by consultancy Greenwich Associates shows that electronic trading has stalled while broker dealers are enjoying the first rise in institutional commissions for the first time in five years.

Be25_GreenwichAssc_JBennett The findings, which were based on 590 interviews with US institutional equity traders and portfolio managers in the first quarter of 2014, showed that for the 12 months ending February 2014, the pool of cash equity commissions jumped 10% to $10.34 bn from $9.30 bn. Investment managers accounted for 55% of total wallet, up from 46% in 2011, with hedge funds accounting for 23% of the commission pool versus 28% in 2011.

Interviewees from hedge funds predicted a 9% hike in the US cash equity commission pool by the end of the year, compared with a 3% expansion expected by long-only firms.

According to Greenwich, the main drivers were investors’ “thirst for content-written research, corporate access, market intelligence” and “analytics providing insight into where their orders are going and where their executions are ultimately coming from”.

Investors were both using high-touch execution services to retain access to research and paying a ‘tack-on’ rate over and above the base execution rate.

This could explain the stagnation in the growth of electronic trading volumes in the US equity market. Single stock electronic trading volumes only rose by one percentage point to 37% in 2014.

The report notes that “a renewed focus by investors on how orders are handled and where they are ultimately executed means that perceived broker quality is nearly as important as the accuracy of the broker’s VWAP algorithm.”

Although the study found that mid-tier brokers are snapping at the heels of their larger brethren and gaining market share, the top nine firms still account for a weighty 64% of both low and high touch commission.

According to the Greenwich Quality Index – the firm’s methodology for compiling survey respondents’ evaluations of brokers’ sales and electronic trading services – Credit Suisse, Goldman Sachs and Morgan Stanley were top ranked for sales trading and trading quality, while Credit Suisse and RBC Capital Markets were rated highest for electronic trading quality.

“While bulge bracket providers have seen their presence in US equity research eroded, they have done a much better job protecting their actual commission share in trading – the engine of revenues and profits in the equities business,” said Jay Bennett, managing director at Greenwich Associates.

[divider_to_top]

Fixed income trading focus : Networking : Paul Reynolds

By

Ian Rycott

-

July 3, 2014

LET THE SCALES FALL…

Paul Reynolds, self-professed electronic trading guru and CEO of new trading platform Bondcube suggests that the solutions to some of the key challenges facing the fixed income market already exist – it’s just a case of knowing where to look.

As a long-term inhabitant of the fixed income realm I do find it challenging that this asset class is so far behind Equity and FX in terms of market structure and technology. Fixed income is of course different in terms of the proliferation of securities and the lack of a central market structure, but the idea that these issues present an insuperable impediment to change is now simply not sustainable.

Any market that feels it can resist the benefits of new technology and ideas is in for a surprise. Whether it is taxi drivers acknowledging the presence of Uber, advertisers comprehending social networks or the military understanding the possibilities of real-time intelligence gathering, no-one can assume an established structure is not improvable.

As the bad boy of the global financial crisis in 2008 the impact of regulatory change is and will be especially profound in fixed income. This factor alone opens up new opportunities, but two other influences deserve consideration. Firstly the increasingly secular change in sellside fixed income profitability and secondly the extraordinary accumulation of fixed income assets amongst the buyside. These two features are closely related and to some extent inter-dependent.

In the context of equity and FX trading infrastructure, fixed income trading infrastructure looks primed to enjoy an era of significant innovation. Fifteen years ago fixed income saw the introduction of electronic trading. Since then the market size has grown, as has the volume of electronic volume. Government bonds, especially US Treasuries, account for most of the growth in secondary volume. Smaller orders and recent liquid issues are largely well catered for by existing platforms. In my view the innovative focus will be on the less liquid securities and larger trades that carry price transparency and market risk challenges.

What’s the problem?

So what are we trying to solve here? Firstly, there is a huge universe of hundreds of thousands of bonds in multiple currencies, maturities, issue sizes and structures. A large majority trade as infrequently as a couple of times per year and liquidity or pricing sponsorship from the sellside can understandably be sparse. Added to that, information about traded volumes is almost impossible to find and any enquiries to buy or sell are lost in a spaghetti bowl of unconnected ends. Furthermore, the market risk of opening ones’ intentions to the wrong person can have profoundly negative implications on any pricing resource that may exist.

Under these circumstances it is hardly surprising that many buyside investors choose to buy and hold rather than face the time consuming and often deleterious consequences of seeking order execution. The buy and hold strategy has however paid investors colossal returns over the last five years as central banks have massaged interest rates to extraordinarily low levels and purchased vast quantities of fixed income securities themselves. The buyside are well aware however that at some point in the not too distant future the five-year accumulation binge will end and underlying investors may wish to change their allocations to other asset classes. This may be caused by a bout of inflation, a change in central bank asset purchases or indeed a continuous hike in interest rates to more normal levels.

As things stand the liquidity sponsored by the sellside could absorb very little selling before prices were abnormally affected. A unique feature of fixed income under these circumstances of price volatility is that unlike any other asset class, traded volume declines in fixed income when volatility rises. This is because liquidity is almost entirely sponsored by the sellside.

In other asset classes like interest rate futures and commodities (that I read of so enviously in this magazine), this problem does not seem to arise in the same way. The central market structure grants all types of participant some level of access to price and volume information and the ability to trade with each other, without risk.

How then to overcome the liquidity challenge in a fragmented, low volume market? Firstly we need a structure that permits all users to trade with each other, or ‘all to all’ as it has become known. Secondly, assiduous gathering and dissemination of all price, volume and enquiry data pre-trade. Finally, a mechanism for posting and matching enquiries that mitigates market risk.

Socially challenged

None of that is especially challenging, but in itself it is insufficient to transform the present malaise. One of my other favourite reads is Wired magazine. I am amazed how little of what has been created in Silicon Valley has permeated Wall Street. Trading is after all an intensely social activity. I know from my own experience as a corporate bond trader that the superior quality of my relationships with my sales force, clients, brokers and other traders gave me an advantage over my competitors. That, amongst other things contributed to my intrinsic value. It is no different for sales, buyside execution traders or agency brokers.

How then to introduce the network effect into the new model? Simply put, it is who you are and who you know. If you are a reliable, trustworthy, value-added individual you need a way of displaying that – like a well-known auction site. If you have a vast network then you need a method to communicate with it – like a certain social network site. Finally if you want access to other persons and their trading activities you need to able to request a link to their network.

If you combine these features it is then a question of how well you use them. This means accumulating valuation and negotiation skills beyond the traditional roles of sellside and buyside. Everyone can benefit from improving their skills and network to the point where it can have a profound effect on their trading performance.

This is not thinking outside the box, so much as adopting existing technology that we use every day on our personal devices.

©BestExecution 2014

[divider_to_top]

Viewpoint : Post-trade : T+2 : Denis Orrock

By

Ian Rycott

-

July 3, 2014

T+2 : A GROWING CHALLENGE.

Denis Orrock, CEO GBST Capital Markets, examines this testing issue.

The evolution of the problem

In order to reduce the current high rates of trade fails and associated costs and operational risks, particularly on cross-border transactions, the European Commission published proposals for improving securities settlement and access to Central Securities Depositories (CSDs). The rules, termed CSDR (Central Securities Depositories Regulation) necessitate a move to T+2 or less for all European Union (EU) markets by 2015.

Certain EU countries, such as Germany, Bulgaria and Slovenia, already have a T+2 settlement policy so there is a precedent within Europe that proves that processing transactions within these timeframes works, adding weight to the proposal for the remaining member states to follow suit. The original deadline for the adoption of T+2 was January 2015 but, as is well publicised, this is now firmly targeted for 6^th October 2014.

The key item within the proposal is the shortening of the securities settlement period across Europe from three days, in the majority of European markets, to two days (T+2). The introduction of financial penalties for trades that fail to settle on time has been supported by the majority of market participants, being viewed as gentle encouragement for faster and more efficient settlement practices – practices that lower counterparty risk. Will all financial institutions be ready for a transition to T+2 by this time?

Implications for asset managers and investment houses

Perhaps the most notable item from a move to T+2 is that activities in the settlement process will come under greater pressure as a result of the reduction of the overall cycle by a day or more, such as the trade allocation, confirmation, and affirmation processes. The goal of these processes is to enable the asset manager and the institutional broker to agree upon and match the details of a trade in order to clear and settle the trade; this includes adding data that may be required for the process to progress. The post-trade communication and validation processes are therefore based on the checking and verification of a set of key data items.

Depending on convention, settlement details, fees, and commissions are added throughout the post-trade messaging process or via an external standing settlement instructions (SSI) database. In a T+3 environment the trade allocation, confirmation, and affirmation processes tend to take place at some point between trade date and T+2 (usually on or before T+1). By taking a day out of the lifecycle, firms will be forced to perform a higher volume of these processes on T+0. More specifically, T+2 project teams will need to address:

o same day affirmation processing, requiring verification of the trade to be completed on the same day the trade is executed

o a potentially substantial increase in the number of trade failures – front offices are currently struggling to confirm and settle those trades at T+3

o pressure on STP workflow – resulting in a higher number of settlement failures due to inefficiencies in systems or data issues

o administration of additional fines levied for not reaching T+2

Reviewing settlement failure rates (sourced from ECSDA, BATS and Aite Group as of March 2012) fail volumes vary across the main European markets with Slovakia and Portugal topping the table with in excess of 17% fails, through 4-6% for the larger markets of Germany and UK, down to 0.2 % for Spain. These percentages can represent substantial processing volumes that now require automated rectification and validation.

T+2 will also have an impact outside the European Union, with cross border transactions needing to be brought into line with the T+2 deadlines. The Depository Trust and Clearing Corporation (DTCC) in the US is pressing for a move to shorten their limit from T+3 to T+2. Meanwhile in the Asia Pacific region markets such as Japan and Hong Kong have already achieved T+2 and are considering a move to T+1.

The operational burden

The primary areas of focus for investment for brokers is around enhancing current systems workflow and automation, in order to meet the requirements of a compressed time frame; and improving interfaces to capture more data in order to reduce manual interaction. Naturally addressing these areas will mean a thorough review of business processes, and whilst circumstantial evidence suggests that there will be an initial increase in fails and settlement team workload, matters will settle down, normalising with reduced fail rates to those currently experienced.

One of the biggest problems concerning asset management houses is their extensive use of spreadsheets for trade matching and other back office processes, if these spreadsheets bear incorrect SSIs, the trade fails and there is little time for remedial action under T+2.

The biggest outlay for the majority of participants will be in the review and analysis process itself in order to determine what process changes are required and test that systems are ready for a move to T+2. An example of this could be within the trade cancellation process, where manual checking of data to determine accordance with market rules could be ruled out due to the compressed time frame.

There are likely to be some technology investments required around adding new interfaces between systems and in improving core processing systems to cope with the shortened settlement cycle. The extent of these investments will depend on the age and capabilities of the firm’s current internal infrastructure.

To make T+2 work, there really is a need to automate task management and rules for the rectification of failures. Middle office processes such as trade confirmations and affirmations that are manually intensive today must be substantially reduced. If an SSI fails, firms will need an ALERT, or equivalent interface that will identify the piece of information that is missing or incorrect. Buyside firms must migrate from batch or end-of-day processing to near real time processing and implement data improvement initiatives to improve the accuracy of SSI data.

Perhaps an obvious statement is that firms should aim for improvement in overall pre-settlement matching performance – matching an instruction for settlement as early as possible once the trade is executed will allow for operational risk reduction.

The T+2 requirement also comes on the back of FTT, EMIR, T2S and a whole host of other regulatory reporting obligations that will require already stretched resources to extend even further. The opportunity to outsource this task is something to consider, but for UK asset managers in particular this option has become arguably more complex since the Financial Conduct Authority’s (FCA) thematic review into outsourcing.

T+2 is becoming a global phenomenon. It is time for firms on the buy- and sellsides to prepare a scalable solution to a growing concern.

[divider_to_top]

Viewpoint : Post-trade : Multi-asset post-trade processing : Matthew Pountain

By

Ian Rycott

-

July 3, 2014

THE TIME TO STREAMLINE.

With multi-asset trading continuing to take hold, Matthew Pountain, Head of Product Management, Securities Processing Solutions International, Broadridge Financial Solutions, considers how firms can meet the challenge of integrating asset-based post-trade processing.

The trend towards multi-asset trading has been on the rise for some time: in the last ten years in particular, there has been a huge increase as buy- and sellside firms seek out alpha through diversification of portfolios, increased use of alternative assets and new geographies in response to growing competition in the market and the need to engage with new opportunities.

During this decade of low interest rates, continually shifting regulation and the ever-pressing need to manage costs, the growth in trading of alternative assets, particularly FX and listed futures and options [see Figure 1], has been a response by many firms to improve returns. However, the flip-side of this growth in the trading of non-traditional assets is that unprecedented demands are being seen on post-trade processing, putting pressure on both operational groups and technology budgets.

For many firms, post-trade processing has been divided along asset lines, such as equities, fixed income, FX/money markets and OTC and exchange-traded derivatives, with most firms opting for silo-based operational models that effectively replicated front-to-back office services across each group of asset classes traded.

With the challenges inherent in sustained multi-asset growth, the need to re-evaluate the post-trade approach is clear. Within this new environment, the continuation of the silo model has the potential to cause difficulties for firms. Rising cost pressures, along with inefficiency and increased levels of operational risk, are now driving the need for a more centralized approach.

That is not to say that the integration across asset-based silos does not present challenges of its own; however, there are many benefits to be gained from this approach. Centralising post-trade operations offers enhanced business opportunities, streamlined operations, improved position management, lower operating costs after a year in which financial firms allocated $12.2 billion on technology to support post-trade automation activities [see Figure 2], and a reduction in operational risk.

Providing clients with access to new investment opportunities ahead of the competition is becoming a necessity, with rewards to early entrants into any marketplace. Being able to differentiate service offerings by providing access to emerging product segments or asset segments can offer brokers considerable business opportunities. Clearly firms with the capabilities to support these new market requirements cost-effectively will have a significant advantage over the competition.

Streamlining operations can permit resources that were once allocated to discrete (yet replicated) operational activities to be redirected in order to meet growing customer demands and expand revenues. In so doing, financial firms are able to create a flexible and scalable framework that simplifies their operational processes.

An integrated approach post-trade also encourages a global, business-wide capability for cross-asset position management, enabling a single view across global holdings for all asset groups. A top-end integrated structure may offer the capability to forecast and manage future-dated balances of all asset classes with full breakdown of ownership, better enabling firms to manage real-time positions and maximize the use of all firm- or client-owned assets. It also addresses the need for control with the ever decreasing settlement lifecycle timeframes, reduces funding costs associated with borrowing for positions not forecast, and aids risk mitigation by avoiding unnecessary exposure to external parties for prolonged periods.

A multi-asset class, post-trade solution additionally enhances risk management capabilities through streamlined automation, state-of-the-art workflows and the optimization of STP rates. This approach enables firms to consistently flag and resolve exceptions, reducing risk and capital exposure. Firms can review operational risk parameters encompassing the entire processing infrastructure instead of one segment of the business.

The structural shifts occurring across global markets present both challenges and opportunities to firms in supporting their evolving needs. Creating an enterprise-level, multi-asset class operations infrastructure capable of managing the constantly shifting market structure is a significant undertaking and only a few of the largest global firms have the capabilities to create an in-house solution. Firms are increasingly turning to external IT providers to help [see Figure 3], and securing the right partner is critical for streamlining post-trade operations across asset classes and unlocking the additional benefits from a mutualized cost model.

[divider_to_top]

Best practice | Breakfast club | Finding and retaining talent

By

Ian Rycott

-

July 3, 2014

THE CHALLENGE OF LOSS OF TALENT.

by Roger Aitken

At a Breakfast Club meeting in the City in June, the lead host and partner at talentflow, Susan Cuff opened the proceedings by positing that the practice of recruiting, retaining and motivating staff in the financial services sector could be considered akin to the best execution requirements under MiFID, and challenged a small, but distinguished panel to discuss this assertion.

The chairman of the panel, a director at one of the ‘Big 5’ global consulting firms then framed the discussion with reference to a recent benchmarking survey that indicated the cost of bringing in a new member of staff and losing them in short turn (inside the first three months) typically could amount to around 12 months salary. No hard figures are available, but given that the UK financial services sector employs around two million people in around 34,000 businesses the total cost would be huge.

The panellists, comprising three leading practitioners from the electronic trading, exchanges and consultancy space, commented in turn. “My worst ever hire was my most expensive,” said one “the interview process lasted about seven weeks and involved nine interviews. Plus we utilised a very expensive executive search firm. The candidate only lasted slightly longer than the interview process!”

Another noted: “Often I don’t recruit purely on technical expertise…far from it. The things I look for most in people are openness, honesty, trust and integrity. Right from the very outset I want somebody who can always challenge me and is going to bring me to question and make sure I’m not just delivering my ideas.”

A panellist from the exchanges world said: “What’s critically important and yet famously forgotten by most people – most of the time – is that the way you deal with people you are recruiting is an extremely powerful synonym for how you deal with your customers. If you’re a bit disorganised, a bit laid back or simply lackadaisical with the recruitment

process then the chances are you are very similar with your customers.”

With a consensus that the interview was only one aspect of the evaluation of candidates, discussion turned to other methods of assessment including psychometric testing, background checks and screening tests and their validity.

“The more senior one gets, I really think those [tests] become less relevant because by the time you get to a senior position you’ve probably been tested up to the hilt,” noted the former exchange official. Another, speaking with direct experience, pointed to the comprehensive Royal Navy officer training programme which takes several days and could be a model that the financial sector could look to.

As perhaps could have been anticipated, no magical formula for the perfect recruitment process was arrived at; rather that a balanced and common- sense approach should always be maintained.

On the theme of employee retention, the chairman quoted research that showed once an employee had made the decision to leave there was no effective way of changing their mind. There was general agreement with this statement and what was critically important to the motivation, and therefore successful retention of an empoyee was the culture of the workplace. However, there was also agreement to one observation from the floor that “it’s fundamentally all about the culture. You cannot have best practices because of the cultural differences that exist between organisations. So, consequently you can never achieve a one-size- fits-all solution.”

This seemed an apt encapsulation of the morning’s discussion.

This meeting was the latest in a regular series of talentflow Breakfast Clubs, and was organised and hosted by talentflow in conjunction with Best Execution magazine. It was conducted under Chatham House rules, hence participants’ names have been withheld. For more information on talentflow and other events see: www.talentflow.org.

[divider_to_top]

.cls-8{fill:#fff;stroke-width:0px;}

CREDIT BEST EXECUTION.

aka “the block trade and the screen price fallacy”

Caroline Brotchie, Sales manager and Neil Murray, Head of European Sales at Algomi, discuss credit best execution.

SECURING THE FUTURE.

Europe prepares to harmonise its Central Securities Depositories. Alex Merriman, Head of Market Policy at SIX Securities, looks at the issues.

Disciplining the markets

Levelling the playing field

Churning away

Battening down the hatches

BEST EXECUTION? IT DEPENDS ON YOUR DEFINITION.

SET BOOSTS ITS FIREPOWER.

In 2010, the Stock Exchange of Thailand (SET) decided it was time to make a major improvement to its trading technology infrastructure. Best Execution spoke to Cinnober, the Swedish technology firm that won this challenging contract.

Going live

HELPING THE OVERSTRETCHED DATA SCIENTIST.

By Stefan Hendrickx, Founder and Executive Director at Ancoa.

Content matters.

LET THE SCALES FALL…

Paul Reynolds, self-professed electronic trading guru and CEO of new trading platform Bondcube suggests that the solutions to some of the key challenges facing the fixed income market already exist – it’s just a case of knowing where to look.

What’s the problem?

Socially challenged

T+2 : A GROWING CHALLENGE.

Denis Orrock, CEO GBST Capital Markets, examines this testing issue.

The evolution of the problem

Implications for asset managers and investment houses

The operational burden

THE TIME TO STREAMLINE.

With multi-asset trading continuing to take hold, Matthew Pountain, Head of Product Management, Securities Processing Solutions International, Broadridge Financial Solutions, considers how firms can meet the challenge of integrating asset-based post-trade processing.

THE CHALLENGE OF LOSS OF TALENT.

by Roger Aitken

.cls-8{fill:#fff;stroke-width:0px;}