Single-dealer platforms are likely to play an ever-larger role in the markets of the future, especially for regional banks, by Paul Caplin, CEO Caplin Systems.
Trading was simpler in the old days. Some instruments, like equities and futures, were centrally traded on giant exchanges, while others, such as FX and rates, were traded in an OTC free-for-all. The distinction was pretty clear.
But as trading became more electronic, and regulation more complex, the picture changed. Crossing networks and dark pools have proliferated in the equities market, so that finding the best price now means searching many venues. Meanwhile Dodd Frank and MiFIR are forcing much of the traditional OTC flow in the opposite direction, on to centralised SEFs and OTFs.
The result is that the equity markets now look a lot more like the OTC markets used to, with complex, fragmented liquidity. At the same time, despite the efforts of regulators to force something like a traditional exchange model on to the traditional OTC markets, the large number of firms lining up to become swap execution venues makes it almost certain that a fragmented market will emerge there too.
In effect, both kinds of market are converging on a hybrid multilateral trading model where liquidity is found in many places simultaneously, and where sophisticated algorithms and smart order routing are required to achieve best execution. And it’s quite likely that, over the next few years, the partly centralised, partly OTC hybrid swaps market is going to look more and more like the partly exchange-based, partly off-exchange equity market. This is not really a surprising development in a world in which electronic communication allows everyone to trade everywhere all the time. This rapid change in the structure of giant markets is prompting a lively debate about the future role of single-dealer platforms (SDPs). It has been suggested that multi-dealer platforms (MDPs) will all evolve into regulated exchanges, and that therefore SDPs will become redundant. However it can be argued that the reverse is true: SDPs are set to become more important than ever –– especially for regional banks.
The right tools for the job
To think about the SDP versus MDP debate, we have to think about what business banks are actually in. Investment banks provide a range of services, but one of the most fundamental is providing access to the capital markets for their clients. Banks need to think about what the capital markets are going to look like in the near future and the kind of help their clients are going to need in accessing them. There were two fundamental models for this in the past: dealing and broking. In the dealing model, they made the market and warehoused risk; in the broking model, they provided access to a centralised market and took a commission. As discussed above, however, most markets are now converging on a hybrid model where liquidity is heterogeneous and available simultaneously from many venues.
What the buy-side now needs from the sell-side is an effective way of managing access to that increasingly complicated world –– a combination of OTC dealing, direct market access, smart order routing, collateral management and margining. This adds up to some pretty sophisticated tools that banks are going to need to develop rapidly over the next few years. The new regulations will not, as some regulators may have fondly hoped, create a situation in which the buy-side will simply go directly to a centralised trading venue and do all their business there, any more than they do now in the equities market. They will, instead, create a situation similar to that which has emerged in equities, where there is a proliferation of trading venues and where a lot of help is needed to access those venues efficiently in a way that provides best execution and optimal use of collateral.
Faced with the erosion of their traditionally highly profitable OTC franchise, thanks to mandatory clearing of swaps, banks have no choice but to move on to the new dominant profit opportunity: clearing and collateral management services. But they won’t have any clients to sell those services to unless they first immerse themselves in the client deal flow, by offering something that the clients badly need: powerful and convenient best execution soutions. And the only way to deliver these cost-effectively is via an SDP.
The challenge for banks is therefore to electronify the client channel, but without losing the advantages of “high touch”.
From global to regional
The tier-one banks embraced electronification much earlier than their tier-two and tier-three counterparts, because they are more forward-looking, more technically capable and have much bigger budgets. Those tier-one banks that most quickly and aggressively rose to the challenge of electronification have been hugely successful, at the expense of their slower competitors.
But in the tier-two regional banking marketplace, it’s even more important to maintain great client relationships, and to move to electronic channels in a timely manner. And this goes double in emerging markets, where web-enabled mobile devices will soon outnumber fixed-line telephones.
Many regional banks are grappling with the challenge of simultaneously meeting two very different goals. One is to provide their domestic client base with access to the global markets. The other is to sell specialist domestic products and services in a global marketplace. For most large regional banks, they’re both very important businesses, and both are dependent on electronic delivery.
In the domestic marketplace, the regional banks typically have a large base of captive clients, usually skewed towards the retail end of the spectrum. These are dominated by corporates that have come to them via retail banking, but have quite big requirements for trading in the capital and FX markets. The regional banks need to protect this franchise against increasingly aggressive predation from global banks that are using sophisticated SDPs to lure their customers away. The best way to resist this is by providing an electronic offering which is accurately targeted at those customers and provides the workflows that they specifically need. But those banks must move fast, while they still have a market to defend.
In the global markets, regional banks often have a good story to tell. They can offer unique access to, and expertise in, local currencies, commodities and capital markets, and there is likely to be a global opportunity for this. But they cannot reach that global marketplace without a sophisticated electronic delivery channel. The margins on MDPs are just too thin –– even if they are able to support the products and services in question –– and voice trading is too expensive and not scalable enough.
The smart regional banks are already aggressively investing in building high touch electronic sales channels to address both these needs. The ones that aren’t are likely to be in trouble very soon.
Every single tier-one bank already has an SDP offering across multiple asset classes. In the FX market, in particular, more flow now goes through those tier-one SDPs than through all the MDPs put together. Tier-two banks now need to build effective SDPs of their own, but of a very different type that appeals to their very different clients. How effectively they do this will be a major factor in the future success of those banks.
The Future Of Trading In A Hybrid Marketplace
What’s the next frontier for post-trade processing?
By Bill Hebert and Ignatius John of Alpha-Omega Financial Systems.
Multiple Asset Classes
As with many other initiatives involving FIX and electronic trading, equities has paved the way for the development of innovative post﹣trade solutions. With the adoption of FIX based post-trade that is now gaining significant momentum in the industry, the questions looking forward are: “Which markets and security types will follow suit, and how much of what has been developed for equities is suitable for other asset classes?”
The newly organised Global Post-Trade Working Group and other involved committees within the FIX Community are now addressing these issues. For starters, fixed income is receiving a lot of attention. With its legacy of manually intensive processing and limited options for front to back automation, fixed income post-trade is ripe for new solutions. Several buy- and sell-side firms have also expressed interest, or are currently engaged in pilot programs for enhancing FIX post-trade for foreign exchange, derivatives and even commodity-based instruments.
Expansion of FIX Post-Trade Workflows
Trade allocations have been provided for in FIX since the launch of v2.7 in the 1990s. The enhanced workflow in v4.4, with the addition of comprehensive affirmation and confirmation detail, has driven much of the more recent focus and led to the development of complete FIX post-trade solutions for the industry.
So where do we go from here? Cross border trading may add some complexities to post-trade. These will need to be addressed and any necessary changes incorporated, especially with regard to local regulatory mandates and operational practices. Fortunately, FIX has anticipated much of what will be needed and is also capable of working and coexisting with other established standards to gain greater traction in the post-trade space.
Communication with custodians and the management of settlement instructions are also an integral part of post-trade. With recent enhancements, FIX is now capable of accommodating settlement instructions that can be sent to the custodian banks, thereby providing a comprehensive FIX-based solution for the post-trade process.
Achieving Straight Through Processing
With the advanced adoption of FIX beyond the more traditional equities and front office usage, the post-trade process will soon become more tightly integrated with that of trade execution. Order and execution management systems will further collaborate with post-trade solution providers in order to deliver seamless, accurate and timely messaging from pre trade indications, to order routing and execution, to post-trade. This will increasingly eliminate the processing barriers between front, middle and back office and result in a fully automated lifecycle from pre-trade to trade settlement.
Shaking Up The Back Office
In late May, the GlobalTrading journal organised a roundtable examining the current trends and issues in post-trade standardisation and technology. From amongst the delegates, including buy-side, sell-side, clearing house operators and solution providers, a number of key takeaways from the ongoing changing nature of post-trade processing were established.
As with many areas of the trading lifecycle, cost pressures are a paramount concern in post-trade. Everybody is being asked to cope with lower commissions and lower revenues, and technology costs are ever-increasing at the same time. A key question for the roundtable was therefore, where can savings be made? Is it in standardisation of platforms across the trading lifecycle? Is it through a more holistic version of TCA, to allow for greater analysis of costings to see where the money is leaking? Is it through outsourcing, and if it is, what is the wider cost/benefit, and regulatory troubles associated with such a split?
An area of increased analysis by all participants is the value of each respective client. The granularity of data on the value of individual clients, and how that data is used by sell-side firms to calculate high value and low value clients has the potential to change business models for the industry. With some firms looking to capture the larger buy-side and larger flow, and others deliberately looking to target the smaller more niche clients, there is definitely space for differentiation in trading, and in post-trade.
Dr Darryl Twiggs
EVP Product Management
SmartStream Technologies Ltd
“To achieve operating costs reduction, yet meet ever stringent regulatory reporting requirements, automation alone is not the complete answer. Firms must reshape the back office and adopt a utility model providing an internal service to the lines of business. Simplifying and eliminating duplication, putting in consistent best practices, in a utility model to deliver a 30 – 40% reduction in cost. We’re driving forward in new initiatives with externalised utility services to multiple clients with truly low operations costs delivered through the economies of scale.”
Jean-Remi Lopez
Manager, Asia-Pacific, Sales Planning and Execution
Omgeo
“The key theme was cost pressure being placed upon the operations groups on both the buy and sell-side. While regulation and market dynamics have made processing more complex, lower commissions and asset yields severely limit expenditure. Technology and functional mutualisation were identified as possible contributors towards relieving such pressure.”
Robert Rooks
Director,
PwC Consulting, Hong Kong
“With the continued drive to achieve ever higher levels of transparency during the post-trade process, the emphasis will continue to be on the effective management of operational risk by regulators and participants alike.
Transactional cost analysis in the front office has been with us for a long time, now as a part of the many initiatives underway to meet with the increased demands of regulators the drive to increase the level of efficiency in operational management will only help to reduce the costs of the post trade process but also raise the levels of visibility now required by both clients and regulators alike.”
Lyle Williams
Vice President
Head of APAC Broker/Dealer Operations
Sanford C. Bernstein
“With 65% of the cost of a trade in Asia coming post-execution, it is imperative that all participants engage the Exchanges, Clearing Houses and Depositories to look at ways in which we can reduce these post-execution costs (i.e. clearing, settlement and matching). Doing this, together with encouraging additional infrastructure providers (clearing and houses and depositories), would give investors and market participants more choices of venue to both clear and settle.
As a broker, we strongly focus on being part of a safe and transparent framework where international investors can enter the market in a secure and open manner with little concern about settlement risk.
Software vendors are offering more and more modular processing of trades allowing you to select the parts of the post-trade space that you need to control to run through their system. Attending the roundtable where most of the participants were present allowed a wide exchange of views and viewpoints as to where the industry is in the post-trade space.”
The Changing Desk
By Joe Kassel, Head of Global Equities Dealing and Exposure Management, AMP Capital.
There have been significant developments to trading platforms in the last five years or so. Prior to that most internal systems were developed in-house; then five or six years ago there was a major project across the organisation to review the range of platforms that we were using from an equity investment management point of view (and across other asset classes) and the decision was made to purchase the Charles River investment management system. Since then the system has continued to evolve (we are now on version 9.1.4) as has our usage of it. It is still front and centre for mandate compliance but is also now pretty closely embedded across portfolio managers and we are increasingly using it for EMS purposes as well. Since the decision was taken to use Charles River, the business has continued to globalise. We now have a global trading presence in Chicago for our Global REITs and Global Listed Infrastructure funds as well as investment teams in Hong Kong for our dedicated Asian funds as well as London. That said, we also use ITG’s Triton as our EMS for our Asia-Pac trading and are looking at EMSX for our global trading for pre-trade analytics and market monitoring.
Are you finding that over time you’re reducing the number of vendors that you’re engaged with or are you expanding that number?
Certainly we are very conscious of trying not to proliferate vendors. There was a mini explosion in the early 2000s where it was not unusual to have three, four, five or even six EMSs on a single trading desk. Since then we’ve evolved, some of the EMSs have gone and we’re very conscious of picking and sticking a little bit more. And so, the Triton application we use was a considered choice and something that’s working quite well for us in the Asia-Pacific region. We’re also conscious of trying not to proliferate FIX connections out of multiple systems and I know that’s probably appreciated by our counterparties too. On the electronic side, coverage is now global and by far the majority of the flow is via electronic trading rather than using more traditional methods.
We are still building out our electronic trading strategies and technologies. We have made a concerted effort to push into that space over the last twelve months. Currently we have pretty much full access to the entire suite of broker algos with our top half dozen global counterparties and in that time frame we’ve gone from effectively zero low touch to about 10%-15% of our total execution now being electronic or self-directed in some way at the moment.
PMs involvement in trade orders
It is changing, but it’s changing not so much in terms of getting involved, but actually PM’s getting less involved. If you look at the Australian experience but in a global context, Australia would probably be described as a relationship market more so than the larger markets (particularly UK, Europe and the US). But the sell-side and buy-side are evolving here just as they have in the offshore markets, and the tools that are standard on a global trading desk offshore are now the same as those we enjoy here on the buy-side and the sell-side. Our ability to measure and monitor trading is a lot more quantitative now than it was and that’s pretty much been the key in evolving trading decisions and trading infrastructure.
Changes in application of TCA metrics
We’ve made this very much a priority over the course of the last two years. We now have a strategic partner in ITG to conduct our TCA for us. And I guess what’s changing is how we actually use that analysis in a practical sense both on the trading desks and also within the investment teams. We have come from a relative standing start in terms of having that deep level of analysis of every single trade and now having trade reporting daily proves invaluable not just to traders but to portfolio managers as well.
Data and workflow management
The range of benchmarks that portfolio managers and our clients are interested in looking at has definitely been evolving and converging to the implementation shortfall benchmark which we view as the real cost of trading. From a data and workflow management point of view this can sometimes pose a challenge to properly capture the unrealised costs when an order is cancelled before it is fully executed or conversely when an order is cancelled and re-instated shortly afterwards. We have made good progress, working with ITG to properly link orders to reflect the real implementation shortfall in these circumstances. As large investors, especially in our home market, VWAP is also still relevant and — though a much maligned benchmark — is still a good pointer to the optimal times of the day to be trading.
Dark pools debate and the fragmentation in Australia and the HFT conversations in light of ASIC regulation
It is interesting and pleasing that ASIC see themselves as thought leaders in this space in terms of appropriate regulation of HFT and dark pools. I think ASIC are asking the right questions and trying to address genuine concerns and perceptions of misbehaviour in a productive and consultative way. Recent statements suggest that they are also reasonably pragmatic in some of their findings in particular with some of the fees they’re looking at, minimum resting times and minimum size in dark pools, etc. They are quite willing to rely upon evidence rather than making a statement of intent and they seem happy to continue to play a look-and-see role. I think other initiatives have been good too in terms of kill switches to maintain orderly markets and — more recently — mandatory price improvement for trading in the dark. I think it will be interesting to see how these play out in terms of overall participation in dark pools but I think the general intentions are good. I do find an increasing amount of my time is spent on global regulation. We do try to adhere to the highest global benchmark when it comes to actual specifics of what’s permissible and best practice in individual markets; it’s the responsibility of our respective trading desks to make sure that happens. I am pleased to see ASIC taking a leadership role globally and would point to ASIC’s Greg Medcraft becoming Chair of IOSCO as an example. It is in everyone’s interest that regulators talk to each other and seek to standardise their procedures.
Lessons to be learnt from equities
I do think that the electronification of the equities markets and the ability to gather and analyse data has made a genuine difference to our knowledge and understanding. What we know now about the costs of trading and the real cost to a portfolio of trading activity, both before, during and after trade, is streets ahead of what we knew a decade ago. We are now moving forward very quickly in terms of, say, futures markets because we can capture prices and we don’t have the issue of fragmentation in those markets, so we can get a pretty reliable consolidated tape to conduct the same analysis. And in FX markets we are closer to being able to capture big data in a more accurate manner and if that pushes forward into the fixed income space, there will be much to learn in terms of the real costs of our activities. This will all have a bearing on investment decisions.
Evolution of the client
Yes, very much so and I think particularly we are near the end of that period where they have feared HFT — “who are they”, “what are they doing” etc? There is now a better understanding of who they are, what they do, how they operate in a way that there never used to be. And, similarly, dark liquidity carried with it this connotation of evil but the understanding now is that actually it’s a place to trade and what might be of more concern is what goes on at that place rather than the venue itself.
A New Market Structure For Fixed Income?
Lee Sanders, Head of Foreign Exchange and Money Market Execution for AXA Investment Managers’ Trading and Securities Financing Division.
When you go down the waterfall to investment grade bonds away from rates, trading is not easy. Once you’re looking at high yield instruments it’s getting really tricky. There is a lot of stuff at play here. First of all, the banks have been told to rein in their balance sheets. They’re not throwing as much capital at running market-making operations as they did pre-Lehman or even a couple of years ago. The amount of capital they have to put aside to be active in these businesses is not helping liquidity at all. The market breaks down into two kinds of banks. The first is a bank that makes the most of its money out of the primary market, and it has to be in a secondary market to support the primary business. Then there are the banks that are more active in the secondary market. The result of this is that you have a striking difference in opinion in how the market should change direction. When I have a conversation about changing market structure to the banks in the primary market, they’re all for it, and the secondary banks are less open to a reform agenda. The problem being that despite certain banks asserting that everything is fine, on the buy-side we know we still can’t get everything done. Looking at the big houses, they can’t do 15 by 15 million trades switching one bond to another anymore.
I thought that maybe an order book might be the solution to the illiquidity, where we can all come together in a common central limit order book and execute our business there. But the end user banks were not ready for that, not even the ones who are financing their secondary business through their primary business. So looking through the data, I began to have thoughts towards the development of venues similar to dark-pools or liquidity matching engines, almost like a UBS Pin environment, where we have a piece of technology that will scrape an order book and tell a trader that there’s a potential match, or even on a level smarter than that, scraping portfolio and management systems or wish lists and then creating a conversation. I definitely see more organised sessions similar to the G sessions environment where people come together at one point to trade one particular bond or one maturity of a sector.
I definitely feel that we haven’t got any kind of safety and comfort going forward in just thinking that the market is going to price all of our secondary business. What’s happening as a result is that turnover numbers are just dropping off. We used to trade three to four times our portfolio because it was one bip bid/offer but now the spreads are 20-25 bips in liquid corporate bonds. Now we’re trading significantly less than that. So to get the market working, you almost have to stimulate it. A really interesting point said by one senior investment banker at a big UK house was that about six months ago, they had 80 percent of their balance sheet caught up in bond holdings of less than one million, which were deemed to be illiquid or slightly off market, and they couldn’t get out of those positions because they couldn’t find the other side. And as I say to all my counterparties, fixed income has got to be about finding the other side of a trade. Now, that’s good for people who believe in the kind of market that I believe in, but there are people who believe that they could take advantage of opportunities due to this illiquidity.
In a recent conversation with a big American bank very active in credit, I said, “Surely, the idea is to write a ticket with a person who is willing to write the short or the long” to which he replied, “I look at these opportunities to get short or long and to make money out of those positions.” And I’ve seen that more and more. So you have some who are very pro-market structure changes and you’ve got some who are very anti market structure changes. Success is going to need everybody to be behind an initiative. There have to be some concessions to the firms who are looking to be more active market makers, but I think what will happen is that the buy-side quite like the model of going to a bank, so, if the banks, really embraced ‘all to all’ systems it will give them more balance sheet to service the bigger institutions.
We will continue to use the phone or the ECN but not like we’re doing at the moment, we will get more liquidity because they will know that they can recycle on these more organised venues; it looks likely that you could end up with fragmentation.
The way that we’re going to go forward is more with an EMS style of management. I’m currently moving our FX onto an EMS, and we have the ability to use TradingScreen EMS for fixed income.
We feel that if we’re going to place an order via the EMS, there could be access to two or three aggregators to see whether there is potential matching business there. Then a firm could see streaming prices, have the ability to RFQ, to leave a limit or an order and the trader could then gain access to all of the improved functionality which could look a little more like an equities operation. If the market does become very fragmented we could also look at smart order routing. We’d like to see trading hooked up within an EMS rather than just orders via FIX in three or four different systems because we’re never really sure of getting the best fill in any one of those systems.
Market making model vs venue reform
These two elements are quite complimentary. You can have more volume going into the market via a wholesale market making model. There is a little bit of bank paranoia that is reticent to this change, but if we get the pricing, the buy-side has always said we’re quite happy to talk to the banks. It’s a great relationship. We get the research, we get their pricing, we get all the bits to go around the edges and we know we pay a little bit for that in the spread. But when we pay large spreads it makes us think twice about trading. If the market was more organised and traders knew that they could recycle and then use these new venues to gain more liquidity they would get their balance sheet a little bit more in order to price the bigger trades, and that would make them more efficient and probably more profitable.
What they don’t want to be doing, which happens in the fixed income markets, is that we look at the relationships with our top banks and say, “Your hit rate trading is 15 percent, 20 percent.” So the senior relationship manager and the salesperson that head the trading tell them to get more business with us, which just means that the bank is getting positions that they don’t want, inflating their balance sheet; it’s self-perpetuating. However, with the right reforms, if they know that the market is developed or develops quickly in that arena then they’ll be a lot happier about pricing bigger trades and then having a particular session around it. And then, the information they get from the session goes to re-price that particular issue or that part of the curve or sector.
Are other asset classes becoming more like equities, or vice-versa?
The crux is that these asset classes are very different from each other. With equities, there is a bit of a tail but it’s concentrated on roughly 500 to a thousand stocks, as opposed to the 100,000 items we have in fixed income. I think where the real success may come in terms of changing market structure or using equity innovation for fixed income would be from the likes of Liquidnet. If they came in, they would look at it very closely for how they match people up buy-side to buy-side or all to all. I don’t think buy-side to buy-side is a winner, but I don’t think you want to make fixed income like the equities market. But what I think you want to do is pick out the efficient part of those equity initiatives and try to see whether they would be credible in fixed income as a way of gaining more liquidity because, whatever happens, the liquidity is not going to miraculously appear. Banks aren’t going to all of a sudden throw a load more balance sheet at this any time soon.
I think it just takes everybody to buy in to some change in market structure and that’s going to be the hard work.
Buy-side Driving Allocations And Confirmations
Examining the latest developments in post-trade, with Darrin Vallone, Vice President Investment Operations, Capital Group.
Status Quo
At Capital Group we have a proprietary trade processing system that we’ve developed internally. We’ve always done local matching both for non-US, as well as US equities. For the past 10 years, we have been using FIX on the trading side and as well as to send allocations for non-US equity transactions to our brokers. For the US, and other regions within the Americas, we would use domestic OASYS to send the allocation. Everything is traded over FIX. For confirmations, we’ve used OASYS Global for all of our non-US confirmations and we have a pipe directly into DTCC for DTCC confirmations. We match at the allocation level. Today, we don’t do any block-level matching.
But that’s just the current landscape. What drove us to this project was Omgeo’s decommissioning of OASYS Global.
Going forward with FIX
Though we can see some of the benefits of what Omgeo is trying to do with CTM and central matching environment, we decided to look at other alternatives in the market for how we can confirm trades and that led us to FIX. FIX has been in the market for many years. We were already doing allocations via FIX, so after a lot of analysis on our side, we said a natural continuation of the FIX execution and allocation would be the confirmation space. Then in speaking with some of our peers, there was, for different reasons and actually for different markets, a further push for FIX allocations and interest towards FIX confirmations.
Where we are today is we are slowly putting some brokers on the CTM, that are still in an allocation-based workflow, but we’re not doing blocks. Our big push with our bigger broker dealers, is to have them on FIX confirmations. We have a project that has been going on since summer 2012, where we put a lot of emphasis on trying to develop a FIX specification that would be used across counter-parties, by many investment managers, trying to put a common specification playbook out there that everyone could use to create consistency in the marketplace. We’ve been developing to that specification since. We completed our development last month and in May and we went live with our first broker. As we were going through the specifications within the FIX Trading Community working group, we benefited from the participation from other investment managers and the sell-side, as well as some vendors that would be supporting this as well. There was a lot of work being done in various meetings to bring everyone together and really try to harmonise the specification. The goal being that the sell-side didn’t want to have a lot of customisation and were looking for a standard.
Any sticking points?
I would say it wasn’t necessarily an easy task; as there’s already been investment put into the existing systems, so there was a bit of a sticking point in that this working group was introducing another way to confirm, and it was going to require a build for every single broker. But that said, the brokers saw the value of having another means to confirm, leveraging what’s already part of the infrastructure and the allocation and the trading as part of a cost-effective model. The value proposition was there. The push is towards harmonisation, standardisation, with many buy-sides using it so there is scalability, and now it’s actually gone the other way where we’re starting to see more people interested in it. It went from being a problem of “How we get people on board?” to now people saying, “How do we get on board?” The timeline was also a factor since we were using OASYS Global and when a decommission date was indicated, we had to strive to meet that timeline. As much as we expect this to go smoothly, we anticipate a few bumps. Right now, we are solely focused on the non-US markets. However, there’s some traction in the fixed income space and we know that some of our peers are looking heavily at the US equity space.
And the reaction from fellow buy-sides?
The buy-side has been growing receptive to it; just trying to have something different, a cost-effective solution and complementing the existing lines that they have today within FIX. They’ve been really supportive in joining the efforts to meet some of the timelines as well.
The convenient part is that it should achieve a smooth flow. If you’re getting the allocation, all those tags would be populated to help populate the confirmation.
Our focus is global; we’re rolling out across the globe for all locations. One of our requirements to the sell-side is that we wanted to have global coverage.
FIX post-trade guidelines
By David Tolman, Chair of Buy-Side Post-Trade Solutions WG, Professional Services, Greenline Financial Technologies, Inc.
About two years ago the FIX Trading Community Americas Buy-side working group identified post-trade processing for equities as a high priority. The initial motivation of the buy-side working group was to reduce the single points of failure in the typical current post-trade processes. As the tolerance level for post-trade inefficiencies is minimised, the industry is witnessing a determined drive to adopt free, open and non-proprietary standards as the platform on which firms can manage their operational risk and cost base. The strain on the industry’s post-trade infrastructure is expected to permeate further with increasing regulation, shorter settlement cycles and the recognition that there is no competitive edge in this space. Investment managers and broker dealers are focused on using mutually agreed standards to deliver higher efficiencies and lower costs.
In response the FIX Post-Trade Initiative for equities was started. Though initiated by the buy-side working group, the effort was quickly expanded to include the major sell-sides and related vendors. This has been a very significant industry-wide cooperative effort and has resulted in a documented set of “Guidelines” for equity post-trade processing via FIX. These guidelines are in the process of being implemented by major sell-sides, buy-sides and vendors across the industry. The guidelines conform to the FIX Trading Community FIX standard messages, but provide detailed best-practices for the use of the FIX messages and fields in the post-trade workflows. By following the guidelines parties need only implement once in order to perform post-trade processing with other counter-parties as well as being able to take advantage of value-added intermediaries as desired.
The trading workflow has the following basic steps:
1. Placement: Order placement by the buy-side (investment manager) and fulfillment by the sell-side (broker/dealer).
2. Allocation:
a. Allocation-Block match: The set of trades (the block) to be allocated is agreed upon between the buy-side (investment manager) and sell-side (broker/dealer).
b. Allocation: The investment manager allocates the block among one or more accounts and communicates this to the broker/dealer, along with the client settlement instructions. The result is the individual transactions.
3. Confirmation/Affirmation: The sell-side prepares and sends to the buy-side “confirmations” that document the final details of each transaction (e.g. instrument, side, parties). The buy-side then “affirms” the transaction back to the sell-side as well as transmitting the information, along with broker settlement instructions, to the client custodian. This is the legal contract.
4. Clearing: The affirmed transactions are communicated to the appropriate central clearing party (CCP) for clearing and settlement initiation.
5. Settlement: The counter-parties then settle the transaction by exchanging money and securities.
6. Reconciliation: The client or their custodian will reconcile the transaction data that they receive from the investment manager against the information that they receive from the broker/dealer.
The FIX post-trade guidelines focus on the Allocation and Confirmation/Affirmation steps. These are architected into two distinct stages so that there is the flexibility for the Confirm/Affirm stage to utilise different channels of communication for the Allocation and Confirmation/affirmation stages (which in the US would be a US qualified vendor). In addition the guidelines specify best-practices in these areas, to steps that facilitate downstream reconciliation.
Currently, the most common equity post-trade workflow utilises intermediary-vendor facilities that provide communication between counter-parties and matching. Because these facilities were designed and implemented when orders were still being placed through a variety of mechanisms (i.e. not primarily via FIX) they utilise different proprietary protocols and must provide complex matching and mismatch-resolution algorithms. Considerable manual intervention is required to resolve the frequent matching (block, confirmation, fees) and reconciliation issues. Now that FIX is firmly in place for order processing the post-trade workflow mechanisms can be redesigned to leverage FIX, in particular:
- The identifiers from the FIX placement and fulfillment messages can be used for exact block matching – potentially ambiguous economic matching is no longer required. The FIX identifiers in the Allocation Instructions can be used for Confirmation matching.
- The infrastructure and expertise built up to support the order processing can be directly utilised in FIX-based post-trade processing. Communication links and different protocols can be reduced, saving time and cost.
Also during the process of developing the “guidelines” several significant additional “opportunities” for improvement were identified:
- There is no defined process to insure exact reconciliation at the custodian so there are frequent issues.
- Settlement instruction management is complicated and requires significant buy-side processing and attention.
- Market specific fees are difficult to identify because they are aggregated and aggregation criteria are not always clear.
In order to facilitate value-add intermediaries the guidelines also include the interface architecture so that intermediaries can develop new services and buy-sides and sell-sides can take advantage of them without high costs of entry/switching.
The timing is right for this initiative, as is shown by the ongoing implementation across the industry, because FIX is now the primary mechanism for electronic order placement and this can be leveraged for significant improvements in post-trade processing. This has been a very significant cross-industry effort, building on many years of post-trade processing experience, and it has the potential for substantial industry-wide risk reduction along with cost savings, improved processing time and accuracy, as well as access to alternatives.
Standardising TCA terminology
By Mike Caffi, VP and Manager of Global TCA Services, State Street Global Advisors and Mike Napper, Director and Head of Global Client Analytics Technology and EMEA Client Connectivity Technology, Credit Suisse.
The FIX Trading Community TCA working group has attracted strong interest with representatives from more than 55 firms across the industry choosing to participate. The group commenced by creating a prioritised list of the key issues relating to TCA currently impacting the industry. At the very top of the list was the concern that inconsistency in TCA terminology and methodology used across providers was presenting market participants with many challenges.
Starting with this area, the group began by exploring the language currently being used across the industry and established a working group aimed at creating a consolidated glossary and associated best practices guide. The initial document is focused on Equity TCA across pre-trade, real-time, and post-trade analytics. Once complete, the next phase will begin which will provide support for non-equity asset classes.
Northern Trust On Futures Closing Auctions
By Northern Trust’s EMEA Head of Dealing Martin Ekers.
Like a lot of passive index managers we use index futures to augment portfolio investment to avoid cash drag on portfolios etc. So when you’ve got an element of cash in any passive portfolio, you would typically have that invested in futures. Historically, there have not been opening and closing auctions, as we know them in equities, and I think it’s mainly an anomaly that’s never really come to the fore. There is a lot of activity around the open and the close in all the major equity index futures markets which would, I believe, be significantly helped by an official opening and closing auction algorithm that allowed people to enter orders, either at market or with limits and then everyone would be treated equitably and fairly. The answer to who might drive that to happen is the exchanges where these products are listed, all the well-known big venues. The issue is that the ownership of those entities varies significantly.
But the incentive for them to introduce this process is not great. The pressure for them to not vary comes from the makeup of those exchanges, because if you’re an exchange that’s predominantly owned by locals trading on their own behalf they’re very keen not to see closing auctions come in because it’s a very important source of revenue for the day traders who put bids and offers in the marketplace and try to capture the spread.
These are exchange listed and traded equity index futures. They’re not OTC derivatives. These are pretty vanilla instruments. If I have the same contract out with different brokers for the same benchmark, I frequently get different prices and that’s just the nature of the market and, although it can be a matter of a few seconds, obviously, between one order hitting the system and the other one hitting the system you just get a different result.
I think other buy-side firms have, to some extent, started to try and grapple with the problem about first of all, which benchmark point we should be targeting. Continuous trading in the UK for example, stops at 4:30 and then the auction is 4:30 to 4:35. Now, the official close, as far as the index providers are concerned, is 4:35. And yet, if you ask 50 people in the street, probably 30 would say the market shuts at half-past four, but actually it doesn’t. So, I’ve asked my futures executing brokers what the standard is and some of my peers target 4:30 and some target 4:35. The liquidity in the futures market is slightly better I think at 4:30 than 4:35. But our view was that we wouldn’t be targeting 4:30 and having five minutes of risk because our benchmark is 4:35.
And on the developed European markets now, maybe 20 percent or so of the whole day’s volume is done within the closing auction in equities and yet that is probably the highest risk point for an index arbitrager because the index future can move so quickly either side of that very definitive point after the closing auction price has been decided, determined and distributed. So if you think most markets, whether it is the UK market, German market, French market, etc., have a five-minute period of orders building into the system for the closing auction calculations to be made. And then, in an instant, those prices are distributed and people know what they’ve sold at and what price they’ve bought at. And if you’re an index arbitrager and, as that happens, the index future suddenly moves, or all the equities moved because of somebody putting a big order in just before the close of the auction, then your calculations can be very seriously adrift. So maybe if there was a futures closing auction coinciding with the equity closing auction, it would be a very simple case of calculating the mass and putting your orders in contingent one against the other.
Precision Time for Precision Trading
Dr. Jock Percy, CEO of Perseus Telecom looks at precision trading across global market-to-market trading architecture.
Source Time Recognition
Today the main communication linkage between the US’s master government clock in Colorado with companies’ clocks and servers distributed hundreds or thousands of miles away, connect through a broadcast of GPS data. The time it takes to transmit data from the NIST UTC clock to the site of most financial markets in Chicago, New York, Boston and Washington DC is about 500 milliseconds Round Trip Delay (RTD).
GPS communications transmit time data in different protocols than telecommunications protocols used in Local Area Networks (LAN) and Wide Area Networks (WAN) such as IP Internet Protocol at Layer-3 or Ethernet at Layer-2. GPS data must be translated to a networkable time protocol such as the widely utilized NTP – Network Time Protocol NTP. Since the source of time is translated, transported, translated again, networked and then recognized by a system’s operating system, many local enterprise clocks experience unpredictable drift, jitter or delay in receiving accurate time and thus throttle expectations to account for drift.
PTP – Precision Time Protocol
In a fast paced environment where communications continue to evolve, so does the need to transmit data have to evolve and keep up with higher demands on performance and latency. PTP as defined by the IEEE1588 standard offers the highest precision of time synchronization over ethernet networking. Ethernet is now an industry standard for LAN networking and ultra low latency connectivity across an enterprise architecture.
Through the use of PTP, networks can avoid many of the software and operating system issues that additional processing undergoes with NTP. PTP works at the chip level of devices and therefore can be injected right into the processing of a system rather than have time wait in queue with other process data. The use of PTP brings oscillation, jitter and delay down substantially, helping to provide predictable and deterministic time delivery. A series of high-tech advancements in various industries, particularly within financial markets such as higher processing speeds of data, larger data bases, data collection and data transfer, have led to the need for faster time synchronization measures.
FINRA regulations have allowed for financial firms to certify it’s time against the NIST UTC timescale within one second. Today, time certification for processing OATS clearing reports must now be proved to be in sync with the NIST UTC timescale in “1 millisecond or finer increments,” according to FINRA Regulation CAT – Consolidated Audit Trail to be implemented by the end of 2013. Current market participants use various forms of time stamping with varying degrees of accuracy. The problem is that this can lead to deltas and discrepancies in the time stamps used to record and report trade events. Increasingly accurate solutions that delivery the same UTC heartbeat to all market participants will save a considerable amount of human time and effort because there will no longer be discrepancies to resolve.
As the exchanges and members adopt a more precise, consistent, legal and standardised source of time there will be fewer disagreements because of the absence of discrepancies between parties timed events.
Regulatory reporting and audit review of activities will also be made more simple because with more accurate time stamps participants are subscribing to a time stamp service that is already certified and attested to as legal time.
