By James Cochrane, Director TCA for FX Product Manager, ITG
Unless a TCA system has plentiful data and flexible benchmarks, it will only answer the most basic questions and fail to provide valuable insights that will lead to lower transaction costs and improved fund performance. As in the equity market, the foreign exchange market demands pre-trade analytical tools and peer group analysis that will measure slippage in traditional trading styles as well as quantitative trading and algorithmic trading.
New FX TCA tools reveal currency costs in a market that was previously ignored or believed to be too ungainly to accurately measure. Before the advent of electronic trading platforms, liquidity pools were accessed through banks that offset client transactions in an interbank market largely hidden from view. Aggressive investors managed their foreign exchange relationships tightly, keeping costs low, but accurate measurements of costs was only undertaken by a few firms using internal systems. Without access to all available data in an over-the-counter market, transaction cost analysis could only provide educated estimates. Over the past four years that has changed, but too many of the tools still lack the data and experience to precisely measure transactions on a millisecond level over the course of a trading session, quarter or year. Recent FX TCA analysis has relied on too little data and used only daily benchmarks such as high, low, daily average and an estimated weighted daily average.
Transaction cost analysis in the foreign exchange market must mature from the present perfunctory state. Demands for simple compliance and best execution measurements will not satisfy the needs of institutional investors to manage portfolio risk and improve fund performance. In order to better measure these costs and design a product that will evolve with industry demands, transaction cost analysis tools must have a solid foundation of copious market data, flexible benchmarks and calculation engines that will correctly apply the former with the latter. This will also lead to more accurate peer group rankings and advanced pre-trade analytics.
One key area of development is access to new sources of liquidity that have been formed outside of the interbank market, although the bank’s prices are still considered the official market. Through price aggregation and prime brokerage, funds can access prices that are inside the traditional “pip” and in sizes less than one tenth the traditional block amount. Quantitative and high frequency traders can access liquidity that will not be offset by traditional brokerage firms. Access to these prices is important in order to measure trading costs against all available liquidity. Millions of indicative quotes, tradable quotes and actual executions from many of these new liquidity pools, as well as the traditional sources, must be collected and analysed in order for dissemination of cost analysis to be accurate. To keep pace with the competition, institutional trading teams require sophisticated analysis of their foreign exchange transactions and standing order fills. Portfolio managers need sharp analysis in order to be more cognisant of foreign exchange transaction costs that negatively impact their returns.
Developing quality benchmarks
Regulating ETFs: IOSCO's global perspective
Since their appearance in the early 1990s, ETFs have grown to become successful investment products. Looking at the decade 2002-2012, assets managed under ETF structures grew from US$142 billion to US$1.8 trillion, with the number of products going from 283 to 3,339 over the same period. North America emerges as the largest market of listed ETF products (US$1.3 trillion), followed by Europe (US$350 billion).
These dynamics have naturally come to the regulators’ attention. Already in 2008, acknowledging the rise of the industry, IOSCO began work on ETFs, leading the way for further regulatory changes. IOSCO analysed ETFs’ specific features with a view to develop a common regulatory approach across jurisdictions. In 2011, other international institutions (e.g. BIS and the FSB) started looking more closely at this fast growing market. This increased focus has led the ETF industry to engage more with regulators. The gradual maturation of this global debate on ETFs has produced a two-fold effect: First, it has spurred regulatory amendments to existing legislation in a number of jurisdictions, as in the case of Europe with the elaboration of ESMA’s Guidelines on ETFs and other UCITS issues published in December 2012. Second, it has brought ETF providers to gradually adjust their disclosures and product offer to take into account some of the concerns expressed by regulators and investors (e.g. providing investors with access to “live” information on their ETFs’ portfolio components via their website).
These dynamics have naturally come to the regulators’ attention. Already in 2008, acknowledging the rise of the industry, IOSCO began work on ETFs, leading the way for further regulatory changes. IOSCO analysed ETFs’ specific features with a view to develop a common regulatory approach across jurisdictions. In 2011, other international institutions (e.g. BIS and the FSB) started looking more closely at this fast growing market. This increased focus has led the ETF industry to engage more with regulators. The gradual maturation of this global debate on ETFs has produced a two-fold effect: First, it has spurred regulatory amendments to existing legislation in a number of jurisdictions, as in the case of Europe with the elaboration of ESMA’s Guidelines on ETFs and other UCITS issues published in December 2012. Second, it has brought ETF providers to gradually adjust their disclosures and product offer to take into account some of the concerns expressed by regulators and investors (e.g. providing investors with access to “live” information on their ETFs’ portfolio components via their website).
“IOSCO particularly encourages a clearer differentiation between ETFs and other non-fund exchange-traded products (ETPs), such as notes (ETNs) and commodities (ETCs),..”
IOSCO’s recently published report on Principles for the Regulation of ETFs represents a key development in the global debate since it outlines a set of minimum global standards for the regulation of ETFs. The Principles focus on two major aspects of ETFs namely the disclosure and structuring of these products. Regarding disclosure, IOSCO particularly encourages a clearer differentiation between ETFs and other non-fund exchange-traded products (ETPs), such as notes (ETNs) and commodities (ETCs), as regulators remain concerned as to investors’ confusion between these competing products. Further recommendations aim to foster increased disclosure of the chosen index, of the ETF’s replication techniques and features (e.g. physical or synthetic, leveraged or inverse, etc.), as well as of all incurred fees and costs (including those from the material lending of securities). IOSCO further stresses the need to properly address conflicts of interest which may arise in the different ETF structures. Lastly and importantly, IOSCO also highlighted the risks inherent to counterparty exposures and inadequate collateral management and formulated recommendations on ways to address those risks both for physical ETFs and synthetic ETFs.
The PM & The Trader
Senior Portfolio Manager at Allianz Global Investors Ian Lee looks at the changing communication patterns between PMs and traders.
The nature of the relationship between Portfolio Managers (PMs) and traders is undergoing a constant revolution. Changing communication technology has meant that more than ever PMs can stay on top of their investment actions and executions throughout the trade cycle, either at the desk or on the road. Traders themselves have become much more autonomous with their execution decisions.
Ian Lee, a senior portfolio manager at Allianz Global Investors joined AllianzGI in 2000, comments about the changing relationship between PMs and traders saying “I myself started out on the trading desk and it gave me a bit more perspective than others about what the role involves, however, that was well over a decade ago and I can see how it’s evolved. Among other things, orders get electronically routed and executed, added to the fact that there’s a lot more ‘noise’ in the markets themselves. Gone are the days of having to place orders over the phone and have them read back to avoid mistakes. Today’s traders have to be alert to factors such as high frequency trading, queue stuffing, and high cancellation ratios, plus a whole new mix of hedge fund activity.”
Coming back to the specifics of what the trading desk does for the PM, Ian adds “I trust AllianzGI’s trading team to monitor our orders; that allows me to make the best use of my time, often going out to meet the management of the companies in which we are interested. Although one should monitor short-term drivers affecting stocks, my primary role is to focus on identifying strategic long-term investment ideas and to make sure the structure of the portfolio is intact. I sometimes turn my trading monitors off and focus on research so I don’t get caught up in the day to day price volatility of stocks and noise. I leave it to the traders to watch the markets, as they follow the cash, futures, and derivatives markets and are able to adjust to market conditions on the fly allowing me to focus on what I do best.”
“Traders are on the desk all day, every day, and are more in tune with which brokers are making significant research calls, who’s buying or selling, or may have shown up with changes on the register of substantial shareholders in a host of different stocks. Traders are able to use slower periods to sift through news and commentary of the more meaningfully held stocks; they get a feel for which stocks brokers are pushing investors to buy or sell, catalysts that could trigger short term price action, and if impactful enough highlight these in the daily morning meetings and emails.”
Changing communication
Communication between the PM and the trading desk has undergone dramatic transformation and evolution in recent years. As AllianzGI’s senior portfolio manager, Ian has a long-term perspective on the changes in communication methods, saying that “in this day and age it takes so many forms and it’s the same for the interaction we have with the trading desk. Though I leave most executions to the trader’s discretion, I may make short comments on the electronic orders we send to the desk’s traders. If it can help my own executions to let them know why I’m investing in a stock, the reasons behind it, then I certainly will. Communication between the PM and trader is paramount to executing effectively, and when I’m in the office I may walk over and just discuss my orders with the traders. Should I be away from the office, I can make use of Bloomberg IB’s, messages, Blackberry email, and good old-fashioned phone calls, though for security reasons we’re not going to get into too much detail on those mediums.” “Often on the PM-side we make investment decisions collectively as a team, but each PM or their portfolio assistant enters their own fund’s orders. The trading team coordinates and works them together. When one or two of the PM’s are out and the lead PM for that stock decides to change their execution strategy, or put a limit on the order, the trading team can communicate this with all the PM’s involved.”
The traders
The levels of autonomy given to traders are a key consideration. While the PM has views over what they want to trade, and when, sometimes the market can make that difficult. As Ian says “there are times I’ll enter orders and it may turn out to be the ‘wrong day to trade’. Every day is different and just because you find enough liquidity one day to pick up a million shares without moving the price; trying to do the same thing the next day could drive the stock up 5%. I rely on the trading desk to advise me on those cases where the supply and demand is off kilter. This reminds me of that old trading adage, ‘You don’t trade when you want, you trade when you can’.”
And as the information flow goes back up the chain; “I’m OK to take the trading team’s advice on orders with liquidity constraints. There’s always the risk of a stock moving away from you and never coming back, but for the most part, with a bit of patience, they do somewhat revert to the mean. A few will get away from you and that’s unfortunate, but more importantly it is the communication level between the two teams that leads to a successful execution.”
As with all times, when autonomy is granted to a trader, there are occasions when things will go wrong, and the trust and communication between a PM and trader becomes paramount, as Ian adds of his traders; “they certainly don’t always get it right, and I feel it’s important that I don’t fly off the handle when a trade goes the wrong way. I think if I did, it wouldn’t be constructive in the longer term because the traders would move towards not taking calculated risks, resulting in only average executions. Instead I want the traders to take advantage of their insight and seize any opportunities in the market. Empowering them to be disciplined and use their experience, taking a stance with true discretion will help to build their confidence. They want an excellent execution as much as I do. With the benefit of hindsight any of us could do better.”
The trading desk
“In many ways our trading desk has some similarities to the way we as PM’s pick stocks, which is to say we are bottom-up, fundamental investors. The trading desk looks individually at each of these orders. I know they consider factors ranging from liquidity and flow in the name to moves in the stocks peers, sector, and the general market. Every PM has different execution expectations, but having worked so long with the same group of traders I’ve become confident that the traders understand how I work. Though our global benchmark is Participation Weighted Price (PWP) 15%, many times our traders may choose to execute my orders on implementation shortfall strategy, in that they get filled rather quickly in blocks if they can find the liquidity. I rely on the traders to decide to use the market’s liquidity, or for the sake of expediency utilise a broker’s capital to facilitate an immediate completion. One thing I feel strongly about is that traders just like fund managers, have to understand risk, use it, and make decisions based on all the information available to them at the time. However, anybody taking risk over and over knows it doesn’t always go your way. So it’s important to firstly be constructive in analysing actions that don’t deliver the expected outcome. I’ll certainly question a trader why an execution was suboptimal, but I am more concerned that the thought-process was intact, and a mental checklist of how the trade was followed. It’s this expertise and experience that overall achieves AllianzGI’s best executions longer term. I need the comfort that in a larger data-set of trades over time most would be winners, and if that doesn’t happen, then our trading desk would have to make changes”.
“There are more parallels to trading and fund management; we talk to the same firms, talk about the same stocks, and live the markets. But the content to these discussions are different. I may speak with the best couple of analysts but that doesn’t mean that traders at the same broker have the axe or experience executing the covered stock of their analysts. Some firms try to trade franchise names that their research team excels in, but that’s not always the case.”
There is also a large extent to which the traders are expected to be autonomous and exert a degree of control over the fact that they are clued into the trading environment itself, as Ian adds, “traders are proactive and react quickly to take advantage of the temporary mispricing we occasionally see in the markets from time to time. They realise things don’t get done without effort and I see them working hard to stay ahead of the curve. Nobody improves without action and initiative, whether it’s researching and signing up to a new initiative, or showing an innovative approach to do something differently. Years back when stand-alone dark pools were just being introduced to Asia we were the first clients in one of them to get a trade executed. As Marie Curie once said ‘Nothing in life is to be feared, it is only to be understood’. ”
“Traders keep an eye out for accelerated book-builds where time’s short. Kent Rossiter acts as our company’s dedicated gatekeeper for material non-public information (MNPI), and partners with the street’s syndicate departments.”
Trader review
An important part of any relationship between a PM and trader is the ability of the PM to hold the traders accountable for their part in the investment chain. With increasing granularity of TCA data, and using trading analytics specifically as a measure of a trader’s performance is one area of quantitative feedback flowing between the traders and PMs: “The traders present their TCA results at our offsite meetings, and I know Kent does regular reviews with our Asian Investment Management Group, and separately they’re reviewed by the Regional Brokerage Committee. The trading desk has sat down with individual PM’s to discover styles and discuss some habits that may be impacting trade performance. Observing stocks reverting to their mean after finishing an order can be an indication we’ve been too aggressive in our executions. The over-use of limits put on trades that continue to move against us when the stock continues to trade away is another area of discussion. Percentage of volume (POV) restrictions or preferences is yet another area of TCA results that can be looked at.” Ian adds “As a PM entering a trade I’m generally happy to execute the trade around current levels given my expected upside on the stock, otherwise I shouldn’t put the trade on. I trust the traders to execute it to the best of their abilities.”
Allianz also takes the quantitative performance into account when deciding remuneration for traders, as Ian says “Allianz Global Investors investment culture has long been built on a pay for performance mentality. That’s true of my own remuneration as a fund manager, which is mainly dependent on a rolling three year performance track record, and it’s true of our traders’ performance, where their quantitative trade cost analysis (TCA) metric versus their peers makes up 50% of their year-end evaluation. The other 50% is qualitative, including formal and informal comments of co-workers and fund managers.”
So with traders and PMs increasingly aware of each other’s capabilities while becoming more autonomous, and with communication becoming ever faster, the nature of the relationship between the PM and trader is sure to increasingly evolve over time. Ultimately in any successful partnership it’s often built on communication, trust, respect, and integrity. That’s the Allianz Global Investor’s way.
Staying Power: Why the ETF boom is bound to last
By Stephan Kraus, Senior Vice President of Market Development, Deutsche Börse AG.
Since their European introduction on Deutsche Börse’s Xetra platform in 2000, ETFs have proven themselves as one of the most successful instruments in European capital markets. Over the course of just 13 years, assets under management have grown from EUR 400 million in 2000 to 213 billion in May 2013. In the same time period, the number of listed products has increased substantially from two ETFs to more than 1,000 products as of today. As unique as these impressive growth rates, are the product characteristics that helped ETFs to gain such popularity: ETFs combine the advantages of both equities and structured products while avoiding the downsides of these two instrument groups. ETFs can be traded as continuously and as liquid as equities, but they do not share the disadvantage of being the single, undiversified investment that equities stand for. Very similar to certificates, ETFs offer a wide application spectrum since whole markets and sectors can be tracked, making them ideal instruments for risk diversification. However, unlike structured products, ETFs do not suffer from the inherent issuer default risk.
Besides the flexibility of being able to enter and exit markets throughout the trading day, another main reason for institutional investors to pick up ETFs are their low costs and high level of transparency. Both aspects can be applied to the ETF itself as well as to the trading layer. While ETFs are already well-known for their low annual expense ratios and high degree of transparency in terms of investment objectives, replication methodologies and portfolio compositions, trading costs have also become increasingly important when comparing ETFs across markets.
Correspondingly, we have established various liquidity incentivisation programs to facilitate the implementation of cost-effective trading and investment strategies within a highly liquid trading environment. As a consequence, blue chip ETFs have become the most liquid instruments tradable on Xetra. The Xetra Liquidity Measure (XLM) – a means to improving transparency for market participants by estimating market impact in advance – shows a decrease in implicit transaction costs of 80 percent for the 20 most liquid equity ETFs on Xetra from 2003 to today.
The growing product awareness among both institutional and retail investors will continue to set the path for future growth in the ETF space. It is also easy to foresee that this demand will lead to more innovation in the years to come, be it in terms of new markets covered or the way ETFs are employed as investment and trading tools. Further supporting these developments and creating further trading opportunities, is the recent introduction of new exchange traded derivatives on ETFs through Eurex, Europe’s largest derivatives exchange.
FX TCA for peer analysis
By Lee Sanders, Head of Foreign Exchange and Money Market Execution, Trading and Securities Financing Division, AXA Investment Managers.
One of the main areas which we looked at when we were changing our dealing system was the provision of transaction cost analysis. What transaction cost analysis allowed us to do was essential for us developing what we were doing in FX and how we sold that internally, and how we relayed it externally. We did a lot of work with Trading Screen to get the data that we wanted. The problem that we have at AXA is that 90 percent of our business globally is swaps, so it is very hard to put in the right information to benchmark the quality of the execution for those swaps. But that said, we worked very hard with them and a quant guy and it’s given us a credible data set which we distributed internally to the COOs and the CEO. We’re now using it to distribute to our clients, externally as well as internally; showing them the quality of the execution we’re doing. It’s also a valuable thing for us to use when we’ve outsourced FX execution to our custodian.
But, more importantly, for me, I did a number of counterparty reviews and it was a major point of discussion in those reviews; averaging out over peer groups on quality of execution. I think development-wise, there are some things which we would like to do, but in terms of more development, we have the data, but it is also about how we present that data. I think the real skill in transaction cost analysis for foreign exchange is finding more and more credible defined data that we can use for the benchmarking. I think transaction cost analysis is very advanced, if you look at the equity side which, obviously, luckily working with our Head of Trading Paul Squires I can see the high-quality results that we are able to produce. I think the other thing is being a little bit more savvy about how we execute.
If we do it electronically, obviously, making sure that the time stamp is quick and if we choose to execute by voice, making sure we book the trade quickly so that the data is credible.
I think FX TCA is developing very quickly. More people are beginning to come to the table with these offerings. And I think foreign exchange has benefited quite a lot from some of the directional change from the banks. Investment managers are looking at it more and more as well as a fully fledged business. The quality of that execution is essential. I suppose the other point will be in the light of various high profile FX execution disputes and the in-sourcing or out-sourcing of execution to custodians, there’s a quick box to be made on producing some good quality TCA.
Everybody is going to want to see whether they’re getting credible execution or not. And I think the last thing which will be developed there would almost be a peer analysis; stacking up all the banks against each other and saying “You gave us three and half bips, you gave us four and the average was two and a half. So you’re doing alright, the guy on one isn’t doing so well.” But really what we are doing is looking for massive outliers to see if someone was so far out that we have to a chat with them. But I think going forward people will want to say, “OK, well, you’re doing the analyses now of 25 investment managers.
Where do we rank like for like on euro-dollar in 10 million at mid-day,” and are we being tiered by our banks. They’re saying that they are placing us in a platinum tier, but are we in fact copper or bronze. That will be an interesting development. I think as we go down this road, a lot of the data just becomes almost consuming and more important to you because it just gives you a feel for where you sit in the marketplace.
iShares Evolving Uses Of ETFs
Mark Brady, Director, Capital Markets team at iShares.
The predominant users of ETFs in Asia have been institutions, and we’re seeing a lot of sovereigns, insurance companies, and pension funds using ETFs to get exposures that would be a lot more difficult and require a lot more infrastructure and set-up than they’re prepared to invest in.
There’s a huge convenience aspect to it. Obviously, the index businesses are really about scale, and we have a mass of scale in our business which allows us to construct products that offer access and simplicity into markets and places that even the average institutional investor cannot make this level of commitment to. But I also think there is a definite need for transparency. These are products that are easy to understand. If you’re sitting at a pension fund and you need to get access to Brazil, you can buy a Brazil ETF that is listed, you can buy the stocks listed on the Brazilian exchange, or you can buy some kind of derivative.
When you start looking at some of the derivatives out there you rapidly develop single counter party exposure, and obviously there’s a lot of concern about counter party risk as it is difficult for institutions to justify the risk to investment committees.
ETFs are a simple and transparent way to help them implement an investment model or an allocation strategy. You can short an ETF just like any stock; we do see clients that are adverse to leverage or inversed ETFs, but are very comfortable shorting an ETF as a means to hedge a portfolio for an exposure.
Institutions are in-housing some of their operations, and that’s definitely a trend that we’re seeing globally. However, within that trend, while firms are in-housing the CIO function, they do not want to build out the necessary infrastructure to support a full blown trading operation.
They also don’t want to hire a whole team of analysts to help them look at companies. If your model tells you to buy Brazil – you need to buy Brazil. The easiest way to do that is through an ETF exposure. If you have a preferred index provider, there are multiple exposures out there and you can implement a model very cheaply and efficiently versus buying the underlying index or making a bet on a few stocks that you think would give you a proxy to the exposure that you’re trying to achieve.
Wider uses of ETFs
I could grossly characterise uses according to the client’s size, the big institutions are using ETFs for tactical allocations. Blackrock has extremely good relationships with many of these firms and in the last couple years they have definitely woken up to the ability to help to implement these portfolios effectively through the use of ETFs. Asset managers will often use ETFs as a cash equitization tool or a liquidity sleeve.
For example, we’ll see an active fund manager that has got an inflow of capital but isn’t prepared to put it to work yet. One of the things they can do, to reduce cash drag in the portfolio, is to invest it in an ETF that is the same benchmark or a very close benchmark and thereby achieve some kind of performance versus having it sit in cash and just dragging down performance.
Cash equitization could be one-day, it could be five-days and we’ve seen people come in with very large sizes and then come out in bits and pieces as they allocated their cash. It is a very useful tool for them and it’s also, I think, a good story to an investor who’s saying, “Look, we’re not just sitting on your cash. It’s being put to work” and then invested as a firm can find the opportunity.
The other use that we’ve seen is as a liquidity sleeve, and that’s very similar to cash equitization. A liquidity sleeve is very similar in that you might have someone who is managing a small cap portfolio for example. Small caps can be incredibly hard to buy and sell. In certain cases you can spend months trying to build up a position and if there was a fund redemption, all the hard work building the positions could be gone. If you have a liquidity sleeve you have a mechanism whereby a portion of your portfolio is made up of liquid ETFs which can be sold at any time to generate cash. You don’t have to touch the underlying portfolio which reduces trading costs and so forth. I think it’s a pretty obvious argument that it’s a great tool for that type of portfolio or exposure.
The client’s questions
ETFs are still very much on the ground floor in terms of understanding. We spend a lot of time educating investors. We spend a lot of time talking about the hidden liquidity in ETFs whereby we’ll have funds that may or may not have a large amount of secondary liquidity, but the fact is that as long as the primary market is liquid you can create and redeem that fund at any time without any market impact and get the exposure you want. Once clients understand that, we have seen clients come into funds and quadruple the fund’s AUM in one trade because they understand that the underlying liquidity is really the key. The other questions we get asked are just the basic questions that someone will need to know to understand how to value the product, such as how we’ve constructed the portfolio and how we manage it and so forth. Transparency is one of our absolute headline beliefs; one of the things that makes our job easier in explaining how ETFs work to our clients, is that our websites across the globe have so much information freely available we are frequently sending out links to materials already put together.
Downsides?
In terms of niche products, we have over 600 ETFs and we have some niche plays where a client will come to us and say, “I’d really like this exposure. Could you work with us and make it?” and in a lot of cases we’ll do that. It’s like a custom basket. In some cases, we can get a fund into the market in three months, so we can actually bring some very niche products to market. Do they all trade fantastically? No, they don’t, because they’re niche and the client that’s really interested in them is looking at them more as a fund than an exchange traded instrument, and they understand that the underlying primary market allows them to create and redeem this fund to achieve the exposure without having to access the secondary market. The worry in this case is that the lack of secondary liquidity could be misconstrued by certain investors, which is one of the main misconceptions we are trying to alleviate on a daily basis. ETFs definitely encourage liquidity because ETFs require market makers to make two-way pricing on exchange, market makers will be hedging exposures and they’ll be creating, redeeming, etc. Off the back of this, they’ll be trading futures and so forth, so ETFs definitely increase the pie rather than sucking liquidity out of the exchange.
What’s next
We have two very well-developed platforms in the US and in Europe. In Asia, we have what we call manufacturing centres in Hong-Kong, Singapore, Sydney and Tokyo, which means we have locally domiciled funds with Participating Dealers who are able to create and redeem. Institutional clients can really go anywhere they want for their liquidity and we’ve spent a lot of time working with our Participating Dealers bringing this liquidity closer to clients, so we really don’t need to build out a mirror set of products in Asia-Pacific. Part of the capital markets team’s mandate is to really leverage our global platform and become as global as possible.
So potentially you could see a move towards a 24-hour trading model for the underlying primary market, for some of the US listed funds, so clients in Asia could access these funds without having to send an order overnight and wait for fill.
In terms of retail investors, that’s really the other half of the liquidity puzzle as ETFs do not live by institutional liquidity alone. We need the retail flow in there because that really drives these funds into moving them up the liquidity curve and making them trade a lot more like equities. And so in that case it’s really trying to find a product that solves a particular need or problem for our customers.
Driving change in Australia
Citi’s Head of Australia & NZ Electronic Execution Murrough O’Brien looks at ongoing technological and competitive change.
Competition is usually the biggest driver of technological change, however many of the technology projects that brokers have been implementing over the past few years in Australia have been driven by a raft of regulatory changes. In tandem with this, the ASX and Chi-X have been continually updating their offerings, so brokers have had to expend large amounts of resources on what are, in essence, unavoidable changes to the market.
However, since the 2008 financial crisis, these resources have been in decline, so doing more with less and doing it smarter has become something of a mantra across the street. For a broker this means leveraging our global footprint and continually using the intellectual capital and technology that we’ve created in other regions to fit the local market. While this sounds easy, it requires investment in the right local expertise as well as increased communication with our global colleagues. The rolling out and optimising of global products such as new connectivity infrastructure, Smart Order Routers (SORs) and algorithmic frameworks are prime examples of the increased synergies between local and global that is likely to continue into the future.
In a similar vein, where we see value in automating tasks to take the load off of local resources we leap at the opportunity. Since the introduction of competition, there’s been considerable growth in the amount of systems that make up our trading infrastructure and the complexity of their interactions. This has led to a drive to increase the automation of testing across all of our systems. Automation frees valuable resources, increases scalability and reduces release times. Intertwined with this, we have streamlined the processing of releases while ensuring that there are touch-points across the business, technology and compliance for each release providing a best in class review process to ensure issues are captured before release. Given the increased regulatory scrutiny both in Australia and globally on electronic trading, the importance of getting this right is vital to the individual broker and the broader market. Neither user acceptance testing automation nor improved processes are very glamorous but they are becoming the bedrock of reliable platforms.
Regulatory and venue updates have been coming thick and fast over the past few years and have been a priority for all participants, but with change comes the opportunity to improve our clients’ trading experience, but the trading platforms need to be nimbler in order to facilitate this on-going evolution. The lighter nature of the trading systems also has the spin-off benefit of increased and more rapid customisability. The theme of customisations is something that we’ve seen a pronounced increase in over the past 6-12 months.
With more mandated technology changes on the horizon in Q3 and Q4 for the ASX and Chi-X, the need for brokers to be lighter on their feet and more efficient in how they achieve this will continue to be a major driver of technology in Australia.
Assessing The Stack
Varghese Thomas (SVP, Infrastructure) and Mark Wright (VP, Infrastructure) of NYSE Technologies examine the mounting pressures and alternatives for technology solutions.
What are the principal pressures on buy-side and sell-side firms in terms of their technology provision?
Varghese: There are always cost pressures, especially in today’s environment, but at the same time there are pressures to maintain legacy platforms, generate new revenue and stay agile while managing challenges ranging from reduced volumes to regulatory reforms. These mounting pressures make the economics of today’s IT unsustainable and a game changing shift is required.
Mark: We’re still in the cost-out part of the economic cycle, but firms are starting to turn and think more about how they grow in this environment. Clients are looking at services that previously differentiated them to source as a managed solution. It’s important to keep in mind that if a client is working on the cost out part of a business line, they’re not necessarily giving up anything as far as capabilities available to their clients.
Varghese: It’s a painful process to assess your home-built operation, design a new solution and go through the implementation process, especially with the associated migration costs. That’s where properly evaluating managed services comes in. A firm needs to be able to identify their core competencies and competitive advantages, and determine which resources are better off in a managed environment. The economics of cloud based consumption enables clients to alleviate transition costs by leveraging infrastructure as a service.
What workloads, tasks, and functions are firms typical looking to move into a managed services environment?
Varghese: Early on, we saw a lot of firms moving front office workflows into a managed environment as they wanted low latency access to markets and managed access within data centres. Now, we are starting to see the entire trading workflow as well as broader enterprise applications move to a managed environment.
Firms are looking at all their workflows and determining how to find cost savings in the front, middle and back office through the clearing processes. The key to identifying outsourcing opportunities is to ensure that a firm still has the availability and flexibility to manage the infrastructure and control the workflows in their own environment within their own context.
Mark: As an example, let’s say you have a firm without a presence in Asia. They are considering building systems internally in the new region, but that’s inevitably expensive. Yet it can be something which a managed service provider can offer you in a remote region.
Another workflow ripe for outsourcing would be FIX connectivity. Everyone had built massive infrastructures for managing FIX connectivity within their firm, but that’s pure legacy now and something you can easily give to a service provider to manage.
What questions should firms ask when evaluating their technology stacks with respect to managed services?
Varghese: If you look at the whole technology stack of a firm, a lot of what sits in the infrastructure is legacy or commodity services that are non-differentiating. So, does a firm really need to focus on data centres, networks or even compute and storage layers? Or could it be more efficiently managed in a cloud environment?
As you move up the stack, a platform approach is available for a firm to leverage in building an application with a suite of services from middleware to content. It’s here where firms can make changes so they can build their own application, but will that platform have all the tools and services that are needed?
Further up the stack, you can probably outsource everything as software-as-a-service — the entire infrastructure and middleware is abstracted from what a firm needs to build or operate. So, depending on a firm’s particular situation, each of the approaches offers flexibility in systems and applications. Depending on current in-house capabilities and core strategy, a firm may decide to just focus on one specific area to outsource or they may look at a much broader spectrum of the technology stack.
What hurdles must firms deal with when evaluating a managed services solution?
Varghese: Larger firms have to deal with more legacy systems. If they’ve been undergoing acquisitions over the years, there are many distinct and disparate systems in place. However, they are now looking ahead not only to reduce costs and operations, but to discover what actually provides differentiation, gives quicker access to new markets in other geographies or asset classes, and to develop new ways to create revenue and value.
Mark: I do believe that the switching cost to take something developed in-house and move it to a vendor can be significant. It can be a painful process without experienced service providers. What people tend not to see is that once it’s managed by a vendor, then you’re in a marketplace of service providers and you’ve gained mobility and leverage as your needs evolve.
Will the trend of firms outsourcing parts of their technology stack continue?
Varghese: Building your own infrastructure is a more difficult undertaking nowadays. For example, financial institutions need to collect, store and process market data, so is it worthwhile to build your own infrastructure for that task? Is there a way that a firm can operationally reduce their cost while gaining access to the latest version of software, hardware, OS patches, and security that’s deployed by a provider? If managed in-house, does the client have the flexibility to maintain a data infrastructure that gives them a way to still focus on a core business? In the end, enterprising firms are outsourcing what they feel comfortable with and what they can do quickly. The migration to managed services is growing rapidly — the industry spend is poised to double in a few years.
Mark: I don’t think it will ever go back to the way it was, the future is a marketplace for services of all levels of the stack. IT departments will, over the long haul, become more and more of an interface between their firm and the vendor marketplace for services. The days of doing it all yourself are over.
Announcement : Robert Barnes new CEO of Turquoise
ROBERT BARNES APPOINTED AS NEW CEO OF TURQUOISE.
Turquoise, the pan-European MTF, today announces the appointment of Dr Robert Barnes as its new CEO. Dr Barnes has extensive industry experience and market knowledge having formerly been CEO of UBS MTF and a Managing Director, Equities, at UBS. He is a well-regarded industry expert on market structures, having served as Chairman, 2004-2009, of the Securities Trading Committee of the London Investment Banking Association and participated on a wide range of key advisory and policy groups within the financial services sector.
Robert holds a PhD from Cambridge University and a BA from Harvard.
Subject to final FCA approval, Dr Barnes is expected to take up his new role in the coming weeks, replacing current CEO, Natan Tiefenbrun who will be leaving the company.
David Lester, Chairman of Turquoise Holdings, said: “I am delighted to welcome Robert as the new CEO of Turquoise. Robert is a highly regarded senior executive, with extensive industry and market experience and expertise. His skills and knowledge will be of immense value to Turquoise and to the wider Group. I very much look forward to working with him as we continue to grow and develop the Turquoise business.
“I would also like to thank Natan for his contribution to the business’ development in recent years and wish him well for the future.”
News : Deutsche Börse – Liquidnet tie-up creates waves. Source : Financial News
SELLSIDE RALLIES TO CHALLENGE DEUTSCHE BÖRSE – LIQUIDNET TIE-UP.
Tim Cave and Anish Puaar, Financial News
05 Aug 2013 Updated at 09:59 GMT
Two of Europe’s largest brokers have pulled out of a dark pool run by German exchange Deutsche Börse, after it launched a partnership with buyside-only venue Liquidnet in a bid to boost volumes on both platforms.
Morgan Stanley and Credit Suisse last week stopped routing client orders to Deutsche Börse’s Xetra MidPoint platform, fearing information might be leaked to other traders.
The move was in response to a new service the platform launched on July 29 with Liquidnet, allowing orders above a certain size to interact with orders resting on Liquidnet’s venue. But brokers fear the service allows Liquidnet’s members to view information about MidPoint orders without an obligation to trade against them.
Brian Gallagher (left), head of European electronic trading at Morgan Stanley, said: “With this link, a Liquidnet member knows there is a buyer of a stock that meets a certain size but isn’t obligated to execute. This means we lose control of our orders and there is the potential for information leakage.”
On July 29, Credit Suisse sent a note to clients saying it had stopped routing orders to MidPoint: “Our policy is that orders sent to trading venues must not be onward routed to other venues.” It said it would review the decision “when we receive either an explicit opt-out for flows, or a guarantee that no order information is sent to third-party providers from this venue”.
Credit Suisse declined to comment further.
The value of trading in the Xetra MidPoint dark pool fell sharply at the start of last week. Between July 29 and July 31, the platform conducted trades worth around €716,000, compared with the €2.5 million traded on the Friday before the link went live, according to data from Thomson Reuters. Last Thursday (1 August), volumes recovered partially to €1.9 million.
Since the launch of the service, the average size of trades in Xetra MidPoint has increased tenfold to €100,000, according to Deutsche
Börse.
Michael Krogmann, its head of market development, said in an e-mailed statement: “The integrity of the market is a very high value for Deutsche Börse.
When we developed the Block Agent model, we defined parameters, processes and requirements which are all specified in the exchange rulebook. Our objective was to protect the integrity, safety and stability of our members and our market at any time.”
Mark Pumfrey (right), head of Emea at Liquidnet; said in an e-mailed statement that it had seen a “very positive response” for the service.s to protect the integrity, safety and stability of our members and our market at any time.”
The backlash is a further sign of the growing tension between exchanges and brokers over the issue of trading in off-exchange, dark-pool platforms. Exchanges are leading calls to restrict trading in dark pools, contesting they damage price formation in the lit markets, while brokers maintain they help ensure better prices for institutional clients.
