Home Blog Page 645

Frank Troise : JPMorgan

RAISING THE BAR.

JPMorgan, FrankTroise

Frank Troise was hired last year to build a best-in-class global electronic trading franchise. He explains the steps taken to differentiate J.P. Morgan’s offering.

Q. There is so much regulation coming down the pipeline, how do you prepare when the final drafts are not yet written?

A. It is too early to say what the final results will be but regulation is definitely front and centre for the industry. However, you cannot let it distract you from the job at hand. We need to know more of the details before that happens. It is important to think about the future of the landscape but also address the issues today. One of the biggest challenges facing the industry remains the same and in many ways is similar to ten years ago. It is how to access liquidity and now consolidate the fragmented trading landscape in the US and Europe in order to get the best execution results for our clients.

Q. How do you concentrate that liquidity?

A. We have several sources of liquidity that come from various lines of business that we can pull together into a centralised anonymous electronic merchandise hub. Liquidity comes from cash equities, delta hedging and the transition management business which is part of our custodial services. We are also able to consolidate the retail flow from the private client network we acquired from Bear Stearns, JPMorgan Chase branches, and the J.P. Morgan Private Bank.

Q. What do you think the impact of the market access rule will have?

A. We have been supporters of the regulations around market access (it requires broker-dealers with market access to implement pre- and post-trade risk management controls and supervisory procedures reasonably designed to manage financial, regulatory and other risks of accessing markets directly) because it can only help level the playing field and reduce the level of competition based on regulatory arbitrage.

Q. What impact do you think the current wave of merger exchanges will have on the industry?

A. This is just another cycle of operational efficiency-driven consolidation that we have seen in the past. However, this time it is more global in nature and has some implications on clearing. For example, the US in the 1990s experienced a proliferation of electronic communication networks (ECNs), which gathered liquidity and challenged the incumbent exchanges. This led to a reduction in explicit trading costs and subsequently, a wave of mergers and acquisitions ensued. The incumbents bought back market share and technology to gain scale. For example, NYSE bought Archipelago after it had rolled up REDIBook, GlobeNet, and the Pacific Exchange; NASDAQ acquired the combination of Island, INET, Brut, and Strike. This is very similar to what is happening today. The barriers to entry are low and the exchanges need scale. They have pursued new revenue streams, technology driven infrastructure plays, and sought operational efficiencies through consolidation. The global mergers that we are seeing could be beneficial in driving down explicit costs while also providing greater optionality for liquidity access.

Q. You were hired to raise the electronic trading group’s profile. How are you achieving this?

A. I joined J.P. Morgan last April with the mandate to build a best-in-class global electronic trading franchise. The first step was building a team by complementing the existing top talent with additional subject matter expertise via new hires. We pursued an aggressive global hiring plan across client coverage, sales, product management, and quantitative analytics. The vast majority of hiring was accomplished in 2010. We also began to tune up our full suite of electronic products such as algorithms, smart-order routing, crossing engines, and pre- and post-trade analytics. We have been investing heavily in the back end core technology infrastructure as well as client-facing products. In addition to building the team and investing in products and technology, a core part of our strategy has been to deliver to our clients best-in-class service levels via subject matter expertise on market structure, execution consulting, and day-to-day order flow support. We believe that the level of services that we provide as well as our product quality will help us differentiate ourselves from our competitors.

Q. How many people have you hired in the past year?

A. We have hired a significant number of personnel globally across technology, quantitative analytics, product management, client coverage, and sales. Our focus has been on finding subject matter experts who understand what clients are trying to achieve via end-to-end electronic trading tools; whether it be direct market access, algos, routing, or analytics. Also several of our new hires – quants, programmers – have a thorough knowledge of HFT strategies and a deep understanding of low-latency trading, which we’ve leveraged in our products to obtain a competitive edge in the marketplace.

Q. Can you tell me about the new algos that your group is rolling out?

A. Our focus has been threefold: quantitative modelling, customisation, and simplification of offering. Over the past year we have built quant models into our algo platform that provide intelligent order placement for liquidity access and pricing. We’ve also expanded our customisation capabilities and sped up turn around time for client requests. Finally, we simplified the naming of our algo offering to emphasize trading behaviours vs. creative names.

Q. What future trends do you see?

A. Our clients have become much more sophisticated in their use of electronic trading. They are much more interested in liquidity pool usage, routing decisions, and trading analytics. I’d expect these trends to continue. Also, more clients are focused on standardizing their algo offering across providers based on trading behaviours. This can simplify workflow and reduce overheads on desktop real estate and systems integration while at the same time providing for improved trading performance measurement.

Q. What do you see as the biggest challenges?

A. The biggest challenge today for brokers is how to differentiate themselves in terms of algo offerings and execution products. This is especially true in today’s environment where clients are reducing their broker list and deepening their relationships with the largest players. I think we are all trying to break free from each other and differentiate in our levels and quality of service, access to liquidity, and delivery of pre-and post-trade analytics. It is important that we don’t get distracted with far flung ideas. Our focus is to socialise new product ideas with clients to make sure we are delivering top quality practical solutions.

[Biography]
Frank Troise, is global head of equities electronic client solutions at J.P. Morgan. He was previously the head of equities electronic trading product at Barclays Capital. His responsibilities included global product management for the electronic trading of equities and listed options. Prior to Barclays Capital, Troise worked at Lehman Brothers from 2005 to 2008 and at ITG Inc. from 1997 to 2005.
©BEST EXECUTION

Steve Smit : State Street

A NEW LANDSCAPE.

StateStreet_Stephen-Smit+Q

Steve Smit, executive vice president, head of global markets Europe and investor services UKMEA at State Street explains how regulation is of the industry, and creating opportunities for a global investment servicing business.

Q. There has been so much regulation coming down the pipeline since the financial crisis but so much of it is yet undecided, is it difficult to plan?

A. It is true that the outcome is still to be decided in many cases. The one good thing though about the delays in the US is that the scheduled implementation windows between Europe and the US are getting shorter. One outcome is likely to be that asset managers and end-investors are likely to face higher costs, and therefore diminished investment returns, because of the increased capital requirements of their service providers.

Q. Which regulation do you think will have the greatest impact on your business?

A. Dodd Frank will have a major impact specifically in the area of OTC derivatives. The drive towards increased transparency will require many of these contracts to be traded on swap execution facilities and centrally cleared. The AIFMD (alternative investment fund managers directive) and UCITS IV and V are also going to have a significant impact. The biggest concern for custodians is the introduction of the strict depository liability. The language was softened in the AIFMD but we are still waiting for a final version of UCITs V (UCITS V aims to make depositaries fully liable for any assets held in custody and by an appointed third-party sub-custodian). If it goes through, I think it could lead to further consolidation in the industry and greater concentration, which could have implications for systemic risk.

Q. What about MiFID II?

A. I think the transparency that MiFID has brought has been beneficial to all market participants although it has led to the fragmentation of liquidity. The current review is intended to address perceived weaknesses, including, in respect of algorithmic and high-frequency trading, the organization of trade execution venues (BCNs and SEFs), pre and post trade transparency requirements, conduct of business practices and client categorisation.

Q. How do you see the asset managers responding?

A. The institutional investment industry is having to respond to a multitude of new and proposed regulation – Dodd Frank, AIFMD, UCITS, RDR, Solvency II – and is looking to institutions like State Street to develop appropriate responses and solutions. One of the major trends resulting from this is an increased demand for the outsourcing of services to providers such as State Street. These new regulations pose extreme operational challenges at a time when the cost base of many asset managers remains under pres­sure. Although the aggregated level of assets under management has returned to pre-crisis levels and the expense base of asset managers has returned to pre-crisis levels, revenues are only back to approximately 85% of pre-crisis levels. Consequently asset managers are looking for assistance in addressing their expenses challenges and outsourcing is an obvious solution. This allows the fund manager to focus on their core competencies of manufac­turing and distributing investment product.

Q. How do you define middle office?

We tend to look at it as all activities that occur post trade but pre-settlement but where you set the bar is really up to the asset manager. We are talking with some asset managers who are interested in outsourcing their execution function. This tends to be more the case with smaller organisations and although it is just talk now, the day is fast approaching when it could be a reality. I think there are more opportunities now if you can provide demonstrable best execution on an agency basis.

Q. What type of outsourcing deals are you seeing – a total lift out or component based?

A. We are seeing both – total lift outs and transactions that are much more modular in nature. The primary modules are the traditional middle office functions of transaction management, derivatives processing, reconciliation and control, recordkeeping and accounting, corporate action processing, etcetera. These can be augmented with activities like performance and analytics, collateral management, and end client reporting to name a few. It really depends on the asset managers’ profile and requirements as to which activities they will outsource. The challenge is in structuring transactions that are commercially attractive to both parties.

Q. Do you foresee further consolidation in the industry and does State Street plan to participate?

A. Our CEO, Jay Hooley last year set out a number of strategic imperatives for the business – first and foremost of which was the goal to double non-US revenues over a five year period. We certainly anticipate further consolidation and we intend to actively participate in it. We believe that a number of the institutions currently offering securities services in Europe will likely exit the business because they determine that it is a non-core competence, that the required level of investment is unsustainable or that the required capital to support the business could be better deployed elsewhere. Last year we undertook two big significant acquisitions – Mourant International Finance Administration and the securities servicing business of Intessa Sanpaolo in Italy, which increased our market share to 30% from 3% in the country.

Q. What about Asia?

A. Asia is a dynamic and rapidly growing marketplace although it is still characterised by relatively few large pools of institutional assets. However, there are opportunities. For example, we are seeing a number of our global clients distributing their UCITS product into the region. There are also fewer local providers and we think that we have the global scale as well as the resources as well as on the ground expertise that will allow us to capitalise on these opportunities

Q. Looking ahead, is regulation the greatest challenge?

A. I think the changing regulatory environment creates both challenges and opportunities. Changing regulation has become a source of new product development for us. For example, we have become involved in developing solutions for the insurance industry to assist them in meeting their Solvency II requirements. We have also recently rolled out a new service for the production of Key Investor Information Documents (KIID) for UCITS compliant funds. Another perennial challenge is fee compression. We need to continually refine and enhance our operating model in order to extract greater efficiency and productivity. Finally we need to continually strive to meet the expectations of our clients – from the smooth and seamless migration of these clients onto our platform to meeting their daily requirements through the provision of exemplary levels of service. l

[BIOGRAPHY]
Stephen Smit, who joined State Street in 1987, is executive vice president, head of global markets Europe and investor services UKMEA. He has regional responsibility for investor services, securities finance, foreign exchange, equities and fixed income trading activities, and operations. He is also a member of State Street’s European Executive Board. Prior to relocating to the UK, Smit was the president and CEO of State Street Trust Company, Canada, and principal officer of State Street Bank and Trust Company – Canada Branch. Smit has also served in a variety of trading and risk advisory roles. He received a Masters of Business Administration from the Boston College Graduate School of Management and a Bachelor of Science (Economics) degree from the London School of Economics©BEST EXECUTION

 

 

Alternative Trading Expands in Indonesia and Malaysia

Lee Porter, Liquidnet, explores the new territory of alternative trading platforms in Indonesia and Malaysia as traders seek new opportunities for growth.
Lee Porter Head of Asia Pacific LiquidnetIn a relatively short time, alternative trading platforms in Asia have emerged as critical venues for institutional traders to source offexchange liquidity. They provide choice and ultimately help reduce costs through reduced transaction costs and lower market impact. So-called ‘dark pools’ have largely been focused on trading around the established financial centres of Hong Kong, Japan, Singapore and Australia, where the majority of the region’s liquidity is located. The next stage in the industry’s evolution in Asia is a push into emerging markets, and moves are well underway.
The increasing interest in South- East Asia stems from two long-term trends impacting the buy-side: high economic growth  which is fuelling demand to trade locally listed securities where there is often low liquidity, and high market impact. As regards the first point, the story of South-East Asia’s economic transformation has been remarkable. Real GDP growth is expected to average 6% between 2011-2015, supported by strong domestic demand, according to the OECD. Meanwhile, South-East Asia’s population jumped 15% in the ten years to 2010, climbing to 607 million.
These demographics continue to attract global investors, helping push higher the local equity markets. For example, the benchmark Jakarta Composite Index gained more than 45% in 2010, making it the best performer among Asia’s ten biggest markets. More money is expected to flow into the region in the coming years. At the same time, liquidity in South-East Asia remains scarce, presenting a significant challenge for  institutions looking to trade large volumes of shares.
The Jakarta Stock Exchange in Q1 2011 recorded an average execution size of US$4,677. This compares to an average execution size of around US$1.1 million on on our platform for Indonesianlisted securities during the same period, i.e. 234 times larger than the local exchange. The story is similar in Malaysia where the Bursa Malaysia in Q1 2011 recorded an average execution size of US$6,053 compared to US$1 million reported by Liquidnet.
Local exchanges across South- East Asia, like most of their global peers, are geared towards the needs of retail investors, as seen by relatively small transaction sizes. Moving forward, we see growing demand from institutional investors to access large blocks of shares in those markets (See [1] next page). The rising demand on alternative trading platforms for South-East Asian securities has been strong.
For example, principal traded on Liquidnet’s platform in Indonesia, Malaysia and Singapore for Q1 2011 was close to US$380 million. This was a jump of over 176% from Q4 2010 (See [2] next page). When traders find a match in Indonesia they are far more likely to execute the trade, we suspect, because of issues surrounding a lack of liquidity and potential market impact costs.
In addition, traders seeking to execute on public venues in South-East Asia are contending with very wide spreads. This is a factor which can be mitigated on alternative trading platforms, helping institutional traders transact at the fairest price. The problems institutional investors face in Malaysia, Indonesia and Singapore are in fact universal. The solution for many traders is to allow institutions to transact large blocks of shares in a safe and secure environment.
Looking ahead, other markets of South East Asia may draw alternative trading platforms, such as Liquidnet. While it may be too early to speculate about a likely entry date, it is fair to say that the demographics and market dynamics support the entry of alternative trading platforms, which in turn, help support the needs of institutional traders.
Logistically, the issue of connectivity for Malaysia and Indonesia is straight forward. In both markets, some alternative trading platforms trade off-shore and transactions are processed through a licenced third-party broker and reported to the local exchange. While there are occasionally misconceptions about the role of alternative trading venues in some markets, our experience in South-East Asia has been overwhelmingly positive.
Local exchanges, we believe, see alternative trading venues as complementary, given that they offer volume discovery to match their price discovery. Alternative trading venues also help bring to the market additional liquidity which may otherwise not find its way to the exchange, as buy-side traders may be reluctant to execute on exchange.
The move to offer trading in listed Malaysian and Indonesian securities also comes as regional exchanges in South-East Asia develop closer trading ties. Four exchanges, operated by Singapore Exchange Ltd, Bursa Malaysia Bhd, the Philippine Stock Exchange Inc and the Stock Exchange of Thailand, announced plans in February for the Asean Trading Link.
This will interconnect markets electronically, enabling investors to buy or sell shares in any of the markets whilst settling the transactions in their home market. The proposal would not impact attempts by alternative trading venues, such as Liquidnet, to deliver  off-exchange trading in local securities, given that all trading is still settled and reported locally.
As we look ahead to the coming years in the region, we remain excited about the potential offered by emerging markets, particularly South-East Asia.

What’s Fast in Europe? High Frequency in Depth

Lakeview Capital Market Services’ Peter van Kleef relates the state of high frequency trading (HFT) in Europe including which trades are overcrowded and where the next breakthrough will come from.
Is high frequency order flow in Europe coming from Tier 1 banks or prop desks?
High frequency order flow in Europe comes mainly from proprietary trading firms and hedge funds as well as bank proprietary trading desks.
How is MiFID II changing the mood for HFT? In particular, how will a consolidated order tape affect HFT traders?
High frequency traders were already using a consolidated order tape for their strategies, so the only difference is that MiFID II might make that data cheaper and more readily available. Also, having a consolidated order tape will improve transparency, but that may indirectly cause problems for prime brokers. For example, if a prime broker’s client sees a price in the market data, their execution partner might not be in that market or might not be fast enough to get the price that their client has seen.
What are the most popular instruments for HFT in Europe? Are there any favorite HFT trades that are becoming potentially too ‘crowded’?
Most people who are new to HFT, trade the most common items such as Eurostoxx, DAX, CAC, AEX, FTSE, Bund, Bobl Schatz Futures, etc. This is counterintuitive, however, as the new traders are entering the most crowded trades and most competitive products. There are crowded trades around Eurostoxx, for example, and as a result, there will always be mini Flash Crashes and disruptions of that kind. The real thing is not to keep people out of these trades but to set up better systems in the exchange to maintain liquidity.
People at buy-sides institutions are often uncomfortable with HFT in markets because they want to trade a large amount, yet they do so in a way that is evident to the market and especially to high frequency traders. If there is an impression that there is a buildup of pressure to sell, then traders will lower their price. Some may complain about this process, but it is not the fault of the high frequency trader. Buy-side institutions need to learn more about interacting with HFT in the market. Institutional investors will find that they enjoy more liquidity when they become more sophisticated in terms of how they interact with high frequency traders.
It is incorrect to view HFT as artificial liquidity. Volume is liquidity. It might not always be liquidity in the direction you want, but it is liquidity. It makes it easier to trade, but people are unfamiliar with how to interact, so they simply need to become more familiar with it.
What are exchanges and MTFs doing to attract HFT order flow?
Many exchanges are supporting volume discounts. Many of the new MTFs want to attract volume, so they offer volume discounts for HFT. If you provide liquidity, you are paid for that liquidity; if you take liquidity, you pay. This model is common in all industries. If you buy more cars, cars become cheaper; if you buy more shirts, they get cheaper. In addition, many new exchanges claim to be faster than their rivals.
On the other hand, the older more traditional exchanges have restrictions for liquidity providers and naked access, which is a  disadvantage for market makers who wish to interact with institutions or directly with exchange members. An unintended consequence of these restrictions is that by banning naked access, they disadvantage those very people they want to protect; i.e. the non members.
Regulators should put more pressure on the exchanges to deploy additional safety features – something you see in new markets. New markets take more care to provide safety features for their market places, which is essentially saying that we want to avoid Flash Crashes and miss-trades on our markets by having features and functions in place at the start. New markets also have the chance to learn from older, more established markets, which are often quite slow in adapting to those features.
Where will the next breakthrough in HFT come from: hardware, data, connectivity, exchange engines?
What you see now is – finally – an adoption of hardware. We have been looking at this for over ten years, but there was not the hardware to make HFT reasonably easy. This type of hardware is now becoming much easier to acquire and use because every few months, new tools and companies are launched. Hardware is the way forward for HFT because it is the only way to really make it quick. Hardware will always be faster than software when it comes to simple things. By definition, HFT cannot be very complex, as complexity slows things down.
The other hot topics at the moment are new or alternative information streams; for example, social networks and other types of information, such as tagged news. High frequency traders are examining those areas that will give them an edge to identify price movements before they actually happen, rather than simply reacting to the movements as they happen. Those are the two biggest trends right now, hardware and news.

Growth Segment: Minority Broker Dealers

Carl Weir, HSBC, provides a snapshot on the MFDV’s space, the market size, why it is interesting and the business possibilities in this market.
In the US, over the last few years, a small yet growing group of broker dealers has been stealing a march on the larger institutions for a share of the pension fund space. This group is known as Minority Female Disabled and Veteran (MFDV ) Broker Dealers.
It is important to remember for the purpose of this article that MFDVs are known by such names  as Qualified Minority Broker Dealers, MBE Broker Dealers, WBE Broker Dealers, Emerging Managers, Emerging Brokers, Underserved Broker Dealers and Economic Transacted Investment (ETI) Broker Dealers – to name but a few. This space requires identification for a number of reasons:
a. The allocations of US state, municipal and corporate pension funds to this space are increasing year on year.
b. The allocations are federal, state and municipal government mandated.
c. Some MFDVs are getting allocations of funds to invest from multiple states and municipalities.
d. Based on 2010 figures from Thomson Reuters, MFDVs have been outperforming larger institutions in the areas of fixed income and global equities (e.g. in 2010 MFDVs participated in 25.8% of all municipal fixed income transactions in Illinois, by volume, compared with 13.3% in New York, and 14.2% in  California).
e. Competitive investment performance is one of the primary factors driving demand for MFDVs among institutional investors.
f. Diversification is leading to the potential   for reduced risk through portfolio diversification in their investment strategies.
g. Their focus is through specialization.
h. They offer reduced organizational risk, and
i. Reduced operational risk.
The simplest way of looking at this space, whether you are a buy-side or a sell-side institution, is to ask yourself: “Do I have a relationship, and am I obtaining order flow from a US pension fund?” If the answer is “Yes”, the assumption is that you are getting as much order flow as can be transacted with that pension fund. Then ask yourself: “Do I have a relationship, and am I obtaining order flow from a US or global investment manager of a US pension fund?”
If the answer is “Yes”, the assumption is that you are getting as much order flow as can be transacted with a US or global investment manager of a US pension fund. At this point you might see a light switch on above your head, as you ask yourself: “Hey, if the pension fund and the investment manager of the pension fund are both giving me order flow, then is the MFDV allocation of the fund not diluted between the two?” The answer is “No”.
Look at it this way… If a pension fund, for example Texas TRS (with Assets Under Management (AUM) as at 30 June 2010 of $92.3bn) dictated that 42.5% of assets are managed ‘externally’, but also states that investments through minority and women-owned businesses equals 5% of externally managed assets, then without access to  MFDVs, your actual available order flow is only part of 37.5%, and so on.
Ideally, if you are an MFDV you should be looking for international organizations with global infrastructure you can leverage, that can take you to more than 100 exchange destinations across the globe. Preferably you would want an organization that has a global reach for both execution and custody, and has ‘bricks and mortar’ (people on the ground that know the local market) including those in emerging markets. Also, you probably want to engage an organization who will not compete with you in your US institutional business.
Why should you care?
Based on data compiled in 2010 from Texas TRS, Albourne Associates, Altius Associates, Credit Suisse, Ennis Knupp, Hamilton Lane and The Townsend Group, of the top 16 US state (10) and corporate (6) pension funds with $1.68 trillion AUM, the total Minority Broker Universe is currently 469 firms (compared to the MFDV Universe recorded in the landmark 2005 LACERS Consultiva report figure of 29), with a combined $AUM of 423.7bn.
The investable Universe by pension funds for MFDVs with >$1bn AUM is 82 firms, with total AUM of $347.1bn. Not taking into account the diversity, products and activity of a $347.1-$423.7bn market would be foolhardy to say the least. To break this down into further total and investable Universes with an example of real pension fund commitment (Illinois pension funds have been intentionally overlooked as they are historically used as a benchmark, Texas Teachers Retirement System [Texas TRS] has been chosen to illustrate the growth of the MFDVs space outside Illinois):
For long-oriented equity the number of firms is quoted as 155 with a combined AUM of $301.7bn with 46 > $1bn AUM, and those with AUM >$1bn equating to $281.1bn. TRS’s commitment is to two MFDVs for $1.2bn, where the $1.2bn was committed to two women-owned MFDVs.
For hedge funds the number of firms is quoted as 21 with a combined AUM of $21bn with 7 > $1bn AUM, and those with AUM > $1bn equating to $18.1bn. TRS’s commitment is to three MFDVs for $370m, where the $370m was committed to two Asian-owned MFDVs.
For real estate the number of firms is quoted as 62 with a combined AUM of $16.5bn with 7 > $1bn AUM, and those with AUM > $1bn equating to $12.6bn. TRS’s commitment is to four MFDVs for $400m, where the $400m was committed to four African American-owned MFDVs.
For private equity the number of firms is quoted as 231 with a combined AUM of $84.5bn with 22 > $1bn AUM, and those with AUM > $1bn equating to $39.4bn. TRS’s commitment is to eleven MFDVs for $121m, where the $74m was committed to six African American -owned MFDVs; $21m was committed to two Hispanic-owned MFDVs; $15m was committed to one women-owned MFDV; and $8m was committed to two Asian-owned MFDVs.

Smart Liquidity Management Goes Global

ITG’s Clare Rowsell and Rob Boardman outline the best practices for liquidity management across multiple regions, focusing on Asia Pacific, North America and Europe.
In an increasingly global and fragmented trading environment, finding and managing liquidity is the top priority for buy-side traders. The practicalities of doing so are complex, and are underpinned by the trade-off between the time taken to find liquidity – which can result in delay costs as the price moves away, and the quality of that liquidity – trading against certain counterparties can increase market impact costs.
Meanwhile, the global liquidity environment is changing rapidly due to evolving regulation, market structure and the trading tools available. What follows is a short summary of some of the most significant developments affecting liquidity management in different regions around the world.
Clare Rowsell1Asia Pacific
Often cited as having a ‘last mover advantage’ in coming latest to the world of dark pools and alternative trading venues, Asia is now catching up rapidly. Growing awareness of the region’s higher trading costs (approximately one third higher than those of the US and UK) is creating market demand for both new lit and dark liquidity sources.
Japan is the only major market that currently allows ‘lit’ or quote-publishing venues to compete directly with the exchanges, and in the past year market share on these venues (including SBI Japannext, Chi-X and Kabu.com) has risen, although they still average around 2-3% of total turnover.
Australia will be next, now that the launch of Chi-X to challenge the ASX exchange’s monopoly has been confirmed for early in Quarter 4 2011. As alternative lit venues develop, the importance of smart order routing grows and in Australia this has been a core component of consultation which will result in changes to regulation affecting brokers and exchanges and mandating Smart Order Routing (SOR) as a mechanism to achieve best price in a multi-market environment.
For other Asian markets, buy-side traders have been turning to dark pools as a way of managing trading costs and finding quality liquidity.Most of the large banks and brokers now offer a dark pool or internalization engine in markets including Hong Kong, Japan and Australia; but given Asia’s already-fragmented market structures, adding more broker liquidity pools threatens to complicate the buy-side trader’s life. This is where liquidity management, and specifically the aggregation of dark pools, is coming to the fore. Increasingly the buy-side are turning to dark pool aggregating algorithms to connect into multiple sources of liquidity through one access point.
Canada
Canada has long benefited from trading in an auction market supported by a highly visible electronic book. Even though it was not until the latter half of the decade that ATSs began to spring up in Canada, they quickly gained traction and in 2010 ATSs represented 34% of volume. As these changes have taken place, Canadian regulators have continually reviewed emerging regulation in other regions as Canada continues to parallel more mature markets.
With the proliferation of alternative trading venues came an emphasis on the consolidation of data to ensure market integrity. In addressing the need for a consolidated tape, the CSA accepted RFPs and appointed the TMX Group to the role of Information Processor. Also arising from the multiple-market trading environment is Reg.NMS-style regulations to protect against trade-throughs. February’s Order Protection Rule shifted the best price responsibility to marketplaces and also requires full depth of book protection (unlike the US’s top of book protection).
About 3% of Canada’s equity trading is done in dark pools, and although Canada has only two dark pools (Liquidnet Canada and ITG’s MATCH NowSM), Instinet plans to open two this year and Canadian stock exchanges are making moves to offer dark order types. The regulatory body has kept a watchful eye on this development and has already issued early-stage proposed regulation, including minimum size restrictions and the curtailment of direct market access. These moves may be premature and have the capacity to diminish market efficiency and lead to information leakage.
Rob BoardmanEurope
Trailblazing the electronic trading realm, Europe helped lead global adoption of trading technology with the early demutualization of electronic exchanges into profitseeking institutions. The passage of the Markets in Financial Instruments Directive (MiFID) transformed the marketplace by opening up competition among trading venues. Multilateral Trading Facility (MTF) activity has grown substantially since 2007, with some estimates predicting that dark flow alone could account for 6.1% of turnover by the end of 2011. With these swift developments in the European trading landscape, policymakers are now set to use MiFID II to address the issues considered in the MiFID II public consultation  document which included an increase in transparency, data access and the classification of trading entities.
Of note in emerging regulation is the theme of minimum order size restrictions for dark MTFs. By imposing a floor on the number of shares traded via dark pools, many investors will be denied best execution. This will curtail the use of dark pools, which empirical evidence suggests decreases transaction costs and increases lit market efficiency. In addition to regulatory innovation impacting the trading landscape, the global exchange world is in a state of flux. The industry is bracing itself for further shifts in the structure of the European market as exchanges not only attempt huge cross-border purchases but also look to develop new businesses such as derivatives trading and clearing services.
US
As electronification has taken hold of the US, the region has exported innovations like execution algorithms, dark pools and highfrequency trading. Prior to the credit crisis,   regulators generally took a laissez faire approach to US market structure but with heightened scrutiny particularly in the wake of the Flash Crash, many technological innovations have come under scrutiny. As directives emerge in the US, global regulators are keeping a watchful eye on where to reevaluate rules on their home turf.
As the Commodity Futures Trading Commission (CFTC) drags its feet on Dodd-Frank rulemaking for OTC derivatives, eyes have turned to the CFTC-SEC’s 14-step plan in the wake of the Flash Crash. Replacing single-stock circuit breakers, a new limit up/down mechanism will help prevent erroneous trades and guard against another Flash Crash event. More controversial regulation focuses on half-cent price improvement for internalizers and a ‘trade-at’ rule with full depth of book protection. These proposals conflict mandates for competition among market centers and would ultimately end up costing investors.
While regulation spurs controversy and discussion in the US, innovation in liquidity-seeking tools continues. Sophisticated liquidity-seeking tools have been on the scene since 1986, and they have evolved and grown to now offer integration with algorithms to access natural blocks combined with technology to filter and differentiate liquidity types. With the range of tools now available and the increasing fragmentation of markets, it is extremely important for the buy-side to implement real-time transaction cost monitoring tools.
Bringing it all together
Globally, market structures are at various stages of development but the differences are becoming smaller and the rate of change quicker. The interconnectivity of markets has become increasingly apparent, particularly in light of recent cross-regional exchange merger activity which promises to bring new technologies to the fore. Regulators are continually reviewing these developments and the industry awaits feedback on this changing landscape. It is now crucial for the buy-side to select the right tools for liquidity management and to monitor how market structure changes will affect their performance in the various regions.

The New Electronic Broker

J.P. Morgan ‘s Frank Troise sat down with FIXGlobal to chart the expansion of electronic trading tools available to the buy-side and point out which new tools will make the difference in the months to come.
In what way has the trader’s desktop improved?
Over the last few years, the biggest improvements have been the inclusion of more multi-asset class execution capabilities and the inclusion of additional analytics. Desktop trading platforms that support equities options, futures and FX trading, with the ability to track all of those orders in the market and give aggregated profit and loss are much more prevalent. More trader desktops incorporate pre-trade analytics measures, such as market impact estimates as well as post-trade execution information.
What do your clients say they want most from their analytics?
Clients want a combination of real-time and post-trade analytics. Prior to starting the trade, clients want tools that help their investment decision process. Once an investment decision is made, pre-trade market impact and trade scheduling tools can help traders develop an implementation game plan. Through the course of the trade, clients like to see real-time analytics that can help them improve the performance of their trade; for example, abnormalities around volatilities and volumes. Post-trade, clients want performanc reports measuring actual execution costs against various benchmarks on a daily, monthly, and quarterly basis.
How does putting so much technology in the hands of the trader change the role of the broker? How does the broker add value in addition to the electronic tools?
In the electronic broker business, our value added comes in our role as execution consultant and our ability to educate clients on the use of pre- and post-trade analytics and execution tools. I look at the roles and responsibilities of the people on our electronic  client trading desk as helping clients implement their investment ideas. When a client has a trade to execute, it is up to our team to educate that client on the tools they can use to put together a plan, present them with the tools to execute the trade and while they are executing the trade, provide information that can be used to improve their plan throughout the execution period.
After the trade is executed, we work with clients to evaluate how well they did against their plan and help them improve their trading process in the future. We focus on creating and enhancing client products continuously. Our goal is to make it easy for them to use analytics and execution tools to achieve best execution. The better we understand a client’s goals and objectives the more we can collaborate with the client on custom solutions and training.
Electronic trading products are very different from traditional equities execution capabilities. A key differentiating characteristic is that the products reside and are used by the client at the client site. In the traditional model virtually no broker technology oriented product existed at the client site.
The communication mechanism for order delivery was the telephone and execution occurred in the broker/ dealer environment. Electronic brokering is a very intrusive business. Our products exist in the client’s technology infrastructure. This has led to changing core competencies of brokerage firms. We now have to be experts at delivering products into the client site. This has implications on training and technology integration.
How does the electronic broker assist clients in locating liquidity, either through tools or the consulting process?
Liquidity has and continues to be a top priority for clients. They have always come to brokers to find liquidity in as ‘quiet’ a way as possible. In today’s landscape, much of that liquidity exists in electronic form and is fragmented. The result has been a proliferation of tools (e.g., algos, routers) that help clients navigate liquidity pools to logically consolidate the fragmented liquidity. To assist in that process we have created a pool to concentrate order flow across various trading desks, retail segments of the broader J.P. Morgan Chase organization, transition management flow, and third party broker dealer flow. I refer to it as a centralized electronic merchandise hub.
Additionally, we have spent a significant amount of time adding quant personnel to our algorithmic trading effort. Seeking liquidity and trading at fair value in a world of electronic liquidity provision is a challenge. We have personnel on our team that have experience building high frequency trading models. Our team has implemented electronic market making models in our algorithms to assist in determining optimal trading opportunities in various liquidity pools. The ultimate role of the broker is to optimally manage access to various liquidity pools: in-house, third party private pools, and public exchanges/venues. Best execution relies on the optimal use of traditional and electronic execution tools to access liquidity.
On the electronic side, it is our duty as a broker to deliver high content algorithms, smart routers, and liquidity pool access to our clients via their desktop of choice. Ultimately, the business always reverts to optimal liquidity access.
Are you seeing traders including proactive risk management into their desktops?
Over the past few years I have seen buy-side trading desks employ more pre-trade risk controls into their OMS and EMS. On the broker side, since the May 2010 Flash Crash in the US there has been much more attention to risk management as it pertains to market access. The Flash Crash highlighted cracks in US market structure but also sent a message to brokers around their deployment of sponsored and naked sponsored access and their algorithmic trading strategies pricing models and order type usage.
How is this space maturing?
Compared to a few years ago, clients have a much better understanding of what they are trying to achieve with electronic execution. They have become much more aware of the various liquidity pools and providers in the market. Algo trading is a good example. If you go back three to five years, clients would take broker algorithm suites onto their desktop and integrate the entire suite. Traders would integrate all of J.P. Morgan ‘s algorithms and the algorithms of various competitors, with the result that they had several algo strategies from each broker and a long list of drop-down menus.
What we are seeing now is traders identifying their style of execution and asking the  brokers for specific algorithms according to strategy, instead of taking a broker’s entire algo suite. Clients are getting away from buying the marketing and branding of the broker and moving toward using plain language styles of execution. I believe this is a sign of a market that is maturing and better understanding of how to use the electronic execution products to find liquidity.

Setting the Course

Jim Kaye, Co-chair of the FPL Global Steering Committee discusses the future direction of FPL.
Jim KayeIt was not long after my term as co-chair of the Global Steering Committee had begun earlier this year that I realised two very important things about FPL. One was that there was a huge amount of activity going on – much more than I had previously been aware of. The other was that there was an equally huge amount that FPL could be contributing to its members and, through them, to the industry as a whole. In this article I’m summarising elements of both of these, as I think it’s important that we all understand the huge contribution FPL has been making and will continue to make.
Spreading the message
FPL is engaged in more activities than many people realise. So part of our mission is, and indeed always has been, promoting what we’re doing and why we’re doing it. We’re dedicating more resources to communications and marketing, and we will continue to use our increasingly busy events schedule to educate and promote what we’re doing. We have full time event and marketing managers in London, and we are bringing on a new full time resource in Asia to help with these efforts. A key initiative for 2011 is to increase knowledge and adoption of FIX outside FPL’s historical core of North America, the UK and developed Asia; so this year many of our events are being held in other countries.
One complaint I have often heard is that it is hard to find information on the FPL website or, sometimes even in the specifications themselves. To help remedy this, we have initiated work to consolidate our documentation and make our content more searchable. Ultimately this will allow us to link the specifications to and from content from the discussion forums, FPL design documents and even other websites. The new FIXwiki gives us a platform to navigate from and to add to this pool of knowledge. The core of the specifications will continue to be tightly controlled, but members will be able to add their own comments and information. The intention is to allow the wider membership to add information on best practices and usage, provide feedback and so on.
Developing the standard
FPL’s Global Technical Committee (GTC) is the custodian of the protocol itself and is currently working on producing additional functionality to expand the support offered by FIX, especially within the exchanges and fixed income markets.
Alongside this work, the GTC is heavily engaged with other industry groups and standards bodies. This is part of an industry-wide initiative to maintain the ‘Investment Roadmap’ which was produced to leverage the free, open and non-proprietary standards already being used by firms across the industry, to provide market participants with consistent direction as to which messaging standard is most appropriate for use for each part of the trade life cycle for the major asset classes.
This work not only cements FIX’s position in the Roadmap, but also defines how FIX can work with other industry standards at the crossover points where FIX officially ‘ends’ and other standards take over. Of particular importance is FPL’s involvement in ISO 20022 – the ISO initiative is to develop a common business process for messaging for the financial industry. By ensuring that FIX becomes part of this ISO business model, we are in effect future-proofing FIX and at the same time validating the ISO design. This may sound somewhat unconnected from our day to day business, but it matters – it safeguards our investment in FIX as a trading messaging standard and helps to  ensure that the next generation of standards continue to work for the industry.
Working to solve business issues
A significant part of FPL’s role extends beyond the maintenance, promotion and development of the FIX standards, to the practicalities of actually using those standards in the trading environment. This is a particularly important area at the moment given the amount of focus on electronic trading from regulators and investors. Various committees and working groups globally are focussing on defining best practices for areas such as trade allocations, execution venue reporting, algorithmic order parameter definitions and European consolidated market data, to name just a few. This activity isn’t solely about thinking through issues and writing documents – it’s also about FPL using its members to implement the results. This is what I see as one of FPL’s primary roles – not just defining standards and best practices, but also overseeing and encouraging their implementation.
In conclusion, the next couple of years are going to bring significant pressures for change across our industry, and I see FPL occupying a vital role to help us all understand and effect those changes.

Can I See Some ID? The Global Legal Entity Identifier System Reduces Risk

SIFMA’s Tom Price translates the industry proposal for a global Legal Entity Identifier system and discusses its potential effects for businesses and regulators.
Tom Price_1How will the proposed global LEI system limit counterparty and systemic risk?
The creation of a Legal Entity Identifier (LEI) is very foundational. With the LEI, firms can better react to counterparty risk and regulators can use the LEI for systemic risk analysis. Financial institutions will be able to efficiently aggregate all exposure to their counterparties in a timely and effective way. Having a holistic view of counterparty risks will be an incredibly important effect for institutions, specifically as it relates to risk management. Also, the creation of an LEI system will make it easier for data aggregation, modelling and analysis in risk management. Finally, the LEI system will also streamline regulatory reporting and analysis, giving firms the benefit of being able to report counterparty exposure efficiently in a single format to the regulators.
As it relates to operational benefits, financial  institutions will be able to get an integrated view of entities across all their different business lines. The LEI system should also help with processing and settlement efficiencies, as well as new client on-boarding. In addition, it should lead to better corporate actions management and a greater understanding of the hierarchical relationships between their counterparties.
From a systemic risk perspective, it is my view that the regulators will now be able to aggregate information about market participants as it relates to products,  markets and positions. They will also be able to aggregate and analyze that data in one central place to identify potential systemic risk in the marketplace, whether that is bubbles, crowded trades, over-concentration, potential liquidity issues or leverage issues. The LEI system will address the concerns of the Financial Stability Board, as it relates to our recent market dislocations.
What mechanisms are necessary to facilitate the coordinated global registration of financial legal entities?
The LEI system could either be run through a federated model or through a centralized model. Federated means that different regions have different models set up to create some sort of identification system for legal entities, or centralized, where you have one issuing agent or international standards body that works with a registration authority. The three necessary mechanisms are:

  • A standards body.
  • A registration authority that actual legal entities would register with to get the identifier, and someone to make sure the data is clear and up to date.
  • Ensuring high data quality is a critical component of this process.

The success of the LEI system is incumbent upon the regulatory community embracing a mandate requiring legal entities to selfregister via a simple process. If I am a legal entity, I register once and I get an identity that I can use in perpetuity. The identity would not carry any intelligence, so a legal entity in Japan that moves to France keeps the same LEI number. The identity number is not bound by geographical region, product or any other attribute.
Will the LEI solution provider develop the solution from scratch or work from an existing standard?
If you go back to the Office of Financial Research (OFR)’s policy statement, there were certain prerequisites spelled out in that document, as well as the lynchpin group document. Some of those criteria for the LEI system were:

  1. It would have to be an internationally recognized standards body.
  2. It must be a not-forprofit or at-cost model.
  3. The entity running LEI should beexperienced and  competent in the financial services industry.

We hope that through the Solicitation of Interest (SOI) process, potential solution providers suggest their own recommendations for  how they would meet what has been put in the public domain by the regulators, as well as what the industry requires. If there is an existing standard that is functional, and can meet the criteria (as put out by the regulatory community and the industry), then that is fine. Alternatively, if there is something new that can be built from scratch to meet the requirements, then that is also fine – I do not want to prejudge. We are leaving it to the potential solution providers to present how they would do this, after which we will make an evaluation and a recommendation.

What do you say to someone who says that this will just add another layer of complexity to trading firms?
In the context of Dodd-Frank there are many new requirements, but if you take the LEI in isolation, not withstanding all the other issues, the global LEI system will actually create efficiencies for firms. An LEI will actually be a benefit to the industry because it will streamline the way firms do business by creating operational efficiencies out of risk management tools. We have enjoyed substantial industry support in this initiative because there are significant benefits. Not only do the regulators view it this way, but the industry does as well.
How can existing financial standards such as FIX and XBRL and the ISO20022 business model be utilized to assist in the development of the LEI solution?
I do not want to identify any particular current standard, but what we are hoping is that whatever is recommended to the industry and the regulatory community becomes a global standard, and that global standard is adopted and embraced by the world community and is not specific to any one jurisdiction. The framework that is ultimately developed should  allow regions and jurisdictions to adopt it as they are ready. That is the main goal. If another standard is fitfor- purpose, I think that would be part of the evaluation process.
What is the timeline for establishing a centralized repository that is compliant with the majority of regional requirements?
There are a couple of components to this. First, the goal is to  create a global framework that different jurisdictions can move onto as they receive regulatory mandates within their sovereign borders. For example, in the US, we have a mandate from the Treasury Department, as it relates to the creation of the LEI per Dodd- Frank and the creation of the OFR.There are similar initiatives from the Securities and Exchange Commission and the Commodity Futures Trading Commission as it relates to derivatives. While we certainly have the mandates in the US, other jurisdictions don’t as yet, but they are talking about it. This may slide, but I think that any global LEI framework provider that comes onto the marketplace should be prepared to be up and running in 12 months or so.
After the LEI system is implemented, will regulatory arbitrage be a thing of the past?
Regulatory arbitrage will always exist. As it relates to LEI, market participants are going to seek, by and large, the most liquid, effective efficient markets in the world and the US  market is one of those. This is a joint industry initiative; it is not a SIFMA process and it is not a US process. The goal is to create a global legal entity identifier framework.

FPL Promotes ISO

Buy-side on Algos in India

Prudential Asset Management (Singapore) Ltd.’s Sanjay Awasthi , Director, Central Dealing Desk, discusses what he looks for from broker algos and the need for adapting algos to the Indian markets.
How has SEBI’s approval of smart order routers changed your order flow?
We are not users of smart order routers because of the additional complexity resulting from the differences in the settlement processes amongst both the exchanges in India. An illustration of this complexity is in respect of the denoting of price by decimal places. While NSE has a 4 decimal place pricing, the BSE has a 2 decimal place pricing. This mandates  a segregation of fills, which can result in difficulties, especially in a market like India where the average trade size is small and consequently, the number of fills is very large. Also, as yet, we have not really seen any significant advantages in the use of smart order routers.
Are your algorithms primarily developed inhouse or by your brokers?
At Prudential Asset Management (Singapore) Ltd, we rely on brokerprovided algorithms. However, from time to time we may request brokers to customize certain algorithms to help us execute trades in the best interest of our clients.
Do you use algorithms for trade execution, to spot opportunities or both?
Algorithms are used for trade execution. From a trader’s perspective, algorithms help to give greater control of the manner of the execution. In Indian markets, using algorithms ensures anonymity and gives better control on execution.
Is there a difference between the type of algorithms you get from Indian brokers and from international brokers?
Most broker algorithms are commoditized in the sense that the offerings across brokers are pretty much the same for a particular market. This however does not hold true across markets. Most standard algorithms need to be customised to match the market micro structure of each market. To illustrate, in India a volume inline/participation algorithm has to be tweaked to ignore block deals which go through in the normal segment.
What new algorithmic products or services would you like to see more of from your brokers?
We are quite satisfied with the existing algorithms provided by our brokers. In future, we would expect brokers to help customise the existing algorithms to suit our specific requirements  which are essentially those of our clients’. This would also entail more research services from brokers on market micro structure.
*Prudential plc, incorporated and with its principal place of business in England, and its affiliated companies constitute one of the world’s leading financial services groups and has been in existence for over 160 years. It provides insurance and financial services directly and through its subsidiaries and affiliates throughout the world. Prudential plc is not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America.
Sell side Perspective on Indian