Best execution 2009 – July 1st 2009
July 2, 2009
A few summary points I took from the Best Execution Europe 2009 event courtesy of Incisive Media that I attended yesterday morning.
The event started with a presentation by Michael Fridrich, Legal and Policy Affairs Officer of the European Commission:
- From what Michael was saying then in my view, it seems that the EU is using the G20 declaration on financial stability in April as a remit to regulate in many areas (not all of which related to the current crisis, see last paragraph in this post)
- He said that the EU is currently working on removing national options/discretions with respect to financial markets in order to create a single EU rule book and combining this with stronger powers for supervisors including much harsher sanctions against offending institutions
- They are also reviewing the necessary information provided to investors in OTCs, even if the investors qualify as "professional investors" under Mifid.
- The EU is currently reviewing Mifid and the Market Abuse Directive (called "MAD" which is at least humorous…)
- EU is also unsurprisingly looking at the regulation of Credit Ratings Agencies (CRAs) given their involvement in rating CDOs and other structured products
So in summary it was a civil servant PR exercise with few surprises, other than we are going to regulate anything that moves. On to a panel debate on "build vs. buy" for execution management software. I will try and put my obvious vendor bias to one side in summarising this one:
- The panel summarised that this decision was about the usual issues of time to market and what is an institutions core IP
- A senior IT manager from JPMorgan said they both build and buy – but given the size of their organisation and the need to innovate they do build a lot
- The COO of Majedie Asset Management said that "build" was "20th Century" and the IT should focus now on "assembly"
- He added that if IT lead a procurement process he finds this tends to lead to more proprietary solutions than if business is managing it.
- He summarised that business people should have the mandate to define inputs/outputs to a requirement and that IT were not qualified to do this.
- Putting it more controvertially he suggested that IT people should work for IT companies
- The JPMorgan guy responded that "assembly" of external components can lead to excessive staffing in managing all the plumbing, and that build in house could build a more generic and targetted platform that would need less management
- The moderator summarised the build vs. buy decision as one of balancing time to market and how bespoke a solution is alongside of looking at the risks for buying of 1) integration risk 2) vendor risk and for building of 1) delivery risk 2) key man risk
The debate on this was pretty standard, but the guy from Majedie was at least controvertial in what he was saying, (including at one point that "investment management does not scale"). I assume he is trading simple products and as such is able to outsource more than the JPMorgan manager. My own slant is that more vendor products need to be designed to integrate easily with the IPR of a financial institution i.e. less black box.
Tom Middleton of Citi then did a presentation on (equity) market liquidity and market fragmentation:
- He started by saying the Smart Order Routing (SOR) was like "Putting Humpty-Dumpty back together again" from all the sources of liquidity now available under Mifid.
- Being no expert in SOR, I was excited (?) to learn a new term which was "finding Icebergs" – apparently an "Iceberg" is a large non-public ("dark") order being posted with a much smaller public trade order.
- He said that market fragmentation will increase further but there will be less trading venues as the market consolidates.
- New algorithms will be developed more specifically for trading on dark pools of liquidity
- Clearing and settlement costs are still high across Europe which limits the usage of small size orders in trading but trading volumes will continue to grow
- The drive to ever-lower latency will also continue
- Usage of SOR will grow
Tom's presentation was then followed by a panel debate on Smart Order Routing:
- A manager from Baader said that the German area market of Europe was not very sophisticated yet, with most German clients specifying exactly where the trade should be executed hence nullifying the need for SOR.
- Deutsche Bank (DB) mentioned that having both US and EU operations had helped them get SOR in place for the EU quicker given their US experience.
- UBS and Baader both said that Algo trading and SOR are increasingly integrated and will merge with the Algo define what and how to trade and the SOR component determining where
- DB said that a "tipping point" towards usage of SOR in the EU will occur when more than 20% of trading occurs away from the primary exchanges.
- DB said that 60% of US liquidity was due to algorithmic trading and that there were now no EU barriers to this happening in European markets and bringing with it increased liquidity, although issues such as not having a consolidated market tape for trading made things more difficult
- Neonet said that clearing and settlement costs were still a barrier to widescale SOR adoption.
- IGNIS Asset Management said that SOR was a "high touch" service for them, requiring SOR vendors to be very responsive and client focussed. In selecting SOR vendors they were concerned with data privacy and also with having a real-time reporting facility to see how orders were being filled.
And finally (at least before I had to leave) there was a presentation by Richard Semark of UBS on Transaction Cost Analysis (TCA):
- He was surprised to find that there were not many presentations around on TCA
- TCA vendors are behind the times and are not up to date with current developments
- Historically TCA was about what had happened (about 3-4 months ago!)
- Mifid has driven fund managers and traders to talk more and TCA is a key part of this conversation
- It is hard to look bad against traditional TCA measures such as VWAP if a stock is always rising or always falling, and this can hide a lack of performance and "value add"
- Using "Dark" for non-displayed liquidity has been a publicity disaster for the electronic trading industry
- Much Smart Order Routing (SOR) is still based on static tables of trading venues that are updated on a monthly or quarterly basis
- Market share by volume of a venue is not necessarily correlated with obtaining the best prices in the market
- TCA should be based upon a dynamic benchmark that responds to the market and trades done not against a static one
- Trade performance is not linear with trade size which is an incorrect assumption in much of TCA
- Trade risk (variability in outcomes) deserves more focus
- Portfolio TCA is much more complicated where the trading of a single stock cannot be looked at in isolation of its effects on the whole portfolio
- Real-Time TCA is becoming ever more important to clients since it allows them to understand more of what is going wrong/right with filling an order
- TCA providers are not doing a good job for clients, not using the right data or answering the right questions for clients
Not sure who the TCA providers he refers to are, but maybe I should find out to see what they offer…