Eye On The Buy-Side

2 | Eye On the Buy-Side

‘Alphatizing’ The Entire Firm Mat Gulley, Global Head of Trading, Franklin Templeton Investments, is changing how his firm embraces alpha, and is making the PM, research desk, and trader a more integrated unit.

I strongly believe in the alpha proposition offered by the truly engaged buy-side trading desk. With an increasingly complex current market structure, less intermediation in the execution process, new technologies, and the never-ending search for opportunities, now is the time for us to rethink and relearn buy-side trading and how it might best fit into the alpha generation cycle of research, portfolio

Published in GLOBALTRADING | Q4 • 2013

management and implementation.

The question, in my mind, is: “How do we leverage trading within the investment process in order to maximise returns?”

Along with revisiting the role of the trader, we must also continue to consider the importance of technology and how it drives structural change within the implementation process. Technology is no longer simply a source of operational efficiency; it is now an integral and valuable part of the entire investment process.

Whether utilising internal applications to manage one’s proprietary data or using trade analytic systems to

help manage execution strategies and create tactical investment opportunities, technology is vital to almost every aspect of the execution process. Furthermore, technology facilitates collaboration across the investment structure and helps frame our ideas on computer-based trading, algorithms, data analysis and performance.

So, this is how I see the trading world: I view trading from a proactive tactical alpha standpoint with well-defined processes, procedures and risk management.

The ‘new’ structure At Franklin Templeton, we have an experienced global network of over 50 traders on 13 desks in 10 countries who trade equities, fixed income, derivatives and currencies.

We have set up these operations to specifically integrate with our research groups in order to integrate ourselves as closely as possible to the decision making process. The key themes for our desks are to integrate, collaborate and participate in the investment process.

I believe that there remains unrecognised alpha that buy-side trading desks can add to the greater investment process. With an increasingly complex current market structure, less intermediation in the execution process, new technologies, and the never-ending search for alpha, now is the time for us to rethink and relearn buy-side trading and how it might best fit into the alpha generation cycle of research, portfolio management and implementation.

The question, in my mind, is: “How do we leverage trading within the investment process in order to maximise returns?”

We think about our investment process as a triangle having three areas of potential alpha creation,

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each with distinct time frames: longterm alpha, medium-term alpha and short-term alpha. We believe that the long-term alpha sits with the research analyst and, broadlystated, might be in the one to five year range. This stage is where the fundamental research and catalysts for the investment are established.

Then you have the medium-term alpha, which is roughly one month to one year, and that is where the asset allocator or portfolio manager (PM) gets involved. This person makes the decisions on what best combination of ideas to put into the portfolio. Then, we come to the short-term horizon, which is when the order is placed and up to one month. This is the implementation process. This is “trading”. The trader should optimise the implementation of the ideas and collaborate with the PM and analyst to make sure all information is understood and represented. The trader will also present new opportunities based upon market dynamics, volatility, liquidity, all the while understanding the PM’s strategic positioning and collaborating with all the various participants in the investment process. Asking this requires that our traders possess a unique set of skills: enhanced fun market knowledge, new technological tools and welldeveloped communication abilities.

So when we think about trading’s input into the alpha generation cycle, the trader is part of the “short-term alpha” or the tactical portfolio construction and implementation process. In my experience, this has historically not been the case. In fact, the More Buy-side Interviews

traditional investment process has not recognised implementation within the alpha generation cycle; generally it was considered a cost mitigation center. As we evolve, the trader must participate at a much more dynamic and interactive level, and the PM and analyst must recognise this value proposition exists or has the potential to. As always, the PM sets the strategic portion of the portfolio according to the investment objectives and the PM’s views on the market or stock’s potential returns while the trader focuses on implementing those ideas using opportunity and impact as their guides, but also presenting the case for more tactical positioning around a core portfolio.

Traders need to understand the investment process holistically and have some accountability and alignment with performance.

The new “trader” should embrace participating in research and PM meetings to the extent that time

‘Alphatizing’ the technology Today, it is hard to separate trading from technology. To have an effective trading team means having an equally effective technology platform which provides information, speed, flexibility and analysis. Over the last decade Franklin Templeton has put significant effort into four strategic technologically focused projects. All four projects; we believe, add targeted value to our process and have allowed us to rethink how we are involved in the overall investment process, interact with PM’s and handle and analyse each individual trade.

Our marquee project is the Investment Dashboard. This proprietary platform brings together all of our internal data in a user friendly and graphically robust front-end inter-face; allowing the trader to instantly understand portfolio positioning and to help generate focused PM/Analyst/

“We think about our investment process as a triangle having three areas of potential alpha creation, each with distinct time frames: long-term alpha, medium-term alpha and short-term alpha.” allows. The new “trader” should want to be involved and understand strategy in order to help explore possible opportunities. If you have traders who have the skills to be anywhere along the investment continuum and they choose to be in trading, why not maximise their skill set on behalf of the clients and fund returns? I see this as leveraging people and doing so in an unconstrained manner.

With this model, you have an integrated and unconstrained trading desk that can assist in tactical decisions based on market movements, liquidity, portfolio manager needs and analyst directions.

Trader dialogue and targeted investment ideas. We wanted the data to be easily accessible, thus allowing our traders additional insight into all investment products broken down by portfolio manager, portfolio, strategy, geographical region or investment idea. Because of our product breadth and global reach, having well-organised and understandable data is paramount.

Having access to a clear picture of our data allows each trader a greater opportunity to present value added ideas which can be accretive to the investment process.

The second project is an analytics platform for screening ideas and Published in Q4 • 2013 | GLOBALTRADING

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viewing intraday liquidity and trends.

We started working with an outside vendor 3-4 years ago, which has led us to deeper aggregate market analysis on a pre-trade basis, as well as position screening for numerous metrics such as implied volatility, CDS changes or insider activity. With this tool, we are able to analyse these metrics across all our securities in order to recognise divergent patterns. We manage many portfolios and invest in thousands of securities in over 80 countries, so it is necessary to get timely pre-trade stock snapshots, understand valuation momentum, and have targeted market factor analysis to guide and focus the trader’s attention. The question we have always struggled with has been, “How do you synthesise all the information about a stock and market in order to have the best conversation possible with a portfolio manager?” Ultimately, this has led us to more intraday trading analysis and the ability to think about daily liquidity patterns and a trade’s relative trading profile.

A system like this helps us to identify anomalies in the market and better understand liquidity and intraday momentum. This in turn is helpful to drive interaction and dialogue which we believe helps us make better trading decisions.

Electronic trading After restructuring our internal data and implementing an analytics process around our holdings and orders, we decided we needed to address transparency across our electronic execution world. About four years ago when algorithms were really gaining traction and dark pools and execution venues seemed to be multiplying at an exponential rate, the leaders within our trading group got together and discussed the lack of trading transparency. The question that kept being asked was, “How do we know what is happening and how do we find out?” We understood it was important for us to be able to get this intraday trade data, synthesise and then analyse.

About 2 ½ years later, we had the Published in GLOBALTRADING | Q4 • 2013

data. We now require any broker whose algorithm, methodology or market access points we use for execution to provide a certain level of intraday trade reporting transparency (through the FIX Protocol) and complete ping and venue and time stamp data transparency in a data file on a daily basis. We then implemented a complex event processing (CEP) engine, which allows us to quickly analyse this information on a dynamic and historical basis; all the child orders, routes, algorithms.

So, finally, this year we were able to have insight into “all” levels of executions and order routing; a look into the world of electronic trading we had never had access to. The light had finally been turned on.

We have a tremendous number of algorithms and data; and now we are able to more clearly use the data to help understand our process. I am now able to tell you information such as: in using 55 algorithmic strategies to execute about $20 billion in US capital, we sent out over 9 million child orders equaling around 21 billion shares with over 8 million child orders receiving no fills and the executed fill rate was 2.24% while the order multiplier was 20.37x.

We feel this level of transparency is critical in the electronic age and we feel it helps us manage our trading,

understand strategies and add value to the investment process. The questions we look to answer daily are, “What are the historically best venues, and best strategies and then how do we produce risk based alerts and risk based matrixes around this data that give us some indication of how to optimise our computer based executions?” For example, we have discovered algorithms that will work well in one environment, but not in another. Likewise, we have discovered algorithms that work well for a period of time and then their performance regularly will trail off. Some of our analysis has suggested a three month halflife for the algorithms we use. We have some examples where we have lowered the volatility of a trader’s blend of algorithms used while also improving their performance significantly. We like to refer to this phenomenon as creating a better “Algorithm Information Ratio.”

These value added adjustments are hard to capture without the proper technology. The goal is to transform and analyse all of this data that we were getting through event processing, and we are now well on the way to meeting this goal.

The benchmarks Lastly, for years we have put significant effort into trade cost analysis in hopes we could create

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thus should create a more objective measure of performance for the trader and the trading process.

metrics, insight and accountability into our process and across each desk and every trader. We have always believed it is impossible to manage what you can’t measure.

Furthermore, to accept the notion that benchmarks and metrics were unattainable for buy-side traders was equally unacceptable to us. We have been working with multiple TCA vendors since my tenure began at Franklin Templeton (17 years ago) and have tried to establish metrics which we feel align with our investment process.

We also hoped this analysis could become industry standard in order to give all traders the ability to be measured and recognised for their work with a better understanding of their performance and attribution to the investment process. I believe this is still a work in process for our industry. We needed our analysis to handle complex data sets that could be used on a daily and intraday basis and then ensure the results are driving strategy and behavioral changes.

We have used participation weighted price for almost 15 years. When we first started using it we called it the ‘value added benchmark’, but it was always a Participation Weighted Price calculation. We wanted a benchmark to align with the portfolio manager’s strategies and

beliefs around their short-term alpha. We also wanted to allow for the traders to have some way to voice their short-term investment opinions and be able to measure these opinions. Of course, this requires mutual understanding and collaboration to incorporate the PM’s beliefs about short-term alpha and beta. Another challenge is that this requires a relearning

When we started collecting the specific data around our computerbased trading/algorithm strategies, we had to develop a way to evaluate this data. This was done by taking several benchmarks such as PWP, IS and post-trade price reversions and creating an index.

Once we were able to analyse our strategies, we put pro-active trading tools in place which allowed the traders to select the optimal back-tested strategies to use in their daily trading. Our efforts in TCA were really to measure our historical participation and execution performance within these exchanges and dark pools in order to dynamically change our strategies and capture opportunities.

This leads us back to the integration and collaboration conversation we continuously engage in with the managers. Do they know what you’re trying to accomplish and vice versa? In an ideal environment,

“In an ideal environment, there should not be a whole lot of surprise around execution outcomes: here at Franklin Templeton, we like to say a best execution is a predictable execution.” of the traditional investment approach by portfolio managers and analysts, but I do believe it is worth the effort. Because there are many times when short-term alpha, liquidity or the market are not the PM’s focus or expertise, it makes sense to push this piece of the alpha triangle to the trader’s level. If tracked and measured properly this should allow the trader and PM to understand the trader’s performance value add to the decision process over time and

there should not be much surprise around execution outcomes: here at Franklin Templeton, we like to say a best execution is a predictable execution. Once we have a conversation with a portfolio manager and the trader takes on the short-term alpha decision and the accountability for that trade, we want to know that those decisions clearly tie back to the original conversations with the portfolio manager. We want to know there is a clear understanding Published in Q4 • 2013 | GLOBALTRADING

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that the trader‘s job is to maximise the short-term alpha horizon and the PM has confidence this is being achieved and measured.

Ultimately, our goal is to have a 50 person global trading team that is constantly relearning, rethinking, evolving, and adapting to what is happening in the marketplace.

We want to stress the importance of adapting to technological changes and proactively molding our own behavior as the world around us changes.

The future There always has been and always will be more to accomplish as we

aim to further integrate ourselves into the investment process with research and portfolio management.

Buy-side trading, if structured and staffed properly, is generally underutilised and unrecognised for its potential value. We don’t want to push too far into those distinct areas of investment expertise that delineates the differences between analyst, PM and trader; however a certain level of integration and collaboration is prudent. A properly skilled trading desk knows liquidity, market structure, trading dynamics, market information and should assume his/her role in the value triangle. There is a higher skill level to be achieved and there

is an opportunity to think more broadly about maximising all of your resources. The investment process has to, by default, follow the path from research to portfolio management to implementation.

I am convinced that there are opportunities for alpha in this area.

Overlooking or misunderstanding the potential alpha opportunity that a strong trading team can capture is a direct cost to clients’ portfolios.

Automating the desk In today’s high-speed electronic markets, the role of the trader is only becoming more challenging.

After all, it’s the trader who is ultimately responsible for the overall trade lifecycle; analysing market conditions, selecting the best strategy for a particular order, monitoring the speed and quality of the executions as they come in, and making appropriate adjustments as conditions change throughout the day. Unfortunately, strategy selection and optimization still remain largely a manual process with traditional execution management systems.

The more orders a trader has to handle, the more difficult it becomes to effectively monitor the factors impacting each one. Factor in the sheer variety of algorithmic strategies made available by the sell-side and the high degree of configurability that allows them to be tailored to so many different market conditions, and it’s easy to see how a trader can become overwhelmed. What’s really required today is a new type of thinking EMS that can bring measurable efficiencies and workflow automation to the trading desk,

Published in GLOBALTRADING | Q4 • 2013

using artificial intelligence to give traders and portfolio managers the highest level of real-time color and TCA on their orders.

Following conversations with our clients, it’s become apparent that significant value can be delivered by intelligently automating this process.

Over time, it seems clear that the buy-side is going to start moving out of their traditional comfort zone in terms of the way they manage their algorithmic executions, because it’s becoming increasingly apparent that real money is being left on the table every month through non-optimal strategy selection. Adopting tools and technologies to automate and optimise this process is a trend which has already started and which is poised to grow steadily in the years to come.

As a result, we’ve spent the past few years working to develop a solution that uses quantitative predictive analytics to optimise algorithm selection and monitoring. At its core is a 45-factor model that diagnoses a trade at inception and generates an execution profile. As the day progresses, the model is constantly re-factored against the

Damian Bierman, Head of Asia-Pacific Operations, Portware initial hypothesis and adjustments are made automatically to maximise alpha capture while minimising impact costs, adverse selection, information leakage and the impact of high-frequency trading.

A key facet to the technology is its transparency; we allow the user to see the decision-making process and the factors driving the decision for any trade at any given point in time. In this sense, it acts as a decision support tool for the trader. It gives them information and color on the key factors impacting the execution of their trades in real time, providing them the confidence and support they need to ensure their selections are appropriate.

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Dexia Asset Management On Multi-Asset Convergence

Fabien Orève, Global Head of Trading at Dexia Asset Management examines the changing strategy of multi-asset trading. is driven by two things. First is technology, second is regulation.

Technology First of all is obviously the growing presence of electronic trading.

Beyond equities, electronic trading is very important in foreignexchange and now, in bonds.

Fabien Orève, Global Head of Trading, Dexia Asset Management The main divergence today between the main large asset classes, equities on one side, bonds and foreign exchange on the other side, is about market structure, OTC and its implications for trading.

OTC is today, in Europe, around 25% of equity trading, but if you look at bond trading, it is mainly bilateral.

Trading fixed income depends on the willingness and ability of market maker or counterparty to make a market in particular instruments and commit capital.

In equities today investors can interact with a much wider range of liquidity pools and market participants than in bonds.

However, I think much more importantly there is an ongoing slow process of convergence emerging amongst the different asset classes, and I believe this convergence

Smart order routing and algorithmic trading in European equities have significantly increased since MiFID. Many investors now split their orders, and splitting an order has become the main way to trade intraday. Either you do it yourselves from your desk or you trade it with the partnership of a high-touch desk.

If you look at the derivatives side, we trade lots of listed futures at Dexia Asset Management and we are now thinking about putting

improved their pricing technology, all of these dynamic pricing algos that tighten bid-offer spreads, but mostly for the liquid instruments.

For the liquid instruments, execution costs are low today. In core Eurozone sovereign bonds, we can execute at a very cheap level now because it’s highly competitive, and we are able to detect the basis points of cost.

I can make similar comments in foreign exchange for the G10 currencies. All of the algo trading now used by banks helps tighten spreads gives faster quotes and it is much easier than before to trade.

In addition to ECNs in foreign exchange, there are now algorithmic tools that are available for us. We are not using them yet, but we’re thinking about using algo tools for

“There has been massive growth in electronic enquiries to ECNs or multi-dealer trading platforms in fixed income products.” all of the small size orders into algorithms. It’s basically another aspect that is automating.

clients who would like us to trade new order types, like limit orders, which are quite new in FX.

If you look at the OTC markets, they have embraced technology as well.

There has been massive growth in electronic enquiries to ECNs or multi-dealer trading platforms in fixed income products. We’ve seen that for the small to medium size orders over the last few years.

Another thing is market makers.

Many large banks we work with have

Foreign exchange used to be seen primarily as a hedge. Now we’re seeing that some portfolio managers invested in bonds think about Forex strategies to get more exposure on trading ideas and to generate alpha for their portfolios.

Regulation The second area that is really driving the convergence, I believe, is the Published in Q4 • 2013 | GLOBALTRADING

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new capital and leverage rules. All of these new regulatory models that are coming mean that banks and our counterparties have less capacity to carry inventory. This is a significant issue in bonds, but it’s true for equities as well and may alter our capacity to trade on principal.

Adapting In equities we have recently traded fewer blocks of full size orders. That means we are more likely to fill partially an order with a block then work the rest in a market. In bonds, we’re seeing the emergence of equitylike solutions, such as multilateral trading facilities (MTFs) that could help us trade more instruments.

The point is with the new MTFs in the bond space, traders have a very low chance to get fills for the full size of an order at the desired price; and that’s a problem. But, looking broadly at this situation, we may consider a strategy where we could find a cross

enough tier one counterparties in equities, bonds, listed futures and foreign exchange to help us build long term relationships with them.

This relationship aspect is only one thing though. As a firm we also have to adapt to the new paradigm. In this context, our portfolio managers and traders have reacted in different ways to the changing trading environment.

go, so we have to focus our efforts on trading immediately; to try to find liquidity for the full size of the order.

PM’s adaptation I’ve seen my PMs using more derivatives to hedge positions, especially in bonds, which is one way to react to some liquidity problems. We’ve seen some of our teams on the investment side focus on the liquidity of their portfolio, and as a result they try to select instruments that they know will not cause trouble if there is a sharp movement in the market.

In bonds the traditional model we use is a Request For Quote (RFQ) which means you get the order done at a price for the full size. Today, some of the PMs in bonds are happy to trade a portion of the order at one price and then to have a dialogue with traders for the order balance.

Finally is an increasing use of Transaction Cost Analysis (TCA).

All of these tools that we use to measure transaction costs are used to improve performance and improve our knowledge of clients. TCA has been much debated in equities, now is getting more momentum in fixed income and foreign exchange.

All of these asset classes are now converging with equities in terms of post-trade analysis.

I’ve seen other clients making their trades smaller. Also our PMs are

“As an asset manager, we have a responsibility to ensure that our relationship is very good. We have to concentrate volumes on fewer counterparties. ” for a part of our order in an MTF, and then we can get the order balance executed or facilitated by a dealer.

This is clearly something that gets closer to the way we trade equities.

Being on the right side of the banks To continue on that theme, with the risk of not getting as much liquidity from banks that we are used to, especially in bonds, we have to stay high on the bank’s client list. As an asset manager, we have a responsibility to ensure that our relationship is very good.

We have to concentrate volumes on fewer counterparties.

We also have to make sure that our tier one list of brokers is spread throughout the various asset classes.

Today it’s important that we have Published in GLOBALTRADING | Q4 • 2013

trying to improve communication with traders, and this goes straight into their instruction.

Traders We have strengthened our multiasset model, as now we are trading equities, bonds, foreignexchange and listed futures on one single desk. That’s one thing.

Second, maybe a more interesting aspect of our capacity to react is that we have adapted our trading tactics. For example, we have tried talking to our PMs, to identify those who are of high conviction on a market and others that have a bit less conviction. For people who have high conviction, they have a very short view on the market and a strong idea of where the markets will

But we have also identified clients that have a longer view on the market and they’re happy to leave us more flexibility, to work on their orders carefully. The effort of traders to understand clients’ needs is an answer to our new constraints.

New tools I faced a difficult situation recently while looking at my TCA reports. They showed a very small percentage of our European credit volume in a new MTF. I was surprised by the low number so I was trying to analyse the situation.

One of the reasons for our difficulty is simply technology. The tools we use today are not adapted to getting an efficient completion in this MTF. For example, if I want to be an aggressive liquidity taker in a market in bonds, if I have a one million nominal trade in a particular instrument and I’m seeing a firm offer on a trading platform coming from an MTF, but this offer is only for 300,000 Euros, I will not be able to lift that 300,000 and then manage the rest another way. That’s a problem. A further issue today is we cannot get full visibility of the MTF order book in our system, we have to

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either manually connect to a web site or rely on the broker’s team behind the MTF front-end over the phone.

This market has not been organised to fit the way we should work orders.

It’s an OTC market, so it’s organised around OTC. OTC trading is crucial in fixed-income as there are many more instruments than in equities and we absolutely need marketmakers in bonds. However, in certain circumstances, we need more flexibility in the secondary market and the current tools in the market today are not completely available to help buy-side trading desks navigate between MTFs and OTC efficiently.

I’ve been working with my IT team to find a way to split our order and lift or hit a bid-offer in the market for a portion of an order, and then to manage the rest with a market maker.

There are still many things to develop in OMS-EMS technology today to fit this new paradigm that is emerging in bonds. You may argue that I can pickup my phone and leave a full-size

order with a broker or a maket maker and let them work the order. But I have to gain flexibility and add new bond tools, because there’s no way I will trade everything over the phone.

Now, we want to keep STP working very efficiently from equities to fixed income – cash & derivatives – and foreign exchange.

OMS-EMS technology I’ve seen a lot of innovation and sophistication in the functionalities that are now available to the buyside. For example, we have a decent range of tools to manage equities, but I think third party vendors or probably the industry as a whole are focused too much on this asset class where the available tools are very mature.

asset classes. We have to work more on developing foreign exchange, especially our capacity to improve our transaction transparency in this asset class, and to get some important functionality in bonds that we don’t have today, instead of getting more sophisticated in equities. We have also to focus our system on its main functionalities to minimise the risk of big IT bugs. If your OMS crashes half an hour prior to the closing time it is a big problem.

It’s a matter of balance. You have to balance your technology across asset classes and not to allocate your full resources to cash equities at the expense of bonds, foreign exchange and derivatives.

I have many requests from my traders to get specific algos on our desk or particular direct access to electronic crossing networks etc. I try to limit this because I think we should get more things done in other

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The Buy-Side’s Role In The MiFID II Reform Approval Process Gianluca Minieri, Global Head of Trading at Pioneer Investments examines reform in Europe and what the buy-side need.

The role of policy makers and regulators when dealing with financial markets should, in theory, be that of opposing speculation and short-term strategies and favouring long-term investments in the economy. They have the objective of creating a financial system that eventually serves the needs of those ultimately supplying or consuming capital, the real economy and the society as a whole.

It was with this principle in mind that MiFID I was introduced in 2007. The overarching objective of the original text was to lay down Published in GLOBALTRADING | Q4 • 2013

the foundation for a comprehensive, single regulatory framework capable of opening up European financial markets while ensuring significant levels of protection for end investors. The main belief on which MiFID I was based was that the European economy was getting insufficient funding from the financial markets and that one of the main factors was the high costs of transaction charged by trading venues. According to this theory, such high transaction costs were impeding the development of a secondary market, which, in turn, was detrimental to market liquidity.

Based on the above considerations, I think we make no mistake if we say that the main target of MiFID I was to bring down the cost of transactions for investors and secondly, to facilitate the creation of a large secondary market which could eventually enhance liquidity. The tool that was agreed to address these issues was to promote competition amongst trading venues.

Despite some success in increasing competition, MiFID I could not keep the pace with the rapid developments in financial

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markets, trading systems and execution technologies and soon started to generate a number of major side-effects.

Liquidity was certainly the main one. MiFID I failed in terms of enhancing the level of liquidity in lit markets and had instead a devastating effect on it. It has increased fragmentation of liquidity across more trading venues, which made it more difficult for the buy-side to understand where the liquidity is.

Where before there was a single provider of liquidity, now we see a proliferation of alternative venues, both lit and dark. Moreover, fragmentation of execution venues led to smaller transactions being traded with the aim of reducing market impact. Across all lit and dark venues, average trading sizes have reduced dramatically, roughly by two-thirds since its introduction. Now, because liquidity pools are smaller, the size at which the market is impacted went down as well, making it more difficult to execute large orders.

The concern to reduce market impact stimulated the use of

The review of MiFID I was therefore an opportunity. An opportunity to learn from the mistakes and, counter-effects brought by MiFID I and restore truth in Europe’s financial markets by encouraging a fair price formation process and efficient capital allocation.

Usually the normal approach in a legislation review provides for an open debate with all stakeholders, which in turn provides policymakers with comments, feedback, analysis, evidence and argument through lobbying. This was not the case in the current regulation reform approval process that soon become highly politicised and where many member countries and MEPs often took a philosophical approach on certain topics. Trading too much is always bad while transparency is always good.

Competition is always good while dark trading is always bad.

As a buy-side community, we have tried to be as proactive as possible along this process. We have made many trips to Brussels to meet legislators and policy-makers. We have presented analysis, studies and data. During these meeting, attended also by many buy-side

“The introduction of a single consolidated tape in Europe is of paramount importance to deliver best execution to our clients and enhance the level of transparency in the price formation process...” algo trading specialising in slice and dice strategies. But because structured algos trade in a predictable fashion, it became easy for some High Frequency Trading (HFT) firms to create predatory strategies that watch for these footprints. Hence, instead of minimising market impact, MiFID I led to a growth of HFT, which constantly monitors orders seeking to take short term advantages by scalping them.

firms, we have realised how little we, as buy-side, were conflicted on most issues. Our shared concern was to ensure that we do not lose the capacity to invest money efficiently for our clients. With this in mind, the key message that we brought to European regulators was that we all wanted to keep the interests of long-term investors at the centre of the discussion. Three topics have in particular been highlighted as our main concerns.

Gianluca Minieri, Global Head of Trading, Pioneer Investments First concern: fast tracking introduction of a European consolidated tape (CT) We think that the fragmentation introduced by MiFID I will not be resolved by the MiFID II proposal.

On the contrary, we think that MiFID II will introduce further fragmentation. The introduction of a single consolidated tape in Europe is of paramount importance to deliver best execution to our clients and enhance the level of transparency in the price formation process and we are frustrated to realise that after so many talks this topic fell again into the background.

Best execution today is difficult to monitor because of the lack of good quality post trade data.

The current text proposed is too vague and weak to succeed. In our view, any solution is good as far as it is mandated, reasonably priced and potential conflict of interests are properly addressed. Conflicts of interest will arise in any case where a CT provider is also a market maker or operates trading venues. CT providers will in fact have privileged access to trading data. Hence, it is of critical importance that they are unquestionably perceived to be impartial, otherwise no market operators will allow them to get access to such information.

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Second concern: Maintaining the use of the “reference price waiver” Waivers are a legitimate way for large investors like us to manage their trades without undue disadvantages. Before imposing any arbitrary volume limits, regulators should find a mechanism to monitor markets, gather data and better assess the dynamic of the price formation process. In our

Third concern: Ensuring the new OTF category is meaningful for investors, by allowing the use of Matched Principal Several analyses show that the cost of trading on the primary exchanges can be more expensive than on dark pools, mainly because in the dark you are not paying the spreads.

Moreover, market impact can be significantly lower versus trading

“When we trade in the dark, we feel our investors are better protected. We have also explained that we rely on Matched Principal Trading to provide anonymity to our clients’ orders and to ensure that we do not trade with an unwanted or unregulated counterparty. ” view, a single consolidated tape would provide such mechanism because it would allow assessing the volume of trading that flows through the waiver.

Instead of imposing more restrictions, regulators should therefore make it easier for all types of trading data to get included onto consolidated tapes and enable them to become part of the price formation process.

Until we have a genuine consolidated tape and investors are adequately protected in terms of good quality market information, we will need the protection offered by the reference price waiver. Long term value investors, in fact, are concerned that orders of their clients will be unduly exposed to those market players whose principal activity is to exploit short term movements in markets, resulting in a permanent transfer of value from long term investors to short term liquidity providers. That’s why I also believe that RPW should be allowed for trading on OTFs. Published in GLOBALTRADING | Q4 • 2013

in lit market, enabling trades to be carried out in large sizes. Large asset managers represent the interest of a wide variety of clients, hence they want to build their positions in blocks and with the appropriate level of confidentiality to protect investors. If a large trade is spotted entering the market, our orders might be subject to abuse by HFT firms. We definitely don’t want to deal with these firms that are making it fundamentally more difficult for institutional long-term investors to find liquidity at fair prices. When we trade in the dark, we feel our investors are better protected. We have also explained that we rely on Matched Principal Trading to provide anonymity to our clients’ orders and to ensure that we do not trade with an unwanted or unregulated counterparty.

Without Matched Principal, the OTF category would be of no use to us and to our investors for any asset class. We have also highlighted that OTFs should be used for all asset classes, including equities. We understand that excluding equities from OTFs is a move designed to

push more equity trading back onto stock exchanges, but our concern is that the latter might suppress rather than encouraging liquidity.

Prohibiting interacting with existing client orders in its own OTF will worsen quality execution especially for less liquid instruments. In our view, deployment of own capital should be allowed where the client has consented to it and any conflict of interest should be addressed at regulation level.

With the trilogue under way, negotiations are now in their final stage. However, considering how long the same process took for other directives to conclude, there might be still a long way to go before the legislation becomes law. With this in mind, we hope that policymakers will give buy-side firms more chances to have their voices heard. It is imperative that this time policy makers take the time to understand how financial markets will be affected by their decision.

In our view, the difficulty remains that the legislators’ approach is too concentrated in seeking a one-sizefits-all approach to a wide range of issues with different characteristics.

My concern is that, once again, such approach might lead to unintended consequences for financial markets at the expenses of end investors and long-term savers, exactly those that the policy makers intended to protect in the first place.

Disclaimer This article was prepared by Gianluca Minieri in his personal capacity. The opinions expressed in this article are the author’s own and do not reflect necessarily the views of Pioneer Investments or others in the Pioneer Investments organisation.

Eye On the Buy-Side | 13

The Changing Desk Joe Kassel, Head of Global Equities Dealing and Exposure Management, AMP Capital.

There have been significant developments to trading platforms in the last five years or so. Prior to that most internal systems were developed inhouse; then five or six years ago there was a major project across the organisation to review the range of platforms that we were using from an equity investment management point of view (and across other asset classes) and the decision was made to purchase the Charles River investment management system. Since then the system has continued to evolve (we are now on version 9.1.4) as has our usage of it. It is still front and centre for mandate compliance but is also now pretty closely embedded across portfolio managers and we are increasingly using it for EMS purposes as well.

Since the decision was taken to use Charles River, the business has continued to globalise.

We now have a global trading presence in Chicago for our Global REITs and Global Listed Infrastructure funds as well as investment teams in Hong Kong for our dedicated Asian funds as well as London. That said, we also use ITG’s Triton as our EMS for our Asia-Pac trading and are looking at EMSX for our global trading for pre-trade analytics and market monitoring.

Vendor engagement Certainly we are very conscious of trying not to proliferate vendors. There was a mini explosion in the early 2000s where it was not unusual to have

Joe Kassel, Head of Global Equities Dealing and Exposure Management, AMP Capital

Published in Q3 • 2013 | GLOBALTRADING

14 | Eye On the Buy-Side

three, four, five or even six EMSs on a single trading desk. Since then we’ve evolved, some of the EMSs have gone and we’re very conscious of picking and sticking a little bit more. And so, the Triton application we use was a considered choice and something that’s working quite well for us in the Asia-Pacific region. We’re also conscious of trying not to proliferate FIX connections out of multiple systems and I know that’s probably appreciated by our counterparties too. On the electronic side, coverage is now global and by far the majority of the flow is via electronic trading rather than using more traditional methods.

We are still building out our electronic trading strategies and technologies. We have made a concerted effort to push into that space over the last twelve months. Currently we have pretty much full access to the entire suite of broker algos with our top half dozen global counterparties and in that time frame we’ve gone from effectively zero low touch to about 10%-15% of our total execution now being electronic or self-directed in some way at the moment.

PMs involvement in trade orders It is changing, but it’s changing not so much in terms of getting involved, but actually PM’s getting less involved. If you look at the Australian experience but in a global context, Australia would probably be described as a relationship market more so than the larger markets (particularly UK, Europe and the US). But the sell-side and buy-side are evolving here just as they have in the offshore markets, and the tools that are standard on a global trading desk offshore are now the same as those we enjoy here on the buy-side and the sell-side. Our ability to measure and monitor trading is a lot more quantitative now than it was and that’s pretty much Published in GLOBALTRADING | Q3 • 2013

been the key in evolving trading decisions and trading infrastructure.

Changes in application of TCA metrics We‘ve made this very much a priority over the course of the last two years. We now have a strategic partner in ITG to conduct our TCA for us. And I guess what’s changing is how we actually use that analysis in a practical sense both on the trading desks and also within the investment teams. We have come from a relative standing start in terms of having that deep level of analysis of every single trade and now having trade reporting daily proves invaluable not just to traders but to portfolio managers as well.

Data and workflow management The range of benchmarks that portfolio managers and our clients are interested in looking at has

relevant and — though a much maligned benchmark — is still a good pointer to the optimal times of the day to be trading.

Dark pools debate and the fragmentation in Australia and the HFT conversations in light of ASIC regulation It is interesting and pleasing that ASIC see themselves as thought leaders in this space in terms of appropriate regulation of HFT and dark pools. I think ASIC are asking the right questions and trying to address genuine concerns and perceptions of misbehaviour in a productive and consultative way. Recent statements suggest that they are also reasonably pragmatic in some of their findings in particular with some of the fees they’re looking at, minimum resting times and minimum size in dark pools, etc. They are quite willing to rely upon evidence rather than

“Our ability to measure and monitor trading is a lot more quantitative now than it was and that’s pretty much been the key in evolving trading decisions and trading infrastructure.” definitely been evolving and converging to the implementation shortfall benchmark which we view as the real cost of trading.

From a data and workflow management point of view this can sometimes pose a challenge to properly capture the unrealised costs when an order is cancelled before it is fully executed or conversely when an order is cancelled and re-instated shortly afterwards. We have made good progress, working with ITG to properly link orders to reflect the real implementation shortfall in these circumstances. As large investors, especially in our home market, VWAP is also still

making a statement of intent and they seem happy to continue to play a look-and-see role.

I think other initiatives have been good too in terms of kill switches to maintain orderly markets and — more recently — mandatory price improvement for trading in the dark. I think it will be interesting to see how these play out in terms of overall participation in dark pools but I think the general intentions are good.

I do find an increasing amount of my time is spent on global regulation. We do try to adhere to the highest global benchmark

Eye On the Buy-Side | 15

when it comes to actual specifics of what’s permissible and best practice in individual markets; it’s the responsibility of our respective trading desks to make sure that happens. I am pleased to see ASIC taking a leadership role globally and would point to ASIC’s Greg Medcraft becoming Chair of IOSCO as an example. It is in everyone’s interest that regulators talk to each other and seek to standardise their procedures.

Lessons to be learnt from equities I do think that the electronification of the equities markets and the ability to gather and analyse data has made a genuine difference to our knowledge and understanding.

What we know now about the costs of trading and the real cost to a portfolio of trading activity, both before, during and after trade, is streets ahead of what we knew a decade ago. We are now moving forward very quickly in terms of, say, futures markets because we can capture prices and we don’t have the issue of fragmentation in those markets, so we can get a pretty reliable consolidated tape to conduct the same analysis.

And in FX markets we are closer to being able to capture big data in a more accurate manner and if that pushes forward into the fixed income space, there will be much to learn in terms of the real costs of our activities. This will all have a bearing on investment decisions.

Evolution of the client Yes, very much so and I think particularly we are near the end of that period where they have feared HFT — “who are they”, “what are they doing” etc? There is now a better understanding of who they are, what they do, how they operate in a way that there never used to be. And, similarly, dark liquidity carried with it this connotation of evil but the understanding now is that actually it’s a place to trade and what might be of more concern is what goes on at that place rather than the venue itself.

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,

Murrough O’Brien, Head of Australia & NZ Electronic Execution, Citi 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.

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16 | Eye On the Buy-Side

Change is the new normal

By Ben Jefferys, Head of Trading Solutions, IRESS. carefully so that sell-side brokers have the ability to test, release and ultimately incorporate it into their day-to-day operations. Brokers can become saturated with change and the cost to deploy new software into production can be high. This teamed with scarce or limited test resources means that decent innovation can unfortunately go by the wayside.

The priority for brokers is always meeting regulatory requirements, anything else comes second.

Ben Jefferys, Head of Trading Solutions, IRESS Constant change is the new normal these days for sell side brokers not only in Australia but also across the rest of the world. Regulation is the main driver of this constant change, followed by competitiveness and an overall quest to reduce costs and introduce efficiencies where possible. In 2013 trading volumes still remain subdued even though there have been noticeably good volume for days even weeks seen earlier in the year. The positive in this is that the sell-side is focussing on the order flow that they have, making sure it gets the best possible result for their clients and are keen to do so in the most efficient manner.

Thankfully the barrage of change due to the competitiveness between the exchanges has become less intense. The regulator, ASIC, has helped to control some of this by trying to have exchanges release innovation based changes on a biannual basis. This almost routine release of innovation by exchanges has had to be balanced

Published in GLOBALTRADING | Q3 • 2013

Some of the recent regulatory changes have had a significant impact on trading in Australia.

Perhaps not strictly in terms of the amounts traded, but certainly when it comes to how and where. One of the objectives that saw changes to the Market Integrity Rules (MIRs) was to limit small orders at either the bid or offer price being crossed

Chi-X order books. It would seem that the ASX, where the bulk of passive orders sit, would be the main beneficiary for now as prior to the rule change operators of dark pools and crossing systems could execute both orders via an NBBO crossing at a cheaper combined rate. Orders are now trading separately on the market where brokers must pay the full buy and sell transaction fees instead of a slightly cheaper combined fee for a crossing.

Another of the changes that has been more positively accepted by sell-side brokers is where ASIC have relaxed the requirements for reporting large block sized special crossings by introducing a tiered structure where smaller stocks have a smaller minimum block size requirement. As these crossings

“This almost routine release of innovation by exchanges has had to be balanced carefully so that sell-side brokers have the ability to test, release and ultimately incorporate it into their day-to-day operations. “ off the market by dark pools and crossing systems. Crossings within the spread or rather the National Best Bid Offer (NBBO) are still permitted as long as they offer a meaningful price improvement.

This has in effect removed the far majority of these types of NBBO crossings and instead the orders must route through to the exchange to trade with the existing lit liquidity on either the ASX TradeMatch or

don’t share the restrictions of their NBBO siblings we are seeing dark pools being adapted to cater for the change. Overall the changes bring Australia more in line with its overseas peers which is especially positive when attracting order flow from offshore.

Regulation aside there has been little time left for brokers to innovate by way of introducing new technology. The exchanges

Eye On the Buy-Side | 17

have new products available for faster trading that use ITCH and OUCH protocols, but for the most part brokers still rely on the older and slower products because the new versions are not quite rich enough in terms of the available data to be fully replaced.

above from the exchanges. Others look to fine tune their smart order routers by normalising the arrival times when spraying an order across exchanges. This reduces the window of opportunity to be beaten by an HFT strategy and for the most part is rather effective.

For those that do or rather can take such products, their focus is likely being as fast as possible to react to market movements and subsequently trade whilst for others it will be about minimising the disruption to their existing order flow from latency arbitrage or rather the dreaded High Frequency Trading (HFT) strategies.

Whatever you want to call it, HFT, gaming or information leakage, there has been a noticeable rise in this type of activity over recent months. Some brokers are able to combat the issue by taking the newer products as mentioned

The last area of change that we see is where brokers are reviewing their infrastructure for a number of reasons. First of all is cost, all brokers are under pressure to cut costs in this environment. Add to this the geographical issues associated with using a smart order router and gaming, and brokers have compelling reasons to look at how and where they host their trading systems. Centralising infrastructure to save money, deliver better trading performance whilst at the same time offering a more complete disaster recovery setup seems to be a good result all round.

Looking towards the future we expect to see more of the same.

Globally, regulators are still working out how best to deal with dark liquidity and HFT. Thankfully the approach in Australia has been well balanced and measured ensuring that brokers have enough time to react and adapt.

The pressure to drive down costs and increase efficiency will continue. At least by ensuring that brokers are compliant with regulatory changes also means that from a technology point they are up-to-date and aren’t left behind giving everyone the best possible chance at survival in a tough and changing market.

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18 | Eye On the Buy-Side

The Buy-side :

Transforming FX Through TCA Richard Coulstock, Head of Dealing, Eastspring Investments Singapore.

Have you been using TCA for equities and how are you developing that into other asset classes, and specifically, FX? We began our equity TCA project about seven years ago, so we’ve been working at it for a while. It has been in place for two or three years now without much in the way of further adjustment, so it’s almost running on a care and maintenance basis.

We have subsequently been asked by clients, senior management, audit and compliance, “OK, you’ve done this on the equity side, why don’t you try and replicate it into the non-equity asset classes?” and “how do you monitor custodial FX and your FX processes in general?”

One of the outside influences for our looking at foreign exchange

If you think about equity markets, everything’s pretty transparent. You have the exchanges which provide price and volume information and everything is time stamped, and if you do your equity trades through an order management system, you can do a like-for-like comparison at any point in time and get an idea of performance against whichever benchmark you like. In the foreign exchange world, we don’t have the benefit of equivalent transparency and it is far harder to do efficient comparative measurements.

Generally speaking, foreign exchange has always been seen by long only asset managers as a bit of a nuisance, but something that has to be done. We have been trying to work through that and to

“We have been trying to work through that and to change our thinking about FX, to give it the respect that an asset class deserves. I think that FX trading is generally inefficient because there’s been no measurement and there have been issues with custodial FX,...” were the court cases a couple of years ago in the United States into custodial FX transactions.

So there have been both internal and external forces that have worked on us to look into the non-equity side of things.

I believe it is far harder to do FX TCA than it is on the equity side.

Published in GLOBALTRADING | Q3 • 2013

change our thinking about FX, to give it the respect that an asset class deserves. I think that FX trading is generally inefficient because there’s been no measurement and there have been issues with custodial FX, and it’s imperative that we work towards getting this right.

Richard Coulstock, Head of Dealing, Eastspring Investments Singapore

I think there are huge savings to be made for every fund.

There were no external products available to buy that would do the measurements for us, so we began by asking our custodians and counterparties from the FX side to do some self-analysis.

In the beginning we didn’t know quite what we wanted and the counterparties didn’t know how to do the analysis that we were after.

But after a while we started receiving monthly and quarterly reports from each counterparty about FX trading — this meant that we had a process in place to measure and monitor FX that we could explain to regulators and to clients.

There is a psychological benefit to this, as soon as you tell someone

Eye On the Buy-Side | 19

that they’re being measured and that those results are being analysed, even if the results don’t tell you an awful lot, people do work a little bit harder and put a bit more care and effort into what they’re doing.

You also have to think about what benchmark you use in the FX world and also the fact that the benchmark might change depending on each individual funding you’re trading for. Our spot FX trades fall into three broad categories: • Currency trades in unrestricted currencies where you can trade with any counterparty you like.

• Trades in restricted currencies, where you go through a custodian, but you get interaction at the time of trade; a phone call, Bloomberg message etc.

• The third category is the most problematic; the custodial trades – where the asset manager only finds out what’s being done on a post-trade basis – so there’s very little transparency. You may just be given a rate and the trade date.

So that third category has been the main issue, but we will be looking at each of the three in our TCA project.

What concerns are there around data management issues?

There are data cleansing issues, in particular with custodial trades. If we only receive advice of those trades on a post-trade basis and they are keyed into our order management system, we have to be aware that timestamp data in the OMS will not relate directly to the execution time and date. For example, if we get a trade that the custodians executed on the first of the month and we enter it onto our system on the second of the month at 2pm, you have to be aware that the particular FX trade wasn’t actually made at 2pm, it was actually traded at some point on the first. So the issue of data cleansing requires a lot of work that will

take time and a coordinated effort between us and our counterparties.

So between FX and equities, how are you developing the benchmarks that you need in order to be able to do TCA and what are the significant structural differences between them?

I think it’s more complex in the FX world and I think that the benchmarks we use will vary depending on the fund for which we are trading. So for a custodial trade where all you know is the day you traded, then all you might need to look at is to ensure that they’re in the range of the high and low of the day or you might compare against the midpoint of that high and low and then look for trends over a period of time. If you are constantly,

attainable and measurable and they must be fair to everybody concerned.

I don’t want to come up with a measurement process that none of our counterparties are happy with, so we will engage with them to see what they think is realistic but also relevant in terms of improving FX executions for our clients.

How are you going to use the reports once you’ve developed them, once you’ve got the dataset?

I want to get to a position where I can share a monthly report that shows performance on a rolling 12-month basis, split by counterparties and split by currency pair with each FX counterparty. I want an idea of trends over time, who’s continually strong or weak in certain currencies, and then divert our trades according to

“... as soon as you tell someone that they’re being measured and that those results are being analysed, even if the results don’t tell you an awful lot, people do work a little bit harder and put a bit more care and effort into what they’re doing.” or 90% of the time, on the wrong side of that midpoint or heading toward the worst trade of the day, then that gives you an indication that perhaps the execution is not as good as it should be. But if we go back to the first category above, with a non-restrictive currency, we can trade whenever we like (and we will have clean time-stamped data), then we might start looking at TWAP or VWAP-type measurements as well as the range of the day.

We are not sure yet which is going to be the clearest and the most appropriate benchmark to use. But over the coming months, we will discuss this with both our provider and each of our counterparties.

Benchmarks must be realistic,

those results. We already do this on the equity side and it works well and hopefully, we can transfer this to the FX world too. It will take time to get to that stage because we need to build up a period of clean data.

How are your peers on the buy-side dealing with this?

One of the problems that I’ve had is that I’ve not been able to find an existing model from one of my peers to follow. I’ve made trips to the States and to Europe over the last 12 months and I can’t find any other asset manager with a sophisticated FX TCA project in place. So, to a certain extent, we are developing it as we go along! The only model I can follow is what we’ve done ourselves on the equity side. There have been Published in Q3 • 2013 | GLOBALTRADING

20 | Eye On the Buy-Side

FX TCA for peer analysis 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

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.

“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. ”

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.

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.

“They’re saying that they are placing us in a platinum tier, but are we in fact copper or bronze.”

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

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 outsourcing of execution to custodians, there’s a quick box to be made on producing some good quality TCA.

Published in GLOBALTRADING | Q3 • 2013

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.

Lee Sanders, Head of Foreign Exchange and Money Market Execution, Trading and Securities Financing Division, AXA Investment Managers

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

Where do we rank like for like on euro-dollar in 10 million at midday,” 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.

Eye On the Buy-Side | 21

a few problems in engaging with our counterparties as the feedback that we’ve had indicates that they don’t have other clients doing the same sort of thing, especially in Asia. It’s natural for people to get a bit suspicious about what you’re doing. One of the ways I’ve tried to get around that, particularly with our multi-asset counterparties, is to engage not just with the FX people I speak to, but to make the equity people aware of what we’re doing in the FX world. They can then talk internally and say for example, “Yes, Eastspring have been doing this equity product and it works.

We’re happy with it.” Within each counterparty I want a cross-asset relationship manager covering purely dealing and related issues.

We don’t want to use FX TCA as a stick to beat anybody up with. It’s more a case of helping each other to try and address any issues that we notice.

Some of the problems may be in our processes. It could be that we are trading our FX at the wrong time of day. For example, we may be trading in too big blocks and it might be better to spread out trades over a period of time.

So we need to find out where the problems are, engage with our counterparties to help us address those problems and we might also have to change the way we trade.

Seeing as you’re at the forefront of developing TCA for FX, have you had any particular difficulties finding solution providers to give you the data that you need?

On the back of the work that we’ve done in the equity TCA world, ITG took us on board about a year ago as part of a global beta testing team for their FX product. What ITG do to get around the problem of not having a transparent exchange, is to get price and volume information from most of the top ten global banks and also from three FX crossing networks.

From that information they construct the equivalent of an exchange to get around the transparency issue;

Developing quality benchmarks 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

James Cochrane, Director TCA for FX Product Manager, ITG 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.

Published in Q3 • 2013 | GLOBALTRADING

22 | Eye On the Buy-Side

you’ve got something to measure against at any point in time. But unlike an equity exchange with clear opening and closing times, where you know the period of time that you’re measuring against the period of time that’s available to trade, FX has almost a 24-hour market so what is your definition of a trading day? Is it from midnight to midnight? Is it a 24-hour period or is it the time that your dealers are actually in the office, say 8a.m. to 7p.m. That might also change on a fund-by-fund basis if some trades are done by custodians and the custodians are not even based in the region. They might have a totally different definition of what comprises their trading day. So there are a whole range of issues that come up in the FX world that are new challenges compared to our equity TCA experiences.

We need more detailed analysis in order to find out where the problems actually are. With our TCA provider, we have built a template of the reports that we want to share with each counterparty, almost replicating what we do on the equity side where we do produce monthly reports. You get quite a lot of granularity there.

We’ve been doing a lot of work over the last few months and we’ve started to engage with each of our FX counterparties to get their input.

I think it is also important to look at our internal processes. Are we handling our currency trades as efficiently as we could be? An example of this is the concept of measuring the quality of an FX price at a point in time. It may be more relevant to look at the timing of the trade itself in relation to the underlying asset that the FX trade is covering. For example, if I trade an asset at 9am but I don’t trade the FX until 5pm, there are several hours of currency risk in between, and that currency risk and the movement over that period could far outweigh four or five basis points at the time of trade. It’s therefore important that we look at timing issues as well.

One of the other challenges that seems obvious now, but at the time we didn’t really appreciate, is that if we trade in non-restricted currency, Published in GLOBALTRADING | Q3 • 2013

Standardising TCA terminology The FIX Trading Community TCA working group has attracted strong interest with representatives from more than 55 firms across the industry choosing to participate. The group commenced by creating a prioritised list of the key issues relating to TCA currently impacting the industry. At the very top of the list was the concern that inconsistency in TCA terminology and methodology used across providers was presenting market participants with many challenges.

Starting with this area, the group began by exploring the language currently being used across the industry and established a working group aimed at creating a consolidated glossary and associated best practices guide. The initial document is focused on Equity TCA across pre-trade, real-time, and post-trade analytics. Once complete, the next phase will begin which will provide support for non-equity asset classes. generally speaking, we get two or three competing quotes. So if I get three competing quotes and decide to deal with Bank A and three weeks later my analysis shows that that rate was no good, I can’t blame the counterparty because all they need to say is, “Well, I was the best rate in the market at the time you dealt.

You can’t come to me on a posttrade basis and say that rate was no good.” To get around that issue we will also be looking at win/loss ratios, i.e. how many times we asked a counterparty for a quote and how many times they won the trade.

Mike Caffi, VP and Manager of Global TCA Services, State Street Global Advisors

Mike Napper, Director and Head of Global Client Analytics Technology and EMEA Client Connectivity Technology, Credit Suisse We hope to get to a position where we can focus on counterparty strengths and weaknesses by individual currency pair and start to trade according to those results.

Eye On the Buy-Side | 23

Fixing Fixed

Income Adrian Fitzpatrick, Head of Desk, Central Dealing at Kames Capital expresses strong opinions on the current state of fixed income market structure.

Adrian Fitzpatrick, Head of Desk, Central Dealing, Kames Capital What is driving managers into equities?

A lot of it depends on which market you’re looking at. If you look at the European markets, there has always been a high weighting in bonds. There’s never really been the equity culture to the same degree as you have in the UK. Obviously in the UK a lot of it is driven by the insurance companies that have actuaries to dictate where the split between equities and bonds lies. Before these pensions’ time bombs, the safest investments for most people were bonds.

However, we are all working on the assumption that bonds are currently completely overvalued, but as long as there’s Quantitative Easing they are going to hold these abnormally low levels of yields.

The other thing is institutions don’t want to stand out from the crowd. If everyone’s in bonds and bonds fall then you are going to fall together.

There’s so much short term-ism in the market, you can’t afford to be an outlier for a long period of time and then not be right.

I think risk assets now are relatively cheap; you look at the yields on risk assets compared to the yields on government assets, some of the credit assets like high yield are still quite reasonable. The bond markets are over valued , but it’s probably not going to change until the QE bubble bursts.

So the macro economics is feeding into that bubble?

Yes definitely. It’s like we said about the dotcoms: Why are you buying things that are at that level? We all know if you go back historically and look at bond yields in the UK, they should be around 4½/5%. But at the current level, it’s only sustainable as long as the Bank of England and the government are prepared to keep rates abnormally low because of the state of the economy. So can we see that carrying on to 2013? Definitely.

(See diagram on next page) You’ve got the government printing money, so all you have to say is, “Where are you going to put your assets?” Unfortunately in the environment that we are in you just

can’t stand that far away from the crowd for a period of time.

What is the main problem with the fixed income market?

Effectively the market is not transparent, unlike the equity markets, which are. In equities you can see commissions, you can see the prices, you can see what gets printed. In the bond market you can’t. Platforms have been around for a long time, the likes of Tradeweb, Market Axess, and Bloomberg Tradebook, etc. These will keep gaining more traction because you can send them multiple requests for quotes and they are creating a virtual marketplace, which the regulators will like.

It’s not uncommon to send a trade down electronically to one of these platforms, and for all the banks to just pass; there’s no obligation to make a price or to make a marketplace. They make the price when it suits them. Personally, having traded multiple asset classes, that, to me, is not a marketplace.

Published in Q1 • 2013 | GLOBALTRADING

24 | Eye On the Buy-Side

However, the biggest institutions are very close to the banks; they can dictate when they want to trade.

For us as an institution, it becomes incredibly difficult not just sourcing liquidity, but being able to trade out liquidity when we need to, because you are totally at the behest of the investment banks. In equities you can trade by program, by algorithm, you can ask for a risk price. You may not like the price, but the market will always make you a price and you can decide whether you actually want to take it.

Source: www.gecodia.com/UK-Government-10Y-Yields_a1789.html

You end up working with the fund manager to try and find the other side of liquidity. It’s such a captive market that effectively sooner or later, there has to be some outlet valve that gives institutions the opportunity elsewhere. Obviously, when you look at equities you had the establishment of crossing networks many years ago, of which Liquidnet and E-Crossnet were forerunners.

Now what you are seeing on the bond

cross against it. So it needs to be a slightly different approach for bonds, just because it is a different discipline. You have different variables in bonds, the spread, which obviously a lot of fund managers work off, and you have the underlying Government bond.

The banks are going through what happened in equities. But equities aggregation is now the

“You’ve got the government printing money, so all you have to say, “Where are you going to put your assets?”

Unfortunately in the environment that we are in you just can’t stand that far away from the crowd for a period of time.” market, through Blackrock’s Aladdin and UBS PIN, are various other brokers trying to get that same result.

What they are trying to do is encourage the institutional investor to create more of an electronic market. The biggest problem is in equities you have, for example, Vodafone, but in corporate bonds you can have 12 credits for the one stock; therefore it’s very difficult to identify a specific one and find a natural Published in GLOBALTRADING | Q1 • 2013

key; tools have been created that aggregated across the different dark pools to allow you to send one order to many venues. I think that what is needed is an institutional crossing network similar to Liquidnet. We need to create competition away from the banks.

However, this isn’t necessarily all the bank’s fault because they say “we provide the risk and therefore we should be able to choose when we make prices.”

In bonds, a broker will send out what’s called an “axe”. The axe is effectively the bond equivalent of the IOI. You’ll phone to follow up on the axe but they can back out. There’s no obligation.

In government bonds, where the electronic systems are more established you can trade more effectively, and it is getting there, but the credit part of the market is just completely arbitrary.

Who is going to drive reform?

It will have to be driven by the regulators, in the UK by the Bank of England, and it has to be driven by institutions. The problem is institutions aren’t members of the market. Institutions don’t have the IT infrastructure or the IT spend to be able to create new platforms unless you are a Blackrock or a Pimco.

In the US they use TRACE, and we need a similar system as we need to establish ways for institutions to understand who is doing what, so you can target business to the broker or investment bank. And if not, there should be some form of platform that allows institutions to cross up against each other.

Is this something the regulator will look at?

I would say that they’ve done equities to death, but obviously we’ve got MiFID II and Basel III and all of these things happening.

I think they are realising that equities are pretty transparent.

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Eye On the Buy-Side | 25

If you look at the FX market, at fixed interest and you look at the P&L of any major investment bank, they do not make money in equities, they make all their money on fixed income and FX. Therefore the reward structure of banks is something you need to look at sooner or later.

I think that there is blurring at the edges across the different asset classes that is forcing change, which is why we are going to see transparency in OTC clearing due to Dodd-Frank. The regulators want to know who’s got the positions and therefore where the stresses in the system are.

Most regulators are driven by their governments. Effectively they are trying to force an unbundling of the equity marketplace, through the back door, because you can apply far more pressure to an institution than you can to a broker.

The nature of the bond market has to change from where it is. Sooner or later the regulators will realise that and they will try and create some form of exchange, which is what the platforms provide.

But the problem is that there is no obligation to make prices.

Because I trade multi-asset, I can see the strengths and weaknesses of different asset classes. I want a level playing field. In the bond markets it’s skewed towards investment bank that can pick and choose whether they choose to make a market or not, whether they want to honour their axes.

Some things like algos are far more difficult because there is no depth to the bond market, there is no centralised pot of liquidity that you can trade against.

A crossing network solution which gives another option for institutions would bring in spreads and potentially create additional liquidity as opposed to the investment bank, and if they start missing out on business I’m sure

they will be more competitive and they will want to get involved.

Do you think reform is going to be driven out of Europe and the UK or the US? The US is slowly getting there, because they’ve got TRACE so you can see what’s going on. In the European market we are less liquid and therefore it becomes more difficult.

There are some products that will aggregate trades across the different platforms starting to become more established which will help in providing depth to the bond markets.

It’s all about providing flexibility, depth and transparency to the market. If you can actually do that, then the regulators, governments, institutions are all happier. You can see what’s going on.

I think the problem is that a lot of these houses only trade bonds, and don’t realise that sooner or later regulation is going to change the market place that they are in.

What shouldn’t fixed income learn from equities?

Equities have gone full circle, whereby the end investor, who is effectively the man on the street, is totally disadvantaged. The exchanges now only care about the bottom line, which is their P&L, and they don’t care if this is from a high frequency trader or anyone

else, and the reason for that is institutions are not members of exchanges. We are so far down the hierarchy no one cares about us.

The example I always give to people; if you take Vodafone which was the most liquid stock in the UK prior to the Lehman crisis. As an institution I could trade 25 million shares on the touch. Now if I look at Vodafone, Vodafone’s touch price is barely 36,000 on one side and 65,000 on the other side. I’m sorry that is not a market that is helping the institutional long term investor.

How I could trade Vodafone before, and how I trade Vodafone now, I don’t care that it has a narrower spread, because it’s not about spread, it’s about depth to the market.

Equities are not profitable and the bond markets are hugely profitable but I suspect that regulators and Governments will not allow that to continue.

But the way it is just now; the bulge bracket equity model is broken. We are working on a 1970s model and in 2012 and it just doesn’t work.

Published in Q1 • 2013 | GLOBALTRADING

26 | Eye On the Buy-Side

Northern Trust On Futures Closing Auctions Northern Trust’s EMEA Head of Dealing Martin Ekers.

Published in GLOBALTRADING | Q3 • 2013

Eye On the Buy-Side | 27

Like a lot of passive index managers we use index futures to augment portfolio investment to avoid cash drag on portfolios etc. So when you’ve got an element of cash in any passive portfolio, you would typically have that invested in futures. Historically, there have not been opening and closing auctions, as we know them in equities, and I think it’s mainly an anomaly that’s never really come to the fore. There is a lot of activity around the open and the close in all the major equity index futures markets which would, I believe, be significantly helped by an official opening and closing auction algorithm that allowed people to enter orders, either at market or with limits and then everyone would be treated equitably and fairly. The answer to who might drive that to happen is the exchanges where these products are listed, all the well-known big venues.

The issue is that the ownership of those entities varies significantly.

that’s just the nature of the market and, although it can be a matter of a few seconds, obviously, between one order hitting the system and the other one hitting the system you just get a different result.

I think other buy-side firms have, to some extent, started to try and grapple with the problem about first of all, which benchmark point we should be targeting. Continuous trading in the UK for example, stops at 4:30 and then the auction is 4:30 to 4:35. Now, the official close, as far as the index providers are concerned, is 4:35. And yet, if you ask 50 people in the street, probably 30 would say the market shuts at half-past four, but actually it doesn’t. So, I’ve asked my futures executing brokers what the standard is and some of my peers target 4:30 and some target 4:35. The liquidity in the futures market is slightly better I think at 4:30 than 4:35. But our view was that we wouldn’t be targeting

Martin Ekers, Head of Dealing, Northern Trust what they’ve sold at and what price they’ve bought at. And if you’re an index arbitrager and, as that happens,

“There is a lot of activity around the open and the close in all the major equity index futures markets which would, I believe, be significantly helped by an official opening and closing auction algorithm...... ” But the incentive for them to introduce this process is not great.

The pressure for them to not vary comes from the makeup of those exchanges, because if you’re an exchange that’s predominantly owned by locals trading on their own behalf they’re very keen not to see closing auctions come in because it’s a very important source of revenue for the day traders who put bids and offers in the marketplace and try to capture the spread.

These are exchange listed and traded equity index futures. They’re not OTC derivatives. These are pretty vanilla instruments. If I have the same contract out with different brokers for the same benchmark, I frequently get different prices and

4:30 and having five minutes of risk because our benchmark is 4:35.

And on the developed European markets now, maybe 20 percent or so of the whole day’s volume is done within the closing auction in equities and yet that is probably the highest risk point for an index arbitrager because the index future can move so quickly either side of that very definitive point after the closing auction price has been decided, determined and distributed. So if you think most markets, whether it is the UK market, German market, French market, etc., have a five-minute period of orders building into the system for the closing auction calculations to be made. And then, in an instant, those prices are distributed and people know

the index future suddenly moves, or all the equities moved because of somebody putting a big order in just before the close of the auction, then your calculations can be very seriously adrift. So maybe if there was a futures closing auction coinciding with the equity closing auction, it would be a very simple case of calculating the mass and putting your orders in contingent one against the other.

Published in Q3 • 2013 | GLOBALTRADING

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