Comprehensive TCA: A sudden awakening for CIOs
Back- and mid-office environments have seldom been seen as the most exciting of arenas for investment institutions, but one transaction services chief predicts they will become central to discussions of trading efficiency over the coming years - with far-reaching consequences.
Endre Markos, Asia-Pacific regional head of the execution to custody team at Citi Securities and Fund Services, claims to be no stranger to holding counterintuitive views, but he believes his views on trading costs will eventually become mainstream. "Everybody is chasing TCA (transaction cost analysis), and the only thing I'm challenging is that it needs to take into account the entire lifecycle of the trade," says Markos.
Transaction cost analysis "introduced awareness and optimisation to the execution side of the business, but fell short of a comprehensive view of what it truly costs to complete a transaction", he says noting that this is particularly true in low-volume environments in emerging markets. He notes that the trend until now has been to produce execution efficiencies - pushing execution fees down to sub-basis point levels.
Actually rather than simply aiming for TCA, Markos believes that asset managers should be aiming for what he dubs 'CTCA' (comprehensive transaction cost analysis), which looks shortfall across the board, including mid- and back-office.
"For the next 10 years the big story will be about the chase for operational efficiency," he says.
Markos cites the slightly unusual but instructive example of client looking to make a big trade in Vietnam. The trade was spread over several weeks with the traders "giving themselves high fives for fantastic TCA" as they managed to barely impact the market with a substantial-sized trade, keeping execution costs low. However, the same company's back office was trying to drive down settlement costs, negotiating cheaper settlement to also generate efficiency. "And they never connected," says Endre, who explains that splitting the trade over several weeks meant the trade lost all of its alpha through the multiple settlements.
"This is a wake-up call. It's about seeing trade cost analysis not as execution cost analysis, but as the cost of doing both sides of the trade. There has been a sudden awakening of CIOs and senior management of asset management firms that siloed cost-saving tactics which are independent in front and back offices, do not materialise in operational alpha. In fact, the opposite can take place," says Markos.
On why it has taken firms so long to notice the need for joined-up TCA, Markos notes that the delay is in part because firms had the luxury of not needing to look too closely at overall costs, until recently. He adds that management talent tends to emerge more from the front office, which tends to give extra weight to this side. However, he also notes the constant drive for execution efficiency may have reached a stage where it is not clear further investments will warrant the returns generated, for example with the costs of improving latency.
Taking a holistic approach to the cost of the trade could ultimately see firms changing trading patterns, for example, choosing to split the trade up over fewer days, even if it means more impact and therefore execution costs, as the net cost will be lower. "It will take several years to work out the optimal point - no one has done the research yet," says Markos. He notes that the majority of TCA providers at present don't even collect the data for the portion of the trade after execution.
However, Markos also comments, "The industry doesn't help. There are so many products on offer [for TCA]. There are too many services. Previously, TCA was delivered by a handful of experts but now mid-tier to large broker-dealers are providing traditional TCA without considering the life-cycle of a trade. Most TCA is getting complicated by a variety of specialist and unique calculations."
But Markos believes that senior management are beginning to take notice.
"Based on the discussions we've had with C-level executives - everyone is interested in this idea. Why wouldn't they be? Over the next 5-10 years this issue will come to dominate," adds Markos.