Industry Profile

Bringing it all back home

The world’s equity markets have taken the US as their blueprint for highly automated, highly efficient order execution for at least a decade, but the home of electronic trading still retains a number of unique characteristics, according to Owain Self, global head of algorithmic trading at UBS.

Too much choice? 

First, says Self, is the sheer degree of venue fragmentation, which requires means that off-exchange sources of liquidity can account for a larger proportion of fills than many non-US market participants are used to.

“With 13 lit venues and as many as 40 dark pools available to the buy-side in the US, their approach can’t be quite the same as in other markets,” Self observes.

Fragmentation is a common phenomenon in markets worldwide and has prompted an upsurge in the usage of liquidity-seeking algorithms on the trading desks of institutional investment firms. In both 2011 and 2010, around four-fifths of respondents to The TRADE’s annual Algorithmic Trading Survey said they used dark liquidity-seeking algorithms, compared with 60% citing use of VWAP. Self, also global co-head of UBS’s Direct Execution business, warns that buy-side traders need to take a cautious and calculated approach when sourcing dark liquidity among diverse US venues.

“If you open your orders up to all possible sources of dark liquidity in the US you’re going to get an inconsistent experience,” Self explains. “To avoid being flooded with liquidity of a lesser quality, many US buy-side traders are being much more discerning about how they source dark liquidity. This leads to a lot more demand for customisation, a greater degree of automation, particularly for smaller orders, and more quantitative analysis.”

As the menu of non-displayed liquidity options on offer in the US has widened, the appetite of buy-side traders for details on how their orders are treated in the dark has not diminished. While the recent revelation over Pipeline’s use of a prop trading affiliate caused a number of firms to revisit their previous due diligence, Self says the buy-side’s focus on routing and execution in dark liquidity pools has steadily intensified over the last couple of years. “The more recent change is that these queries are now becoming much more formalised,” he says. “While they might previously have been satisfied with a broad explanation from a salesman, they now want a more formal, written response from their providers. This is encouraging the brokers and other dark-pool operators to become even more transparent.”

The customer is always right 

Another key feature of the US market is the bespoke nature of the strategies deployed by the buy-side. Self spends almost a third of his time in the US and claims that American institutional investment firms lead the world in analysing execution data to improve the performance of their trading desks in minimising trading costs and therefore retaining alpha. For the sell-side firms like UBS, this means that the US includes some of its most pro-active and demanding clients. 

“We work closely with clients globally but in the US there is currently more differentiation in the outcomes. We’ve been tailoring the behaviours of our core algorithms to suit different clients needs for some time, but now the customisations we’re being asked for are so bespoke that they’re not really comparable to the algos we already offer,” says Self.

The impact of constantly evolving buy-side requirements on the electronic trading client service models of brokers has been profound. Algorithms were first marketed to the trading desks of money managers as a cheap, productivity-enhancing alternative to sales traders, but prior distinctions no longer hold.

“The challenge is to be able to deliver on a scalable basis, allowing rapid response, almost real time to clients’ needs,” notes Self. “Five years ago, electronic trading was a truly low-touch business, but the levels of service and analysis required today means that it is no longer low-touch in terms of the client relationship.”

Growing familiarity with electronic trading tools leads inevitably to increased requests for tweaks and enhancements, but it also drives diversity in terms of the coverage preferences of buy-side clients.

“Some clients value the absolute anonymity of electronic trading while others prefer multiple touch points. There are also clients that use electronic trading for its efficiency and lower blended cost but don’t mind their sales traders seeing their flow as well,” says Self. “The need for segregation and anonymity won’t disappear completely but there will be a blurring of the lines between execution avenues for some clients.”

Familiarity breeds confusion 

Other markets may have adopted many practices and processes pioneered in the US, but typically they have adapted them to suit their own local needs. The result is that US equities trading environment may look more familiar than it really is.

“European firms that trade into the US do understand this market, but there are nuances that are worth bearing in mind. In Europe, the tendency when gauging liquidity is to look at the electronic order book volumes of the primary and maybe of some alternative venues, but in the US the consolidated tape gives you a more complete view: lit, dark, other OTC trades all combined, which means you might want to lower your target participation rates,” says Self.

Of the US equity markets exports, it is perhaps high-frequency trading (HFT) that has caused most controversy. Now accounting for substantial amounts of trading and increasingly in some Asian markets, the preponderance of HFT in the US nevertheless has the capacity to surprise, says Self. But subtle adjustments to strategy can yield positive outcomes.

“The view that high-frequency trading accounts for a larger percentage of volumes in the US than in European markets, implying a lower percentage of natural long-term liquidity, incentivises clients to lower participation rates,” says Self. “Fortunately the sheer size of the volume in the US and the large number of dark venues means you may be able to take a more passive approach to accessing liquidity and still achieve your execution over a similar time horizon.”


Chris Hall +44 (0)20 7397 3819