Thursday, September 27, 2012 6:40:14 AM

Buy-side seeks more automation of order flow

Buy- and sell-side firms are looking to increase their use of automated trading despite new regulation that is set to include stricter rules around electronic execution and high-frequency trading (HFT).

Research from software provider MathWorks showed 46% of buy-side firms surveyed are looking to increase levels of automated trading, while the sell-side registered 67%.

The rise in automated trading and the development of algorithms to execute orders across multiple venues and asset classes at millisecond increments has reduced trading costs, but also led to predatory price arbitrage strategies by HFT firms that rely on having the lowest latency trading infrastructure.

Steve Wilcockson, industry manager of financial services at MathWorks, said the figures clearly showed the industry was looking to automate more of their business, despite fears of errors such as Knight Capital’s market making error, which lost the trading firm over $400 million in under an hour.

“The buy-side is leaning towards bespoke, human-driven alternative trading models,” Wilcockson said, adding that establishing monitoring of automated trading systems was key to technological trading innovation.

“A significant conclusion of our research is that the buy- and sell-side agree that more robust and faster implementation of trading – and risk – models is key to better market performance. This can reduce the likelihood of bad trades and provide more effective risk monitoring,” Wilcockson said. The MathsWorks figures are part of a report to be published in November, for which 43 participants were interviewed across the buy-side, sell-side and academia.

The degree of automation varies greatly across the buy-side, with some opting to automate the majority of their business. Hedge fund Marshall Wace automates around 95% of its business, while a more conservative approach is taken by long-only asset manager Investec, which uses algos to execute between 10-20% of their business.

On Wednesday, MEPs in the European Parliament’s Economic and Monetary Affairs Committee voted on amends to MiFID II, which will restrict HFT trading by implementing a 500 millisecond resting time for orders and an obligation to provide continuous liquidity if a HFT firm has a written market making agreement with a venue. Markets will also be forced to establish order–to-trade ratios to cap the number of orders sent to the market, a move some exchanges have already enforced, including Deutsche Börse and Borsa Italiana.

The ECON draft of MiFID II will be voted on by all MEPs, before it is reconciled with a version tabled by the Council of the European Union, with input from the European Commission. Formal implementation expected in 2014-15.

Richard Henderson +1 212 217 6916