Whatever else its legacy might be, the noughties was a decade that
revolutionised how the buy-side executed trades in the global equity markets.
To put the scale and nature of the shift from voice-broked to electronic
trading into context, theTRADEnews.com asked six influential industry figures
to chart the milestones reached and the benefits achieved, as well as the challenges
to come.
The
buy-side trader
Steve Wood, global head of trading, Schroder Investment Management
How did 2000–2009
change trading for the buy-side?
For
Steve Wood, the past decade has seen a “radical” change in the working
practices and the skill sets of the buy-side trading desk. At the beginning of
the decade, it was still possible to hand off a trade to a broker and spend lunchtime
down the pub until fills were reported back in the afternoon. Today, the
buy-side trader exercises considerably more control and judgment.
In
2000, Wood was head of trading for J.P. Morgan Asset Management in London and also had
responsibility for the firm’s Asian trading operations. The firm had already adopted
FIX to communicate with brokers and Wood sees widespread use of the protocol as
one of the key milestones of electronic trading. “FIX allowed us to seamlessly
launch program trades from our order management system (OMS) direct to the
brokers’ trading tools and then receive execution data back. This was also a
great leap forward from faxing over a list of stocks to the broker for risk
programs, not least because they used to build into the spread the potential
cost of the delay incurred in that process,” says Wood.
Wood
also identifies the introduction of broker-neutral and multi-broker trading
systems for the buy-side around five years ago as a “quantum leap” that
increased the choice at the trader’s disposal. “Whereas you might have had
access to ten algos from two providers, of which maybe three algos were in
regular use, a multi-broker execution management system offered access to a
wealth of riches,” he says. “It was not viable to have multiple front-ends on
the trading desk, from either the user’s and provider’s perspective, but now the
trader has to be able to choose from up to a hundred algos from a whole range
of brokers.”
Electronic
trading had initially helped buy-side traders to improve the execution quality
they could achieve in trading baskets of stocks, observes Wood, but this has
been supplemented by increased single-stock capabilities in the past three
years.
What has electronic trading
brought the buy-side so far?
Wood
views the benefits of electronic trading in terms of choice, control and
reduced market impact. “Rather than relying on the broker’s expertise on how
best to interact with a primary exchange, now our traders have the skills to
execute in a much more fragmented market,” he says. “High-touch services from
brokers are still highly valued; they can often access liquidity that we are
unable to reach ourselves. But a broker is just one venue now. We can access
the venues, the multilateral trading facilities (MTFs) and dark pools ourselves
and our visibility in the market is our responsibility.”
There
is no doubt in Wood’s mind that electronic trading has helped the buy-side to
reduce transaction costs to the benefit of the end-investor. “A substantial
amount of our trading is done in low-touch arenas now,” he says. “That reduces
commission costs of course, but the more important factor to reducing overall
transaction costs is the ability to control order flow.”
What can it help the
buy-side achieve in 2010 and beyond?
While
great improvements in the cost-effectiveness of buy-side trading may have been
achieved in the past decade, traders like Wood are discerning purchasers that
continually expect more from their sell-side counterparts. And as fragmentation
increases, that means demanding greater transparency and execution quality from
smart order routers (SORs). “We ask brokers how exactly their SORs interact
with the market,” explains Wood. “Do they reach all the right venues in the
right sequence or are they missing out on some, either because those venues
don’t have the necessary volume or because it’s not cost-effective for the
broker? Does the SOR preference a market that is cheaper for the broker to deal
on or does it go for liquidity?” A better understanding of how SORs will lead
directly to a further reduction on transaction costs, suggests Wood. “We want
to see what percentage of a transaction is executed on each venue so that we
can evaluate the transaction cost per exchange and then direct more flow the
cheaper venue,” he says.
The
broker
Richard Balarkas, CEO, Instinet Europe
How did 2000–2009
change trading for the buy-side?
"Most
senior managers at banks didn’t see any upside or revenue potential in electronic
trading. But they were worried that they would lose clients if they couldn’t
take orders by FIX." This was the situation facing Richard Balarkas as
newly appointed global head of electronic trading at Credit Suisse at the turn
of the century. Credit Suisse had bought BZW from Barclays and wanted to
replicate the UK
firm’s success in automating equity trading for the retail investor at the
institutional level. The way to achieve this was unclear until Balarkas was
introduced to one of Credit Suisse’s New York-based prop traders, Dan Matheson.
Matheson was using rules-based programs or algorithms to execute his trading
strategies more efficiently.
The
meeting led directly to Credit Suisse developing its Advanced Execution
Services business as the first major brokerage to offer algorithms directly to
the buy-side. It took a matter of months for some fairly rudimentary algos to
be developed for internal traders to test, and before long firms such as Putnam
Investments were demonstrating the benefits to rivals and competitors. "If
we’d have only allowed access via sales traders or just provided DMA there
wouldn’t have been the same kind of growth,” asserts Balarkas. “It was a huge
cultural shift for a bank to provide that kind of service. There were real fears
about cannibalising revenues."
In
Balarkas’ view, the availability of electronic tools such as execution
algorithms helped to usher in a new era of professionalism on the buy-side
trading desk. "It signalled the death of the dealer that just outsourced
all risk and responsibility for the trade to the broker and heralded the
arrival of the buy-side trader that could take full control of the trade and be
a more discerning buyer of sell-side services," he notes.
What can electronic trading help the
buy-side achieve in 2010 and beyond?
The
revolution in buy-side trading capabilities that electronic trading has
supported is far from complete, according to Balarkas. For every firm that has
invested in technology to enable traders to reduce transaction costs, there are
plenty that believe that investment is unwarranted, or at least of secondary
importance. "A lot of buy-side desks are not proficient in execution and
are not autonomous because their portfolio managers do not realise the impact
execution can have on portfolio performance,” says Balarkas. “Those funds are
missing a trick."
The
trading venue operator
Peter Randall, CEO, Equiduct
How did 2000–2009
change trading for the buy-side?
Peter Randall has been at the heart of a number of the key developments
that made 2000-2009 the decade of electronic trading. After a period as
executive director of FIX Protocol Ltd, he took on the role of director of
business development at Instinet Europe, the agency brokerage that gave birth
to the first successful pan-European trading venue in early 2007. Randall
became CEO of Chi-X Europe in December 2007 and oversaw a rapid expansion of
the venue’s market share before stepping down in the first quarter of 2009. In
2000, however, he was looking at electronic trading from a slightly different
angle. “I was working in Hong Kong helping to
quantify the size and dynamics of the Asian retail market for an
established stockbroker looking to provide an online service for retail
investors,” Randall remembers.
He believes that the development, adoption and effective
implementation of the FIX protocol has been the most significant driver of
electronic trading over the decade, but says that the changes wrought during
that period have gone well beyond financial messaging. “Electronic trading has
delivered significant liquidity advantages to the buy-side,” he asserts. “It
has also helped to systematise the entire dealing, settlement and
accounting process – issues that represent so much of the buy-side’s
cost base.”
What can electronic
trading help the buy-side achieve in 2010 and beyond?
With many of the building blocks of electronic trading now firmly
in place, the next decade should in Randall’s view be one in which the gains of
2000-2009 are truly exploited to the advantage of end-investors. “Much remains
to be done,” he acknowledges. “However, now that essential standards for
market data, trading, clearing, settlement, fund accounting and modeling have
been established, I expect to see a blossoming of innovation and product
development over the next 10 years.” And with faster innovation comes ever
fiercer competition. “There will be an ever increasing focus on the quality,
the market infrastructure and the costs of the services that the sell-side
provides to the buy-side,” says Randall. “As with all other
products, excellent quality at a competitive price coupled with great
service and innovation will set the standard.”
The
all-rounder
Marcus
Hooper, executive
director, Pipeline Financial Group
How did 2000–2009
change trading for the buy-side?
As head of trading for AXA Investment Managers in 2000, Marcus
Hooper could already see that electronic trading would have “a huge future”. In
the late 1990s, he had been the first member of the Tradepoint Exchange, which
offered the first practical direct exchange membership to the buy-side
community. “Tradepoint didn’t succeed, but it definitely helped to change
the market,” recalls Hooper. “The London Stock Exchange wouldn’t have adopted
electronic trading so quickly without Tradepoint’s appearance.”
Ten years ago, says Hooper, much of the buy-side community was
struggling to introduce technologies and processes considered fundamental
today, such as electronic order and execution management systems. “Almost
everyone was looking to deploy a new OMS and the choice was very limited. Also
the functionality of most systems was often quite poor with very little
connectivity,” he says.
In more recent years, he identifies MiFID as a key milestone
because it put Europe on a common regulatory
basis, thus enabling new electronic systems to come to the market. “I think
we’ll see more consolidation in the electronic trading space,” Hooper notes,
“but without MiFID we wouldn’t have had the opportunity for these systems to
enter the market and compete in the first place.”
What has electronic
trading brought the buy-side so far?
Growing buy-side side empowerment over the decade has given
traders greater freedom of choice and increased anonymity which, says Hooper,
has had a significant impact in reducing trading costs.
But he suggests that electronic trading has delivered a
significant benefit that many may have forgotten about: a massive reduction in
trading errors. “Before electronic trading systems, most traders always had a
fear in the back of their minds that a giant trading error was waiting in the
shadows! The good news is that these events just don’t seem to happen
anymore – no trading the wrong stock, no buys instead of sells,” says Hooper.
What can it help the
buy-side achieve in 2010 and beyond?
But it hasn’t all been upside. Electronic trading has introduced
problems as well, according to Hooper, such as the reduction of order size in
the visible markets. “Trading large block orders is increasingly difficult
because the visible markets really don’t support price discovery
anymore. The prices that are discovered are all ‘at the margin’ in tiny
quantities that don’t represent anything like the full market supply and
demand,” he explains. “Large block orders take place away from the visible
markets even though they often rely upon reference prices from those markets.”
The result is that supply and demand from block orders neither interacts with
nor contributes to the price discovery process and Hooper suggests that technology
“can definitely play a part” in the resolution of this problem.
The
technologist
Kevin
Houstoun, chairman of Rapid Addition; co-chair of the global technical
committee of FIX Protocol Ltd.
How did 2000–2009
change trading for the buy-side?
The difference in client expectations since the start of the
decade is evidence of the distance buy-side trading has travelled in 10 years.
Kevin Houston was running the European equity electronic trading team at
Salomon Brothers in 2000, a market leader since developing FIX to communicate
with Fidelity Investments in 1992. “We
could deliver orders to many markets on a single platform and identified early
on the great potential for electronic trading to expand globally. Now, not only
is this expected functionality for any large broker, but people care how many
milliseconds, or increasingly microseconds, it will take. A decade ago, people
wanted global coverage; now they want high-speed global coverage,” notes Houston.
Although
it had made its debut eight years previously, FIX was far from a ubiquitous communication
protocol in 2000, but Houston
says that’s just one of many step changes across the decade. “Algorithmic
trading techniques were being used by some specialist funds and proprietary
trading desks to make money; now they have been extended to also become
productivity tools used by the buy-side to place orders into the markets. Initially
they were premium services which justified near full-service commission levels
and now they have become just another discount commission channel that the larger
brokers are expected to have,” he says.
What has electronic
trading brought the buy-side so far?
The
benefits of the growth in electronic trading can be seen in the reduction in
commissions and spreads, says Houston, who asserts that the trend is inexorably
downwards despite glitches caused by lower liquidity levels after the credit
crunch and – potentially – by regulators’ increased interest on high-frequency trading.
“This is probably the biggest direct benefit to the buy-side,” Houston comments, “but there are many others
as well, such as: reduction in errors; better risk systems; and algorithmic
trading tools as productivity tools that allow the buy-side to focus on the
larger / more difficult trades where they can add more value.”
What can electronic
trading help the buy-side achieve in 2010 and beyond?
Houston observes
that competition and innovation in the trading technology space has been harmed
recently by consolidation, notably among providers of FIX engines, but he
expects strong demand for software as a service and hosted FIX services.
He also forecasts that regulators will have a bigger role to play in how firms
trade, not least by demanding more risk controls for those currently enjoying
naked access. “Risk and regulation is going to be the next big thing that we
look back at in a few years; there are currently around a dozen and a half or
more pieces of legislation going through the US legislative process alone that
could have an impact on our business,” he says. “Looking back at say 2005 from
2015 I guess we’ll be saying "Wow, were we lightly regulated then!"’
The Consultant
Frederic
Ponzo, managing director, Greyspark
How did 2000–2009
change trading for the buy-side?
On
10 February, 2000, Frederic Ponzo was taking the Eurostar train from London to Paris to
establish the UK
business of Net2S. For most of the next decade, Ponzo was overwhelmingly
engaged in helping sell-side and latterly buy-side firms develop their
electronic trading capabilities, in London
and beyond. In the early part of the decade, he was focused on implementing
direct exchange connectivity for banks as Europe’s
exchanges first automated then consolidated. By 2004, electronic trading was
beginning to be seen beyond cash equities and listed derivatives, and soon
platforms such as BrokerTec and Tradeweb were automating the request-for-quote
process in the fixed income market. “Around five years ago, spreads began to
tighten a lot, especially for smaller order sizes, as electronic trading in
fixed income increased competition between brokers,” says Ponzo. One reaction
to this increased transparency was the complexity of products offered by the
sell-side that resulted in credit derivatives that became all but impossible to
price. Back in equities, MiFID revived innovation in electronic trading,
according Ponzo as the pace of fragmentation and the growth of dark pools
surprised many. “The story of MiFID is not finished yet – no one is sure which
of the MTFs will survive,” Ponzo asserts. “Moreover, SOR was introduced on the
promise of reduced trading costs, but it has not delivered yet.”
What has electronic
trading brought the buy-side so far?
“With
notable exceptions, the buy-side trader’s use of technology extended little
beyond emails and excel spreadsheets 10 years ago,” observes Ponzo, who
believes a shift in power between the buy-and the sell-side has been effected
over the past decade. “The growth of electronic trading on the buy-side has
demystified the business of brokerage,” he claims. “Empowering the buy-side to
take responsibility for their own trades has had at least three far-reaching
consequences: they have demanded better value-for-money from the sell-side;
they have taken ownership of their own technology; and they are achieving
greater transparency on price formation.”
What can electronic
trading help the buy-side achieve in 2010 and beyond?
Given
the progress that has been made in individual asset classes in recent years, Ponzo
believes that multi-asset trading will be a lasting theme at the beginning of
the next decade. “Rather than the complexity and opacity that we saw a couple
of years ago, we will see increased interest in the ability to trade different
asset classes in a consolidated way, i.e. on a single platform. An emphasis on
simplicity will also improve transparency, add more pressure to brokers and
reduce operational risk. Wherever you can, do it yourself.”