In today's electronic trading market where products and services have become highly commoditised, every agency broker is aiming for the ultimate piece of cutting edge technology that will outshine the competition and make trading easier or faster.
While bulge-bracket investment banks are sustained by multiple revenue streams, agency brokers operate a narrower business model, typically focusing on selling agency-only dealing capabilities, electronic trading tools and related services. Unlike the bulge bracket firms for whom high-touch trading is a substantial part of the business, agency brokers have smaller budgets and tend to rely on their technology and low-touch trading services to win clients.
But as needs of the buy-side have evolved, the agency broker model is also undergoing changes; agency broking nowadays is not just about executing trades or investing in technology. “We're not an electronic black box firm. In terms of the human relationship side, I would say it is equal in our business model to that of the bulge bracket,” says Glenn Lesko, chief executive officer of Instinet, Asia.
Traditionally, the sales trader's ability to leverage relationships to source liquidity has been critical to helping clients execute blocks in Asia. But increased fragmentation in recent years mean block trades are increasingly difficult to execute; average sizes on the exchanges have dropped as more firms have adopted algorithmic trading tools that slice up orders. This has created opportunities for execution of blocks that both agency brokers and bulge bracket firms are tapping into.
Will Psomadelis, head of trading, Australia, at Schroder Investment Management, emphasises the continued importance of relationships in Asia's equity markets. “When it comes into block trading, whether that liquidity is through a bulge-bracket broker or an agency broker, soliciting liquidity depends on relationships. The agency guys have a different focus on the technology side of it but the bulge bracket guys are doing a pretty good job. So for me, it purely depends on where the liquidity is on each day and we go with where liquidity is,” he says.
But building up the right relationships to be able to source liquidity on behalf of buy-side clients is an increasingly automated business, as Instinet's Lesko explains.
“As an agency broker, and not a bulge firm that is in competition with other bulge firms, we've been in a better position to strike liquidity aggregation deals in which we are able to route orders into other brokers' liquidity pools from one algorithm which also has built into it some protection in terms of market impact,” he says. “We've never taken the view that we have better technology just because we are an agency in the first place. It's how you employ the technology, what your motivation is and how you create solutions for your client.”
One example of how agency brokers are filling gaps in the market is Instinet's liquidity aggregation algorithm called Nighthawk, which launched in the US in 2006 and is making its debut in Asia. “Nighthawk is not just an just an aggregated pool, it's an intelligent algorithm that uses live and historic market data to determine which dark pools to send orders to, gauge the feedback in terms of what fills it is getting, and return to the dark pool or any alternative liquidity pool where there has been positive experience. It avoids pools where there's negative experience
– i.e. lack of fills or actual price movements when we've accessed that pool,” Lesko adds.
One of the third-party liquidity sources that Instinet's Nighthawk taps into is TORA Crosspoint, a Japan-focused aggregation tool operated by agency broker and technology vendor Tora, which recently announced linkage to Bank of America Merrill Lynch's MLXN dark pool.
Bulge-bracket firms may be sourcing liquidity via technology too, but the fact that agency brokers are independently operated and do not engage in proprietary trading is also an advantage, Lesko asserts. “The agency broker has gained the trust that there's not going to be slippage in the order flow to a proprietary trading book and that 100% of our focus is on the customer. These tend to hold true whether you're trading through a broker by calling him up, or electronically. So yes, the bulge-bracket firms are building the same type of technology and they are investing a lot in it, but that's something that Instinet has grown accustomed to. We differentiate what we're doing effectively with the agency model by customising everything that we do for the benefit of clients without there being any confusion whether its benefiting us or them.”
Bulge-bracket firms often point out the increasing separation of their client-facing activities from proprietary trading desks, which are also under threat of extinction from the Dodd-Frank Act in the US.
For agency broker ITG, having advanced technology is only secondary to being able to customise its products to suit clients' needs. Michael Corcoran, ITG's managing director and head of sales and trading, Asia Pacific, says, “There's a lot of talk about algos being commoditised. However if you're able to have a full understanding of a client's trade cycle and trade performance, you're then in a position to offer customisation of algos to better suit that particular client.”
Clare Rowsell, ITG's head of client relationship management & marketing, Asia Pacific, says the firm's independence has helped make clients “comfortable” with linking into multiple dark pools through ITG. In March, the firm launched POSIT Marketplace to enable buy-side institutions to cross against liquidity from multiple dark pools as well as order flow from POSIT, ITG's buy-side-focused crossing network. The firm plans to extend the service to Australia in the coming months.
“Transaction cost analysis enables us not only to offer our clients the ability to measure across all their brokers, all their trading performance so they can make decisions about what algos they use, what brokers they use, how they are running their trading desk,” says Rowsell. “But we can also apply it to our own trading desk so we can measure our own performance for our clients and be accountable for that. And also we can incorporate that into our other trading products. Our algos have a continuous feedback loop with the analytics so that we're actively measuring them and looking for ways to improve performance.”