OK to 2012 is the year of the tightened belt. How are buy-side firms likely to manage their resources in light of prevailing market conditions?
The dearth of trading activity that currently characterises equity markets means the buy-side generally has less money to spend on execution and research and as such need to be more picky about who they send their orders to. A TABB report at the end of 2011 noted that 56% of buy-side firms in Europe would re-evaluate their broker lists if commission wallets remain stagnant.
While investment institutions have increasingly been able to search far and wide for sophisticated trading tools, it may now be the case that trading activity simply shifts to the counterparts that have the most flow.
Sounds like a grim prospect for anyone outside of the top tier of brokers then?
Well probably, but then again smaller brokerage firms that don’t have as the same proportion of flow as the big guys could well find their niche in specific sectors or geographies. There is no doubt however that mid- and smaller-tier houses will come under increased pressure in a low-volume environment.
So, broker lists may be under review in 2012, what about execution tactics?
There is always a temptation to reduce your commission rate through greater use of broker algorithms but there are a number of underlying complexities. Not least is that the line between cheaper low-touch channels and high-touch sales trader services is increasingly blurred.
This is partly because the buy-side is demanding a more bespoke, consultative approach to electronic execution, a trend that has definitely become more pronounced in the last year or so.
The growing sophistication of the buy-side when it comes to execution means they want to customise algo parameters, understand the characteristics of the liquidity on different trading venues and be offered more assistance in deploying algorithms.
And, yes, they want this without any rise in commission payments.
You can’t avoid commissions but you can keep costs down by delaying capital expenditure, say on technology, perhaps?
Only if you’ve magically been able to future-proof your existing platform. Tech expenditure may well have to grow with the introduction of new regulation including the European market infrastructure regulation (EMIR) and MiFID II.
EMIR, which will push OTC derivatives trading into a centrally-cleared environment, will require substantial technology investment from buy-side firms so that they can manage new collateral requirements.
MiFID II, while a longer-term consideration, will still be on the buy-side’s radar this year. In particular, the extension of the directive to other asset classes could mean many of the same trends we have seen in equities are repeated elsewhere.
Specifically, fixed income markets, which have traditionally been controlled by brokers that determine the prices for trades, will become more transparent and electronic, necessitating further technological investment as markets fragment.
On the bright side, more automation can reduce operational risks and improve execution quality. It’s also cheaper than it used to be these days, thanks to lower installation costs through cloud computing, whatever that is.