Fixed income experts question use of TCA for best execution

Industry participants gathered in London to discuss the use of TCA to achieve best execution for fixed income.

Fixed income participants will face short-term difficulties using transaction cost analysis (TCA) for best execution.

Regulators have pushed for best execution to apply to multiple asset classes, including fixed income, credit, FX and derivatives, in order to accurately measure market conditions and ensure investment managers are taking “all sufficient steps” to get the best price for the instrument they are trading.

The rule essentially codifies the fiduciary obligation of any buy-side firm.

Speaking at an industry event hosted by ICE Data Services and The TRADE, panellists discussed how this concept can apply, but determined that achieving true best execution is more difficult for fixed income than equity markets.

“Unlike exchange-traded markets, fixed income trades mostly OTC, and a lot of ‘best execution’ in fixed income depends on the skill of the executing trader and their respective access to market information and liquidity,” said Mark Watters, director at AxeTrading.

The panel outlined how the main hurdles for achieving best execution in fixed income lie in the lack of data and reference points to demonstrate it.  

However, these hurdles will likely shift as the use of TCA adds to the data and reference points, providing participants with more proof of best execution. Because of this, service providers are seeing increased demand for a wider range of data analysis and data capture tools from buy-side clients.

“The emphasis is on achieving best execution on a consistent basis and it is not only about the price but other factors including size, cost, speed and likelihood of execution and settlement.  We are seeing demand for reference pricing, trading analytics and tools to assess large volumes of information for effective oversight,” said Paul Williams, senior director, business development at ICE Data Services.

Despite the lack of benchmarks to compare trading performance in fixed income, TCA could be a useful tool or guide to inform trading decisions and identify outliers, the panel agreed.

Cathy Gibson, head of fixed income trading for the UK at Deutsche Asset Management, commented that obtaining best execution is less of a problem as it has already been achieved, despite upcoming regulatory requirements.

Instead, the challenge for Gibson’s trading desk is the ‘burden of proof’ buy-side firms must be able to provide in a potentially non-transparent environment.

“Best execution policies must be in place and fit for purpose, they must be monitored, tested and verified and they will need to evolve with the increasingly changing market structure,” she said.

The use of TCA, whether built in-house of provided through a third-party vendor, could act as a useful tool for evidencing best execution, but the panel stressed the use of it in fixed income differs from equities.

“For more liquid instruments TCA could be used to record a details of price data at during the execution process.

Although I am super cautious about advocating use of TCA for fixed income products, it could be used to perform a high-level filter to help identify outliers,” said Julie Beecher, an independent consultant for the buy-side.

Research has suggested TCA usage on trading desks has grown substantially over the past several years, reaching a saturation point in equity markets.

It revealed TCA is currently used by 81% of equity trading desk, up slightly from 2015 when 79% of desks reported using TCA. In comparison, TCA is currently used by just 32% of fixed income trading desks and 58% of FX trading desks.

Fazila Gauhar, a senior associate at the Financial Conduct Authority (FCA), informed delegates the UK watchdog is agnostic as to whether firms use TCA or not and its use is not a requirement under MiFID II.

Gibson explained despite this, TCA is a “useful aid to capture the market environment throughout the life cycle of trade and can help evidence best execution”.

The panel urged delegates to consider that best execution requires firms to take into account not just the price of a trade, but also speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order.

“The danger of shifting toward using TCA as a benchmark for best execution is it will result in behavioural change which will not deliver the best possible outcome for clients,” Beecher added.