Nowhere to hide

Technology and regulation continue to redefine the role of the sales trader and have made the ability to minimise information leakage a more challenging task than ever before.
By None

Isn't information leakage an accepted risk of using a sales trader?

Yes, to an extent. It's long been a maxim of brokerage that information derived from client order flow is more valuable to the sell-side than the orders themselves. The conflict between the broker's desire to market flow and the client's wish to conceal his intentions is one of many that colours the relationship between the investment institution and the broker. As such, the buy-side trader must try to leverage the skills that a sales trader can offer while minimising inevitable amplification.

Traditionally, much of the sales trader's art lay in knowing where the other side of a client's trade might lie, based on market contacts and knowledge of recent interest. Clearly, the sales trader that could place an order with one call would be more effective than one that had to broadcast his client's interest via every channel available. The process is now much more technology driven, but discrete communication remains critical.

How has the role of the sales trader changed over the last five to 10 years?

In just about every way possible. Prior to widespread use of commission sharing agreements (CSAs), a key part of the sales trader's role was to ensure than the trade idea initiated by the broker's corporate access and research capabilities would by completed via its execution services.

The ability to pay for execution separately from research-related services broke this link and forced sales traders to add value in new ways. In parallel, the growing automation and fragmentation of trading meant that buy-side traders had the choice of deploying direct execution or algorithms from their own desks to multiple venues. These new execution options provided a new role for the sales trader: navigating the complex new environment with the aid of an aggregated view of liquidity to help guide the client to best execution.

And what about those conflicts of interest?

Some have been reduced, others have taken on new forms. When passing an order onto a broker, the risk of information leakage is both internal and external. Always theoretically separate from desks that handle client orders, proprietary trading desks of banks have been wound down in many cases following the inclusion of the ”Volcker Rule' in the Dodd-Frank Act in the US. So while information from client orders is no longer likely to fuel prop trading profits, brokers' market making and risk desks still value the market intelligence they receive from client flow. And while sales traders have many technology-enabled channels to external markets at their disposal, the temptation is to keep client orders internal by directing them to broker-owned crossing networks.

Trading venue execution costs can make up 10-20% of brokers' overall transaction costs, so the ability to bypass these fees and match flow internally can save the sell-side millions each year. In this case, information about a client order is not being leaked in the traditional fashion but it can still be exploited by other counterparties permitted into the broker's dark pool.

So what's the future for sales trading?

Like almost everyone else, the sales traders that remain are being asked to work harder than ever. And there is plenty of scope for them to add value. In many cases their job title has changed to ”coverage trader' or ”electronic sales trader' to reflect a shift in skill set and function. While technology helps the buy-side trader take more of his own trading decisions, it also offers the sales trader an opportunity to demonstrate a mastery of liquidity dynamics that can help his client achieve best execution.

By arming the buy-side with up-to-date analysis on how particular stocks are trading in different venues – or appraising them of changes in average trade size – the sell-side trader is bringing up to date his traditional expertise in tapping liquidity as effectively and discretely as possible. Instead of using indications of interest, for example, orders can be passively placed across a number of dark pools for a certain period of time, thereby interacting with other passive orders without displaying any pre-trade information.

The sales trader may be working harder, but they are more likely to get their just desserts. Although CSAs might have shaken up the world of the sales trader, now many are structured to reward sales traders individually for the value they add to each client.