Has there been a move from TCA to LPA?
I wouldn’t say there is necessarily a move away from TCA as such. Liquidity Provision Analysis (LPA) can mean many things to many people, be that from a pre-trade, in-flight or post-trade perspective. All of these are as important as each other depending on the purpose you’re using it for. We still use core-TCA from a post-trade analytics and pre-trade counterparty selection perspective, however LPA from a counterparty selection perspective is very important at every part of the trade.
From a pre-trade perspective, understanding if a counterparty has local franchise for emerging market trades, or how engaged a counterparty is typically in seeing offsetting flow, and how active a salesperson is in terms of reflecting these axes, are all contributing factors to selecting a counterparty to get a risk transfer from or to partner up with and work an order.
How interactive sales and trading are during a trade, particularly in-flight when working orders, is also key. How well a salesperson understands our business, our flow or even our individual style of trading is down to relationship and showing axes, views, liquidity colour and insights – particularly on primary markets or types of flow they have seen throughout the day are also critical. From an e-perspective, the interaction with e-sales mid-flight of an algo is something we really push for. That could be communicating proportionate changes in volumes (vs. previous day, previous week, previous month etc.), how much flow has been internalised, or what our benchmarks metrics are (arrival mid, indicative risk transfer and in-flight how the algo is performing vs. TWAP/VWAP). That’s typically something we don’t actually get to see unless banks have in-flight TCA which is becoming more prevalent now. This is an area that platforms need to improve in giving that level of visibility.
Understanding how easy it has been for traders to clear risk post-trade and even how they have got on with the risk is important for voice trades. From an algo perspective, the depth of information that can be available in TCA can be over-whelming. It’s dangerous to judge algos in isolation as no two trades are ever the same in terms of the market conditions they are executing. That is where big data comes into it, either through the collation of your own in-house data and running analysis on a larger sample size or using anonymised peer-analysis is crucial for us. From a general perspective, using post-trade TCA from bank algos, running analysis using a third-party TCA provider or running in-house metrics all have their place and are equally important for the purposes they serve.
What are the core differences between the two?
TCA we receive from banks has typically focussed on algo trading which cannot be judged in isolation, although the quality of the post-trade TCA is very important to us. Having the appropriate analytics in a digestible format is key. We are constantly working with banks to try to help enhance their TCA in order to get relevant information to us in a format that is easy to read and understand and also to focus on what is important to us rather than what the sell-side might assume is important, which typically is very similar, though we are constantly looking for tweaks along the way. You want to be able to look at the TCA and understand exactly how that trade has gone and if the algo has performed as expected or better or worse than you thought it might when going in to the trade. Digging through fill and venue analysis on an algo’s TCA isn’t something that is realistically possible to do at the time or on every trade. This is where periodic review comes in to play. The use of independent third-party TCA or in-house analytics forms an important part of our selection process when looking at counterparty performance over a longer period and pre-trade TCA is getting better and better as more data is available which will only help to enhance our decision-making process.
From an LPA perspective, I feel it is more of a holistic approach. The interaction with sales and trading has a more prevalent role and your relationship with each of these really comes in to play. How well a bank understands your flow and how well they understand how you typically interact in terms of your style of trading, what information is important to you in-flight (primary market colour, flow colour, how they are handling the risk etc.) and how well you understand their franchise (likelihood of how getting an offsetting axe, local franchise etc.) is an important part of our counterparty selection process. Both parties want to come away from a trade feeling that it has gone well and that can only be achieved by having that level of relationship and understanding of each other’s business to set those expectations in the first place.
What is the most important consideration when choosing the right LP and strategy to execute trades?
I don’t think there is any one most important consideration. It could be as simple as tightest spread or best price if you’re looking to risk transfer, where reflection of a bank’s book in terms of skew can make a massive difference. But then if you’re working an order over a day or multiple days then how that flow is handled, maintaining minimal market impact, the level of communication and colour provided and being shown in axes, trader views and insight all become key.
The level of relationship that you have with a counterparty is critical in all of this. We’re medium to long-term investors and knowing that a counterparty is going to be reliable trade after trade is incredibly important to us. Consistency is key. The last thing we want is for a counterparty to shoot the lights out one month then be bottom of the pack the next. We also understand that counterparties will have their strengths and weaknesses and understanding that is incredibly important. Regional banks will have their niches but may not also have the larger reach of bigger banks in terms of being able to recycle risk. Others will just not have the risk appetite in particular currency pairs and so having relationships whereby you understand that is key and it is always evolving. Keeping on-top of that is also an important part of our role.
Is the move from TCA to LPA evolving the relationship between the buy and sell-side? If so, how?
Absolutely, though I think the relationship has always been of critical importance. Interactions with trading and relationships with them individually rather than just sales has become more prominent for us, though we have always felt that this has been very important. Having trust that your flow is going to be handled appropriately and in a manner that you feel comfortable with is key but the onus is also on us to maintain that communication and feedback and we try to give as much feedback as we can whether that is quantitative or qualitative to enhance that relationship further.
We’re big consumers of data and how we handle, report and feed that back is really important to both us and the sell-side. Dealing in a fair manner and providing quality feedback is paramount to us and I feel that can only help enhance our relationships with our counterparties in whichever asset class we trade.