Adoption of transaction cost analysis (TCA) tools is growing in Asia, driven by the need of the buy-side for order transparency and best execution analysis as their use of algorithms becoming increasing sophisticated, says Josephine Kim, director, Asia Pacific execution sales at Bank of America Merrill Lynch.
“A greater degree of unbundling means that more clients in Asia are now paying attention to brokers' TCA,” Kim notes. “TCA can be particularly helpful since more buy-side clients are using complex benchmarks. Previously clients used a simple volume-weighted average price (VWAP) or implementation shortfall (IS), but now we are beginning to see more combined benchmarks, which can make it harder and time-consuming for clients to analyse the performance against benchmark. And although clients may have one benchmark, for example IS, we often see that the traders actually use a mixture of algos – including IS, VWAP, participation of volume, get-done and stealth-type strategies. Thus it is important to provide performance analysis against their ultimate benchmark rather than each algo's original benchmark,” she added.
Bank of America Merrill Lynch, Citi, Nomura and UBS, supported by technology vendor and TCA provider TradingScreen, have set out TCA best-practice suggestions for comment in a consultation document, titled ‘Transparency and Standards in the Provision of Transaction Cost Analysis'. The consultation closed on 13 May and a final white paper on TCA is expected from the four banks later this year once the responses have been processed.
The consultation paper intended to highlight the issues that the industry needs to address if TCA is to become a more valuable basis for assessment. The paper states that transparency of methodology and calculations is critically important to ensure debate between interested parties is informed and valuable. Secondly, it emphasises that consistency in application of methodology and calculations is essential for effective analysis. Thirdly, the document points out that statistical problems often exist in terms of typical client transaction numbers, but suggests that these can be offset by provision of appropriate measures and explanations within the analysis.
Other key recommendations include stipulations that a ”core level' of periodic TCA should include measures of implementation shortfall (slippage from release time and decision time); market participation (interval VWAP conditioned to take account of bid/ask spreads); participation weighted performance (based on client ”target rates' of participation); pre-trade cost estimation based on a single, ”transparent' calculation methodology; and that the frequency and timeliness of analytical reports should be agreed with clients, complementing rather than competing with end-of-day or real-time trade management reports.
Kim notes that apart from the standard TCA, Bank of America Merrill Lynch also provides a information in formats that cater for an increasing level of trading customisation. “So rather than send a standardised TCA and let the client choose the numbers from our report, we can customise report and send it back to them so they get exactly what they are looking for without spending much time searching for the data,” she says. “A lot of the data is shared with the portfolio managers, so we try to help traders have something that can be used for the PM meeting. For example, rather than just focusing ”on the day' market impact and performance, we can also provide up to T+5 days' analysis of their stock,” she added.
Kim conceded that Asia is more expensive to trade compared to the US and Europe as both internal and external costs tend to be higher. “Many clients are looking to find a way to maintain the costs down,” she adds. “An algo that can help clients save some spreads and a report that can show the actual saving could play a key role when buy-side clients are rating the execution brokers.”
The growing need to adopt of smart order routing (SOR) technology in markets such as Japan, India and Australia means ”venue analysis' is also becoming an important part of TCA. “As the markets are more equipped for SOR technology, people also want to see the benefit of using it,” says Kim.
The most active alternative trading venues in Asia are located in Japan. “Although around 2-3% of total turnover is done in the non-primary venue, the crossing and cost saving levels can quite significant. SOR technology really took off from last year with wider access to central clearing. Prior to that, the buy-side couldn't benefit as much since they still had to settle across different clearing venues,” Kim added.
Japan has been ahead of other Asian markets in terms of allowing competition from alternative trading platforms, known as proprietary trading systems (PTSs), and enabling them since 20 July 2010 to clear and settle through the Japan Securities Clearing Corporation (JSCC). The lack of central counterparty clearing was a major obstacle to the PTSs in the past, but the JSCC adapted its interface to allow it to receive trade data from the PTSs' matching engines in time for the launch of Chi-X Japan on 29 July 2010.
“Similarly, with SOR in India between the National Stock Exchange and the Bombay Stock Exchange, we have seen average cost savings of around 5bps. However there are still some constraints in India, which stop clients from getting the full benefit yet. We are working very closely with vendors and regulators to help solve the limitations,” Kim notes.
Author: Jill Wong