A combination of high levels of automation, soaring market data volumes and cut-throat competition have turned trade execution in the US equity markets into a “complex science”.
A new report from research firm Tabb Group identifies four execution risk forces that have grown in significance as equity-trading operations have become more truly global. A combination of trade automation, multi-asset class investment strategies, market structure changes and product complexity have multiplied execution risks across the equity trading desk, according to Miranda Mizen, senior consultant, Tabb Group.
Speaking to theTRADEnews.com, Mizen said: “There is such a high level of automation and high dependence on it, you can’t ignore anything that goes on in the execution sphere.
You have to look at these risk elements by itself, as part of the whole process.”
The report says that the role of the sell-side sales trader has diminished since 2006 when order flow was focused in one or several primary venues and a handful of dark pools. “In a little over a year, US equity execution has evolved into a more complex science, as Reg NMS requires that the best displayed prices be respected, leading to the rise and importance of smart order routing (SOR),” said Mizen. She predicted that Europe would follow a similar path. “Europe has similar product complexity, multi asset trading as well as automation across these asset classes. Some of the pressure points may be slightly different because MiFID does not demand the links between exchanges that exist under Reg NMS.”
In order to cope with this new level of risk management, both buy and sell-side firms are racing to develop strategies and tools that allow them to improve, monitor, measure and control the execution process. “Both sell and buy side need to be able to evaluate factors such as how their execution is going and the things that matter to them, with the development of tools they have, e.g. speed, fill-rate or price,” Mizen commented.
With the emphasis on managing risk at an all-time high, Tabb estimates that sell-side firms will continue to spend on equity analytics at a compound annual growth rate of 5% through 2012 globally.
In 2008 alone, they also forecast $157 million will be spent on technology relating to algorithms, smart routers and analytics.
“Managing risk is a survival test,” says Larry Tabb, founder and CEO at TABB Group, in a statement.
“As Miranda writes, enterprise risk management is already on everyone’s radar, but in these fast-moving, high-volume, global markets, execution-time risk needs to be developed, broadened and redefined.
Global expansion will escalate the stakes, which are already high and getting higher, as automation grips every asset class and each continent, accelerating the gap between the winners who maximise their ability to manage risk profitably and the others, who might just risk losing their shirts.”