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Planning for the future:

DIALOGUE WITH CITIGROUP

In issue 6 of The Buy-Side Perspectives, Citigroup posed a number of questions to the buy-side traders. Below, we publish a response to these questions, based on feedback we have collected from the buy side.

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Buy-side response to question: How far can EMS smart order routing develop to minimise manual intervention in execution?
K&K Global Consulting (K&KGC) reports that leading innovative buyside firms already record, analyse and categorise their own order flow and trading behaviour in order to a) find commoditised approaches which can be automated and b) identify exceptions that require manual intervention. This means some trading desks have employed a more technical profile of "low touch" traders who continuously are working on automating and streamlining processes to minimise the need for manual intervention. The first and most obvious step is that the buy side wants to avoid manual intervention with a large amount of small orders which else would be time consuming and are less sensitive to market impact.

“My goal is to create a scalable platform.
If I triple my firm’s AUM, I should be able to
do it without increasing the headcount.
Automation is the key. ” Last year, 85% of
Deutsche Asset Management’s flow was
executed electronically – much of it through
customised broker algorithms with no human
intervention.” Mike Bellaro, global head of equities
and listed derivatives, Deutsche Asset Management,
“Radical automation and buy-side empowerment”,
The Buy-side Perspectives, issue 3

Some buy side argue that algorithms have the capacity to outperform the human trader in such scenarios. In the ideal world, the High Touch trader will only focus on trading exceptions, within their specialisation, where human complex reasoning is required. In practice, K&KGC has found that many trading desks are consolidating and reducing the total number of trading headcount in 2016.
In addition to the trader, the PMs need to change behaviour and the firm needs to implement a process where it is compulsory for the PM to provide clear order instructions without any default value. Compulsory detailed PM order instructions may anyway be required within the framework of some firms' future allocation
of research commissions.
Some buy-side traders already debate if such low-touch development in the future also could span across asset
classes when foreign exchange and fixed income are catching up with the automation in equities.

“We won’t organise the trading
desk by asset class. Instead will
have a high-touch team and a
low-touch team. The low-touch team is
in liquid names and small trades with very little market
impact. It will be fully automated and individual traders
will cover all asset classes. At the same time the hightouch
desk will be for very sensitive trades, decent
size notionals and less liquid assets.” Union Investment
estimates that it can automate 20-30% of its number
of orders across the whole business.” Christoph Hock,
head of multi-asset trading, Union Investment, “Breaking
barriers”, The Buy-side Perspectives, issue 5

In a near "perfect" electronified market with standardised protocols such as Fix, and a high level of transparency and fragmentation due to algorithmic trading, such as the USA, there is the potential for relatively higher levels of automation. However, in Asia, where there is a much higher level of dependency on personal relationships and lower transparency, there will be a relatively lower level of automation.

“If anything, the proportion of algo trading we have
may be too much. The commission pool that we
pay our brokers has been shrinking year-on-year for
years. As I recall, 2010 was the last time we
had an uptick. A number of years have
seen double-digit drops. Meanwhile,
our AUM has not decreased so it’s
basically a lower blended rate, and
perhaps a little less active trading.
I don’t want the service from the
Street to fall as a result of lower
commissions being paid, and I don’t
think we’ll be using more algos.” Kent
Rossiter, head of trading Asia, Allianz
Global Investors, “The Hong Kong way”,
The Buy-side Perspectives, issue 4

Impending European regulation and consolidation of trading desks, to handle multiple asset classes, are driving the need for the buy side to evaluate new or additional EMS technologies. Where resources are available, K&KGC reports from Alpha Trader Forum buy-side debates in London, Boston and New York in 2016, that the heads of trading would be satisfied with a central OMS with the addition of a best-in-class EMS for each asset class. Only a few well-funded
large asset management firms choose to have an entirely separate OMS infrastructure between a) listed equities and b) fixed income and foreign exchange. The buy side are positive that EMS SORs are helpful in the design to automate order handling to allocate resources efficiently within the trading desk. There will always remain exceptions where the human trader’s manual intervention is needed.

“Aberdeen Asset Management experienced lower
market impact on trades that were executed
electronically. But even then, the role of services
provided by brokers can be an issue. “It is the
routing that is the problem,” added Godonis
“Too much trading to a particular venue for
example, will alert the HFTs where we are.”
“…the emphasis on cost-cutting means that
some smaller brokers white-label smart order
routing technology from larger firms, but in
that case the buy-side trader may end up
paying a larger fee than if they had just gone
to the original broker behind the technology.
It is always worth checking this first when using a
local broker….” Anthony Godonis, head of trading
- Americas, Aberdeen Asset Management, “Less is
more?”, The Buy-side Perspectives, issue 5

SOR statistics from K&KGC Buy-side Perspectives algorithmic trading research (to support answering question 2):


• In 2015, five out of 40 (12.5%) of the buy side reported use of Smart Order Routers. Five different brands were mentioned which indicated a fragmented approach to the selection of SOR brands.


• In 2016, five out of 16 (31%) of the buy side reported use of Smart Order Routers. Four different brands were mentioned which indicates that there is still a fragmented approach to the selection of SOR brands. The lower response rate to the 2016 survey, in addition to a low level of buy-side interest in discussing the topic trading algorithms at the Alpha Trader Forum, also indicated a significantly lower level of interest among the buy-side to search for alternative
algorithmic brands compared to previous years.

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Buy-side response to question: To what extent will the evolution of fixed order handling drive increased straight through processing in execution?
Out of 40 senior and heads of buy-side trading participating in K&KGC's algorithmic trading research in the end of 2015, 12 buyside traders reported that they use varying forms of STP where the benefits of standardisation through Fix Protocol were also mentioned. STP has not been called out by the buy side as a major challenge or priority area for further peer debate.


Buy-side response to question: Do traders need to spend more time developing an ECM liquidity approach for large in scale block orders?

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“When I first started trading, any significant flows came from a merchant bank or major asset manager, who had the block liquidity you needed. Today, participants are much more varied and you are unlikely to know who you are transacting with.” Paul Squires, head of trading, Axa Investment Managers, “A new dawn for the buy-side?”, The Buy-side Perspectives, issue 5

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The buy side are continuously evaluating multiple alternative avenues for block trading. The majority of traders in Europe
and the USA are generally happy to trade through independent MTF/ATS as an alternative to broker dark pools. More
independent dark pools are entering the market with a focus on minimising market impact even further. But based on K&KGC block trading research in 2016 the majority of the buy side still believe that some legacy dark pools are already providing the needed functionality.

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“There are aspects of the MiFID II
regulation that I see as an attempt
to move more trade onto the lit
markets, but some orders and stocks
really don’t benefit from trading
on lit venues. I believe we will see an
increase in broker intermediated block
trading.” David Miller, head of EMEA
trading and Invesco UK, “Shaking up markets”,
The Buy-side Perspectives, issue 3

Referring back to the Citigroup article comment about MiFID II prohibiting BCNs, this is something the buy side generally think is unhelpful but merely are forced to accept. European exchanges will be the main beneficiary of this regulation getting back business which they lost subsequent to the first iteration of MiFID. The buy side in Asia and USA have not shown any desire to adapt similar rules in their regions.


The European buy side has not seen any evidence of exchange driven auctions and block services being able to replace dark pools yet. Some buy side are already trying to figure out how they will be able to put mechanisms in place to identify the risk of trading over dark pool caps in MiFID II. While there is a more exchange friendly attitude among continental European buyside, the majority of buy side think more block volumes will be executed through a mix of fragmented
algorithmic orders and new exchange driven services when MiFID II is in place. Some buy side are even more pessimistic and think that some liquidity will also disappear as an unintended consequence of such regulation.

“There is no evidence whatsoever
that dark pools harm price formation,
if anything it is the opposite. From data
we have, dark pools actually improve
price formation, especially on large orders.”
“There is a common assumption that when the
cap is implemented, all that volume that cannot be
traded on the dark pools will automatically shift to the
lit market. In my opinion, this will not happen. That type
of liquidity will simply disappear.”
Gianluca Minieri, global head of trading, Pioneer
Investments, “Master of all trades”, The Buy-side
Perspectives, issue 2
 

Testing OMS providers' new automated handling processes for IoIs, the buy-side Fix Protocol working group also had progress in their attempt standardising IoIs. Additionally the buyside in Hong Kong and London have tried to standardise IoIs to encourage a stronger ethical culture. At the end of the day, the buy-side report, sell-side counterparties need
to be disciplined commercially if they don't follow agreed practices in order to enforce changed behaviour.

 


“We’ve tried many times to incentivise brokers to offer larger sizes, but often we’ve found the marker moves against us. It’s hard to incentivise them to offer blocks. On the exchange side, the lit markets are OK because of all the passive trading. The exchanges own the auctions so it’s doubtful they will push for many changes.” Anthony Godonis, head of trading - Americas, Aberdeen Asset Management, “Less is more?”, The Buy-side Perspectives, issue 5

 


The US based buy side are seriously concerned that the trending inflow to passive funds and ETFs combined with less corporations finding the incentive going public may commoditise and take the value out of the equity market. It is already hard to generate more than single digit Alpha in the US equities market unless one makes a bet during market volatility. This trend will drive further automation with algorithms and fragmenting orders and the end result will be that the access to block liquidity will become limited and more expensive. There is a pessimistic outlook how this trend amplified by restricting regulations will affect the survival of capital market participants who are specialised in block and high touch services. The same buy side are contemplating what innovation or what form of changed investor appetite is required in order to change the gloomy outlook.

“There are too many algos. At the
US ATF in the summer, when one
broker asked what kind of algos they
could provide to suit the buy side’s needs, one
asset manager responded: ‘Stop giving us algos”’ It’s
a race to zero for rates, and I think we’re pretty close
to that already.” Patrick Connors, head of outsourced
trading. Weeden Prime Services, “America at the
crossroads”, The Buy-side Perspectives, issue 6

It will be interesting to follow the effects of the geopolitical changes on the capital markets and investment appetite in the western world over the next five years.


Buy side response to question: How far will liquidity matching develop? How do market makers provide a service in this liquidity landscape?


The buy side are clearly calling for a client centric approach among the market makers in order to survive in the current and forecasted liquidity landscape. Personal trust and communication between the buy side and their main point of contact is a major factor for a good business relationship. A senior sell-side sales representative with trusted personal relationships is a clear differentiator. According to K&KGC research, most buy side would prefer if capital was priced
the same as high-touch and are challenged with the idea of special risk pricing. But if the trend continues towards more scarce block liquidity there will be firms who are willing to pay a premium for block the same way as a few are already paying more for small/mid cap liquidity. A few buy side are already evaluating the new types of specialised block service desk that are established by major market makers.

 


“The buy side and sell side utilising technology is the solution. We want to automate as much as we can as intelligently as we can. Do I really need a sales trader to negotiate that sales trade for me? Can we automate that process? Is the next generation of algo design going to be on block trading?”
“We opened our electronic flow in order for our sellside coverage to see our flow. We wanted to be able to interact with available strategic liquidity at a broker if it existed. As a result, some of our largest block trades have taken place as a result of this initiative. We can still stealth on our electronic orders if needed but we find less need to do so currently.”
Mike Bellaro, global head of equities and listed derivatives, Deutsche Asset Management, Radical automation and buy-side empowerment, The Buy-side Perspectives, issue 3

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Buy-side response to question: Lower levels of liquidity have already prompted the creation of fixed income utilities such as Neptune. Can multi-asset trading desks lead the way in promoting an industry utility for automated unilateral market making and liquidity matching?


The number one interest the buy side would be interested in across asset classes is a “consolidated tape” for improved but controlled trade transparency. The policies and design of this tape would require careful consideration as the US Trace project has highlighted some weaknesses as too much transparency can be damaging.


“Minieri notes that despite a call from EFAMA during the MiFID II process that placed a consolidated tape as the number one priority, it is “disappointing” to see that there is no answer to this issue in MiFID II.” - The Buy-side Perspectives, issue 2, 'Master of all trades', refererring to Gianluca Minieri, global head of trading, Pioneer Investments.


The industry overall is still very siloed and uncoordinated between the cash equities, bonds and FX spot. The example of the ongoing development an industry utility within the fixed income market already highlighted a high level of reluctance among banks to give up their control and monopoly of transparency within the bond market. The buy-side foreign exchange traders have also mentioned similar protective stance among banks in their asset class.
It is debatable if the market really needs another new equity liquidity pool which would fragment liquidity further. It would
likely be better to leverage the existing independent services in development and on the market and make sure that there are better opportunities for the sell side and buy side to match. The buy side are in general not in favour of depending on a single monopolistic utility. Here are a few favourable comments about Plato and Turquoise BDS by Paul Squires, head of trading, Axa Investment Managers.

“All the platforms share a theme. A community of buy side
and sell side collaborating within a utility structure. That’s the
new dynamic, where the buy side are more empowered
to determine market evolution without
disintermediating their brokers.” Paul
Squires, head of trading, Axa
Investment Managers, “A new
dawn for the buy-side?”, The
Buy-side Perspectives, issue 5

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