2011 has been the year of "electronification." That is, asset classes such as fixed income that were once traditionally voice-brokered -- one trader speaking to another over a telephone -- are now shifting increasingly onto the trading screen.
The emergence of fixed income multilateral trading facilities (MTFs) -- such as MTS BondVision, NYSE BondMatch and others -- has brought with it order-driven, point-and-click trading and real-time execution. These trades can be fed directly into the buy side's internal platforms, be it a portfolio management system at a hedge fund or an order management system at a long-only shop. With this improved efficiency, however, comes additional responsibilities for the buy side, as regulators, trustees and investors alike look for transparency and clear audit trails and work through implementing centralized clearing. The buy side will need to start planning now if it hopes to turn the trends resulting from electronification into opportunities in 2012.
Item 1: TCA -- It's About Real Time, and Not Just in Equities
While the electronification of non-equity markets is creating a new level of transparency and auditability, a deteriorating global economy has increased scrutiny on traders' performance. These two trends have regulators and investors asking if the trading desk is adding value and helping to drive alpha. Combined with increased market fragmentation and volatility, these factors also have made it more and more challenging for traders to identify the most effective venues to optimize the execution of the hardest-to-execute orders. These trends have set the stage for the emergence of real-time, trader-optimized TCA, designed to facilitate the active monitoring and control of live orders, and to show progress against benchmarks.
Although a number of sell-side firms provide TCA services to buy-side clients (maintaining a Chinese wall between that group and the agency execution desk), some buy-side firms contend that TCA providers need to be completely neutral, with no involvement in the execution of the order itself. Given that most buy-side firms maintain multiple execution relationships, an independent provider with multibroker coverage that is able to ensure the consistency of calculation methodology across all counterparties and execution venues could be the optimal solution.
Buy-Side Checklist for 2012
- Seek out trader-optimized TCA, especially for those trading non-equities.
- Find real-time tools that are intuitive enough to help shape trading decisions on the fly.
- Make sure that your TCA provider has impartiality.
Item 2: Traditional and Alternative Asset Management Converge: With Great Size Comes Great Responsibility
Hedge funds are becoming more like traditional asset managers in their execution behavior. At the same time, there has been increasing concentration at the top end of the industry, with the largest players attracting the biggest increases in assets under management. The ongoing flight to quality and size amid the current financial instability is making this trend even more pronounced.
As these funds take on the attributes of their traditional asset manager counterparts, investors and regulators are pushing them to start resembling their counterparts in their compliance behavior, as well. An increased emphasis on transparency, auditability and reporting is forcing hedge fund managers to increase financial controls and risk management and look at technologies that, just a few years ago, were considered purely the domain of traditional asset managers. But hedge funds still run IT and operations organizations that are quite lean relative to most traditional asset managers, and they need to avoid long, multiphased implementation periods that typically come with locally deployed, server-based solutions.
Meanwhile, traditional asset managers are now competing for capital with alternative asset managers, as pension funds and insurance companies seek greater returns. This has forced traditional asset managers to adopt more agility in their pursuit of alpha, optimizing execution and improving access to liquidity. Traditional asset managers now need to look at tools that provide multiple-venue access and span different asset classes. This is forcing a move to tools and technologies that were previously adopted by hedge funds.
Buy-Side Checklist for 2012
- There are several software-as-a-service (SaaS) options for hedge fund managers, including compliance, TCA and risk management systems.
- Traditional asset managers need to become more agile and adopt multi-asset and multivenue execution management systems to enhance returns.
- As traditional asset managers and hedge funds look more alike, there are risks for funds that try to maintain the status quo that defined the space pre-2008.
Item 3: On the Horizon: Buy-Side Crossing Liquidity Aggregation
Market fragmentation has made it critical for the buy side to gain quick, user-friendly access to crossing liquidity. However, tapping crossing liquidity in a way that doesn't complicate or undermine access to traditional sources of liquidity can present a technological challenge. Currently, traditional asset managers typically access crossing liquidity through custom-built adaptors plugged into their OMSs and the proprietary interfaces of the various crossing network providers, such as Liquidnet, Pipeline and BlockCross. While electronic trading already has made it simpler and easier for traders to route orders to their multiple executing brokers, it has only just begun to consider the aggregation of crossing liquidity on a single platform via a single connection.
This can lead to complications and compromises on how separate order slices can be worked concurrently and interact dynamically on multiple venues, both via traditional broker routes and the newer crossing venues. In an ideal world, the buy-side trader would need to be able to access, and to participate in, all available pools of liquidity simultaneously in order to achieve best execution.
Buy-Side Checklist for 2012
- There are significant challenges to aggregating buy-side crossing liquidity on a single platform, but the potential benefits are significant.
- Right now, the utility of crossing networks is limited because internal systems cannot interface seamlessly with them, creating the risk of over-execution.
Technological innovation and regulatory uncertainty are rapidly changing the industry and already have enabled progressive buy-side firms to increase the efficiency and performance of their trading. As a result, buy-side firms are now held to higher standards in terms of their trading, OMS, compliance and risk management tools. In 2012 the winners will be those firms that are flexible enough to adapt to the evolving market structure and to best equip themselves with the new technology that meets their changing needs.
Chris Hollands is head of EMEA sales for TradingScreen.