Algorithmic trading provides an effective way for buy-side firms to find liquidity in a fragmented market. But in the back office, it generates exponentially more trades -- and ticket charges. To help institutions save money for their clients, New York-based ESP Technologies has developed post-trade aggregation technology to consolidate trade tickets and allocations.
"It allows you to participate in lots of different venues without incurring increased settlement costs," comments Kevin Kelly, VP of equity trading at San Francisco-based RS Investments, an institutional investment firm that manages $15 billion in assets. "Because the equity markets are fragmented and traders need to go where stocks are trading, ESP is a solution to reduce those settlement costs."
Currently, the ESP Clearvoyance post-trade aggregation service is available only for equities. According to ESP, the service aggregates step outs and cancel/correction processes and takes account of exceptions handling in the buy-side workflow so that it's seamless.
"One order could be traded with five brokers by the time you're done if you use algorithms, dark pools, crosing networks, etc.," RS Investments' Kelly relates. "Our clients could be charged for five separate settlement fees on one trade." ESP, he explains, centralizes those allocations and creates one trade that settles at ESP at an average price with the custodian, so the buy-side firm is charged for just one ticket instead of for five tickets. According to Kelly, RS Investments has saved clients approximately $270,000 in clearing costs in 2009 using the ESP service.
ESP offers a ticket aggregation savings calculator on its website showing that a $5 billion investment manager with 30 percent of its orders fragmented and 600 daily allocations at $15 a piece could save $675,000, or 1.35 basis points, a year. "We're looking at it as a way of countering the adverse effect of best execution requirements," says Scott Kurland, managing director, head of product development, at ESP. "You're going to dark pools, algorithms; working principal and agency trades with various broker and agency desks. You're doubling and quadrupling the number of settlements with custodians."
Achieving 'Best Settlement'
With ESP's technology, "Whether you trade with one broker or four brokers, you only get one ticket for back-end costs," continues Kurland, who terms this "best settlement." "You're combining what we call best execution on the front end with best settlement on the back end."
In fact, ESP argues that back-office aggregation technology should be viewed as part of best execution analysis. "Money managers should include clearance and settlement costs as an important factor in their best execution analysis in order to enable institutional investors to reduce their inflated clearance and settlement costs by aggregating fragmented trades, diversify their clearing counterparty risk, and obtain greater transparency into their transaction costs," Kurland wrote in a letter to the SEC in April. "ESP's aggregation technology has demonstrated a 30 percent or more reduction in the number of custodial deliveries," he noted.
According to Jack Kindregan, managing director of sales for ESP, Clearvoyance works from a messaging standpoint after the trade is completed and therefore doesn't interfere with how buy-side firms execute -- how they route orders, how many brokers they use, how many dark pools they ping, etc. "The buy side doesn't have to change the way they do business," he asserts. "They're adding us as a catcher's mitt in the way they collect trades. ... From the trader's perspective, we're behind the scenes."
The trader can stage an order through an order management system or phone it in to a broker. The broker then can slice and dice the trade for best execution purposes. "Once the trade is completed, [the broker] sends the trade for downstream processing through Oasys," Kindregan relates, explaining that ESP's software sits on the client's location along the allocation path between Omgeo's Oasys allocation system, which automatically transmits trade details between investment managers and broker-dealers, and the OMS. In RS Investment's case, Clearvoyance sits between the asset manager's Charles River Investment Management OMS and Omgeo's allocation system, the brokers and the DTCC, according to Kelly.
"It sits in the back end of the OMS," ESP's Kurland says. "We capture all the allocations that come out of the OMS and make sure the downstream systems get the aggregated versions. ... We're compressing all the accounts at an aggregation level, per account, per symbol, per trade." An account that may have received five tickets from five different brokers, he adds, will receive one ticket from ESP and the designated clearing broker.
In addition to the ticket savings, the process results in fewer settlements for brokers, which lowers their costs and also results in a reduced number of trade breaks, cancellations and fails, as well as improvements in workflow, according to RS Investments' Kelly. These efficiencies, he suggests, offset the fee -- a small piece of the commission, about 10 mils -- that ESP charges brokers for its aggregation service. "If we can still get best execution and still reduce settlement fees, then that's the best of both worlds," Kelly says.