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10:55 AM

10 Ways to Manage Conflicts of Interest on Your Broker-Owned Platform

Buy-side clients need to understand that when they trade on a broker-sponsored platform, they are paying for these systems, whether that payment comes in the form of commissions, licenses, or widened spread. Therefore, the most important thing the buy side should do is to think like a customer.

The last year's market deterioration made things difficult for brokers, who are seeing tighter spreads, fragmented flow, smaller trade sizes, and compressed commissions. Brokers now face the most difficult operating environment in recent memory, with decreased market liquidity, increased message traffic and lower order volumes from clients.

Brokers also find themselves in an adverse situation, having over-invested in a number of areas, including their trading infrastructure, their capability to generate algorithms and their ability to process trades. Most broker's capabilities vastly surpass the current needs of their clients.

From Bad To Worse
And just when you thought that things could not get any worse for brokers, they are now increasingly subject to regulation seeking to promote transparency. Brokers also have to deal with plan sponsors who need to justify more effectiveness in trade handling, and, more generally a buy side that wants to clear up the inherent conflict of interest of broker-sponsored platforms.

As broker-sponsored platforms face an uncertain future, sophisticated buy-side firms have to answer difficult questions about how they manage the associated risks of trading on these platforms ... and whether those risks are worth taking at all.

Although broker-sponsored platforms can be conceptually acceptable, investors need to protect themselves against the risks that these systems could potentially generate, such as significant market impact, limitation of transparency and higher, undisclosed, transaction costs.

Top 10 Buy Side Concerns
Here are the the top 10 issues every buy-side trader needs to be mindful of to ensure efficient and effective trading on their broker-sponsored platforms:

1. Control Information: In the financial markets, information IS money. To avoid leaking information (and money) every buy-side firm should maintain a clear policy on its data flow, especially in markets with tight liquidity, like corporate bonds or blocks. Using single-dealer platforms or even multi-dealer RFQ platforms in some cases could be similar to advertising positions to the entire market place. The buy side should assume that information is public as soon as it reaches a broker operated single- or multi-dealer platform and check that its business objectives are compatible with this disclosure. (For example, iceberg and registered orders could be read and used by pricing servers.)

2. Use Multiple Platforms: Do you want to show all your order flow to one broker by accessing only their execution management system (EMS)? This can be a risky strategy. If you need to access single-broker platforms, it is best to have a few of them, so you can avoid giving one counterparty too much control over your execution quality. To be sure, to make it worth executing on a single-dealer platform, the capability to tap internal crossing capabilities should be, at the minimum, flawless. Don't think that consortia platforms are better in that respect -- they just distribute the information to more people.

[For more on how the buy side is evaluating EMS systems, read: Market Structure Drives the Buy Side to Seek New OMS/EMS Systems].

Philippe Buhannic, CEO and co-founder of TradingScreen, is an industry pioneer. Buhannic has stayed on the forefront of global markets and financial technology for more than 30 years, in a career that has spanned executive management, technical, and marketing experience in ... View Full Bio
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User Rank: Apprentice
7/27/2013 | 10:09:18 PM
re: 10 Ways to Manage Conflicts of Interest on Your Broker-Owned Platform has Obsidian, it is also great. Regulation is a bad idea, I would suggest finding a broker that offers full transparency, and a pure agency model. Check out DASH Financial.
User Rank: Apprentice
7/27/2013 | 10:09:18 PM
re: 10 Ways to Manage Conflicts of Interest on Your Broker-Owned Platform has Obsidian, it is also great. Regulation is a bad idea, I would suggest finding a broker that offers full transparency, and a pure agency model. Check out DASH Financial.
User Rank: Apprentice
7/17/2013 | 11:42:24 AM
re: 10 Ways to Manage Conflicts of Interest on Your Broker-Owned Platform
perhaps a better approach is utilize one of the select number of broker-neutral OEMS platforms (OMEX Systems is a good one)--which can be loaded with clients choice of algo's on top of the DMA tool. That said..any algo "manufactured' by a firm that also prop trades, but makes their algo available on a license basis will always have a micro-second 'first look' at any order that goes through their mousetrap. It boils down to trust. Perhaps the industry should adopt a rule that prohibits any order of less than 1000 shares to be algo compatible--so as to limit the gaming by the HFTs?
Philippe Buhannic
Philippe Buhannic,
User Rank: Apprentice
6/20/2013 | 6:27:05 PM
re: 10 Ways to Manage Conflicts of Interest on Your Broker-Owned Platform
Thanks for the note Ivy.

The short answer to your question is: You can't - and that is the whole point.

As soon as a platform is sponsored by a broker (and given the fact that in many markets internalization of flow has become center stage the broker(s) operating the platform) brokers have a strong incentive to "read" the customer flow.

Unfortunately this is true not only for the orders sent but also the reserve in iceberg orders and the orders that have not been launched yet and even the portfolio positions. This is dreadful for the investor, as he or she will be showing all of the cards their hand to the market.

In illiquid markets (and most have become illiquid) the risk is also high. For RFQ especially within the fixed income market, it is really bad as the standard model is to send your intention to multiple banks, so, effectively, you are informing the entire market. This is why the streaming platforms are so superior for the investor.

With-single or multi-broker platforms you will never be "leak-proof." Only FULLY independent platforms (even Bloomberg is not in this category, as they have TradeBook and as was proved recently with their chat) can provide this level of discretion. In the current state of the market, this is the most valuable commodity for large traders.

I am surprised that some large buy side firms are even entertaining the notion of working with multi-broker sponsored platform, as it puts them at odds with their mandate of best execution and conflict of interest free policy. Very surprising. I suppose that this is the power of the banks marketing...
User Rank: Author
6/19/2013 | 1:22:39 PM
re: 10 Ways to Manage Conflicts of Interest on Your Broker-Owned Platform
The number of broker-sponsored platforms has been diminishing in the market, but there are quite a few major sell side EMS platforms out there. How does a buy side firm validate the security of its data flow once it's inside the broker? As you point out, the buy side uses single dealer and multi-dealer platforms for RFQ? Can this really be leakage proof? Or does this come down to trust and relationship.
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