Central clearing offers buy-side firms aggregated electronic stock trades, eliminating the hassle of writing thousands of tickets to clear and settle trades with multiple counterparties. The concept was introduced by Electronic Specialists (ESP), a New York-based technology provider and registered broker-dealer, with the launch of its Electronic Algorithmic Routing Network (EARN) last year.
EARN is a broker-neutral pipeline with messaging that provides the buy side with access to more than 75 broker algorithms and crossing networks as well as direct market access to exchanges and ECNs. If a buy-side firm buys 1 million shares of a stock across multiple venues, for example, ESP gathers all the trades and writes one ticket for each block, reducing the number of trade tickets that the back office has to write for clearance and settlement purposes.
Because ESP - which has one competitor, Boston-based Firefly - is clearing the trade for the buy-side customer, and allocating and delivering against the customer's custodial accounts, the customer, in most cases, remains anonymous to the broker.
According to Madison Gulley, EVP and director of global equity trading at Franklin Templeton Investments, which uses ESP, central clearing provides value in a fragmented equity market in which a single order can be executed through multiple brokers, ECNs and crossing networks in order to capture liquidity. "The aggregation of executions done through multiple intermediaries is a big benefit to the buy side and to anyone who is executing and would have to clear through multiple locations and counterparties," he says.
ESP allows Franklin Templeton to execute through multiple counterparties throughout the day, "And, at the end of the day, you wrap it up into a single block and clear through one counterparty," Gulley explains. "You pay one ticket charge per account."
ESP has been working with the money manager for the past year, says Scott Kurland, senior managing director at ESP. Kurland notes that the buy-side firm is connected to about 18 brokers, crossing networks and ECNs via ESP's EARN portal, which has been integrated into Franklin Templeton's workflow, centralizing its clearing and reducing its costs. "It's giving them one-stop shopping access," says Kurland. "It's giving them the option of anonymity when trading with some of these brokers, and it's giving them centralized clearing and delivery when they use multiple destinations."
While the buy side may find the concept of central clearing valuable, some sell-side firms have had a turbulent relationship with ESP, according to industry sources. Several leading brokers that have made their algorithms available to the buy side through EARN are having second thoughts. Credit Suisse First Boston (CSFB), Banc of America Securities (BAS) and at least one other broker-dealer have backed away from deals with ESP or are working through issues with the aggregator.
Reportedly, CSFB ended its relationship with ESP, which was announced in the fourth quarter of 2004, in March or April. Several sources say CSFB went live with ESP for a short time but ended the partnership because ESP was undercutting CSFB's pricing. Sources say the aggregator was charging institutional customers less to use CSFB's algorithms than CSFB was charging clients directly. CSFB officials declined to comment for this article.
ESP's Kurland declines to discuss if CSFB ever went live with ESP, saying only, "We're in discussions with CSFB, but we're not doing anything with them at this point."
Another undisclosed institutional brokerage also shut off its algorithms for a few days in May after it discovered that ESP was undercutting its prices with an existing institutional client, according to an official at the brokerage firm who requested that the firm not be named. The broker was providing the institutional client - ranked among the top 10 equity asset managers - with transaction cost analysis services, and therefore was charging the asset manager a premium rate for the value-added services.
"[If] the client wants the whole suite of our products," the official says, "[it] has to pay a higher level of commission." After learning that ESP was charging wholesale rates, the broker shut down ESP's access to its algorithms for a few days, he relates.
However, the broker turned the connection on again to accommodate the client, which wants to centralize all of its algorithmic trading through ESP, according to the brokerage official. But this time, he adds, the broker requested "fully disclosed connectivity" - meaning the client ID would be disclosed. ESP has not yet provided the broker with client attribution, the source says.
Angling Over Anonymity
One of the big selling points behind ESP is that it offers the buy side anonymity so that brokers do not know the identity of the firm sending them order flow. But the sell side isn't enamored with the idea.
BAS is among the sell-side firms that have concerns about accepting anonymous orders from buy-side clients via its algorithms. As a result, ESP has allowed the firm to use its service on an attributed basis, according to ESP's Kurland.
"It's hard to support a client if you don't know who the client is," says Rob Flatley, managing director of Electronic Trading Services at BAS. He adds that if a client is anonymous, it's hard to track research credits or contact a client if there is a problem. "We accommodate clients to whatever extent possible, choosing what technologies or systems they want to use when routing trades. In this case, we had a client who wanted to route through ESP so we accommodated them."
Franklin Templeton's Gulley notes that ESP offers multiple levels of anonymity, which it refers to as attributed trades. "You, as the buy side who owns those trades, have the ability to attribute yourself to that trade, or remain unattributed at any point along the execution curve," he explains.
Kurland says some brokers are fine with the anonymity and other brokers will only do business when they know the end customers.
Despite the turmoil with the sell side, ESP is working with a number of brokers to add their algorithms to EARN, though Kurland declines to name them. "The concept of the one ticket is very compelling to investment managers that have thousands of custodial tickets," says Kurland. "If we can reduce that number from 10,000 to 2,000, it's pretty significant."
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Neovest Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio