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03:07 PM
Garrett Nenner
Garrett Nenner
Commentary
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Small 'New Market' Change? I Don't Think So.

I come to you as someone who has managed a desk and a portfolio for many years, then took that experience to the broker-dealer side. This two-sided viewpoint continues to foster a deepened interest in market structure and maintaining client awareness of better execution. I have found that within the 'new market' and its emerging structure a rebirth of an old concern.

By 'new market' I refer to the current decreased liquidity and the ability to source it, and the concern is achieving the best execution price - at the best cost of receiving that best executed price and its affect on PNL.

The first point of attention is on current volumes. With a quick review of monthly NYSE Composite volumes since January 2010, there has been a starved market and an active VIX Index. Sell side commissions earned have noticeably been impacted across the Street, but with stress comes ingenuity. With that in mind, is this something you need to be wary of?

Absolutely. It begs the question of how your execution/trading partner manages your order in this environment. This is just another place where the implicit cost of execution rears its head - again.

We could go back into and revisit any diatribe about running TCA, or demand for Cost Plus accounting - but I am only putting that in your mind for you to reflect upon while I continue.

What are the possible ways to improve inbound broker commissions when there is less order flow to that broker as a result of decreased volume? It's not about commissions paid. You must ask your broker (confirming they are your partner in execution, not just a 'service') how they represent your order on their desk or in an algorithm and why. Sitting with your order on the bid or offer - as a liquidity supplier, in most cases will afford that broker a rebate and an increase in PNL beyond commission.

Now that they have placed your order in the optimum rebate-able position, it can allow the broker to earn an average rebate of 13 mills, to a maximum of 34 mills for adding liquidity to a particular venue - note they can also lower their take fee costs from an average of 17.25 mills or earn up to a rebate of 15 mills as a liquidity taker. This means that your own costs, on a one cent commission, had an opportunity to be lowered between 13% and 34%, or between $1,300 and $3,400 on 1 million shares. Based upon these unseen (and unrealized) rebates, you should care to look at it that way, it is something you will not see highlighted on your confirm, in your funds cost of doing business OR in improved investor PNL.

This scenario unfortunately can be magnified when there is too large of a separation between the sales desk and their own internal execution desk or there is a too high a ratio of sales traders to execution traders. Here the expectation is that these two internal desks aren't disassociated enough to be out of sync with what the client's goal is within the strategy they are trading - and the PNL goals of each internal desk does not create the paradox of who's best interest they are trading for.

Arising issues such as the proposed Volcker Rule on Market Making may limit this as an in-house venue for execution and profit - another stress point for completing client orders, capturing fees and generating broker firm PNL.

Ask the question: How are my orders represented? What routes are commonly used for your orders? A true trading partner will tell you.

It is important to be aware that there are unnecessary risks involved in trying to capture rebates when what you need to do is complete your order at the right price. This can result in missed volume opportunity, poor execution price, and at the same time drive your implicit (you're not receiving any piece of a rebate) costs up - which is slippage that you did not have to fully realize in your returns.

On the other hand, you may get lucky. But, it's not about luck.

Garrett Nenner is managing director, global markets at Momentum Trading Partners, a high-touch agency-only broker-dealer focusing on equities and options execution.

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