In October, the FIX Trading Community hosted a regional meeting in New York titled "Trading and Transparency – the FIX Solution.” During the event, discussion focused on electronic trading execution transparency and transaction cost analysis.
Senior representatives from several local firms were in attendance and offered their perspectives on these issues. The speakers included:
- Ian Domowitz, managing director and head of analytics, ITG
- Vlad Rashkovich, global business manager, Bloomberg LP
- Brian Lees, AVP and trading application manager, Capital Group
- Phil Mackintosh, head of trading strategy and analysis, KCG Holdings
- Kevin McPartland, head of research, market structure and technology practice, Greenwich Associates
The meeting panel members discussed important issues surrounding execution and routing transparency and how to obtain the information needed to effectively analyze the true cost of execution. A lot of material was covered during the event, and being somewhat new to this topic, I found most of it highly informative. Here I'll give a few golden nuggets I gleaned from the conversations.
(Note: The meeting was conducted in accordance with Chatham House Rules, which means that we can write about the content but cannot attribute quotes to any speaker or organization. Therefore, I have not identified the panelists quoted below.)
A bit of background
The process of buying and selling securities incurs both explicit and implicit costs. Explicit costs include items like commissions, taxes, and fees. Implicit costs are variable and are based on the effect that trading activity has on the security. Examples include costs around implementation shortfall, delay, opportunity cost, and information leakage. Transaction cost analysis (TCA) is the process for analyzing these implicit costs. Understanding these concepts helped me put many of the core themes discussed during the event into better focus.
Venues are ahead of sell-side firms in providing transparency
Since the FIX TCA Working Group added tags to FIX messages to provide execution information, certain buy-side firms have begun to gather this data via execution data from the venues. The venues varied in their speed of adding the functionality. Some were able to add the information to their FIX messages very quickly and promptly started transmitting that information with execution reports. Other exchanges, particularly those using vendor gateways and/or more complex legacy systems, took longer. One of the panelists reported that today, they're receiving this data from about 90% of US equities venues and about 80% of the European venues. Asian venues have a different market structure, and I didn't catch the status with these exchanges. The panelist said he's seeing much less participation from their sell-side counterparties.
One of the key goals for the buy side is evaluating how much information leakage is impacting trading results. One of the speakers commented, "If you're on a venue routing mechanism, then you're probably leaking information." The speaker was talking about the issue of routing orders to brokers with the goal of getting the best price. The broker routes the order to a venue, but if the venue doesn't have the NBBO (national best bid/offer) at the moment when it receives the order, and if the order is not set to cancel immediately, then the venue is obligated to route it to where the best price can be obtained. In this case, the market can move during the routing process, resulting in slippage and the potential for the order to bounce around between venues like a Ping Pong ball. The buy side has little or no insight into those routing decisions or which venue actually executed the order.
In this case, the speaker pointed out, it's less about transparency and more about objectives. "Sometimes, it's more important to sweep and signal less. It's better to focus on avoiding leakage than getting the lowest price at any moment."
Strategy must be considered in venue analysis
The moderator reminded the group that we can't compare venues without considering market conditions and trading strategy. He said, "We've generated 20 years of collective amnesia with respect to venue analysis. In the 90s, we realized that you can't analyze the venue without knowing something about the strategy. For example, OMX in London used to have an 80% cancellation rate. But it was because the equities exchange was linked to the options exchange, and the strategies required an execution on the options. So when you looked at the strategies being executed, the high cancellation rate made perfect sense. It's not just a routing decision -- it's a strategy decision."
The panel agreed. You'd never evaluate an algorithm without taking into account the market condition. You should not do it for venues or routing decisions either. The fee structure at each venue also has an impact on routing decisions. These also need to be considered when doing thorough venue analysis. I'm guessing that this is part of the issue for the buy side. Are routing decisions made because of fee and rebate structures, or because that route made the best sense for the objectives of the order?
Understanding the impact of market movement
One panelist said, "When we're trying to understand how the brokers are behaving on our behalf related to a given strategy, we're not looking at all the routing decisions that were made. For example, we'd like to know if when an order hits one venue, the rest of the market runs away." In this case, the buy side is trying to understand the behavior of their selected algorithm, so they can predict performance and potential market impact, and adjust their orders and strategy in real time. "We didn't write the algo, but it's our order out there, and we need to know how it's behaving." Another panelist said, "We need to understand how market movement affects us."
The current FIX message structure is insufficient
The panel talked about how much data this level of transparency would require. They all agreed that the current FIX specification does not include sufficient tags to cover the information needed. A panelist said, "You don't just need the tags we have. You'd also need print size, market cap, volatility, and spread."
I have my doubts that we'll see a lot of progress in this area in the next 2-3 years. I don't think that most members of the buy side have the budget or processing power to actually make meaningful progress with the transparency data that is already accessible. But it will be interesting to see where we get in the next five years, as data volume and computer processing power follows Metcalfe's Law.
An extended version of this blog originally appeared on PropelGrowth.com.Candyce Edelen is CEO of PropelGrowth, an agency helping financial technology companies develop and implement go-to-market strategies. Prior to PropelGrowth, she co-founded two financial technology companies including Selero, a company that provided order routing gateways, ... View Full Bio