Stop, Rethink & Recalibrate: A View From Asia Pacific
I experienced a lightning bolt moment recently that made me reconsider a core principle of our equity trading world: Defining the value of execution simply on the basis of whether it's conducted via a high-touch or low-touch desk is an outdated concept founded on a model that no longer exists. Here in the Asia Pacific region, where bundling research and execution is still the norm, it is time for the industry to stop, rethink, and recalibrate.
The moment came while waiting in a long line at an Australian supermarket checkout and noticing a new self-service checkout section. It was amazingly easy and efficient to scan and pack my goods myself, swipe my card, and get out of the supermarket quickly. There was a moment when the scanner struggled to read one of the barcodes, but some quick help from an assistant got me back in business.
"Remarkably like the buy side using algos," I thought.
I went online to see what people were saying about this self-serve phenomenon. Some demanded a discount, arguing that if the supermarket was to save on wage costs, then the self-serve customer should share the savings. Many more, however, wrote glowing reviews of the new checkouts. They were pleased with the efficiency, the convenience, and the fact that the machines helped save time. Moreover, many complained about a lack of value added by the average checkout operator, so they far preferred using the new system. Does any of this seem familiar?
I realized shoppers were choosing either the checkout operator or self-service based on a judgment of what would suit them best, taking into account factors such as queue size, number of items, and predicted packing difficulty. But no customer was making the decisions based on price. So why has the sell side built an electronic product differentiated on price, rather than the value of the actual client outcome?
History no longer applies
There are two separate but connected historical factors. First, "low-touch" trading originally meant a no-frills DMA or basic algorithm, designed for simple trades and allowing the use of a broker's trading seat without much cost to (or service from) the broker. It was cheap to provide and was not expected to be supported beyond a technical level. It is no surprise that it was offered at a lower cost, particularly to attract business to these new tools.
Second, "high-touch" trading has long been used to pay for more than just the trade. It has also been the payment mechanism to cover research, corporate access, IPOs, etc. For simplicity, we will call this "research."
Now the market is evolving. Electronic tools are expected to be sophisticated and often customized. They are expected to be fed by and respond to complex data sets and include logic that chooses among multiple trading venues. Simultaneously, expectations of "low-touch" sell-side coverage -- advice on strategy selection, stock color, news updates, and accountability for performance -- are remarkably similar to those for a traditional high-touch trader, making the human element of high- and low-touch trading almost indistinguishable. This is compounded by an environment of increasing regulatory stringency, where the risk management and technical requirements of electronic tools are as high as requirements placed on human traders, if not higher.
Additionally, many global regulations and best practices now require a commission structure that clearly separates execution from research -- and with new rules from the UK FCA expected to trigger wider review of explicitly valuing what is being paid for, this is only going to grow. Several large buy-side firms in Asia have already adopted transparent models of trading, where the choice of broker and execution method is based purely on trade merit. These leading firms actively use commission-sharing arrangements (CSAs) to manage research payment obligations while giving their clients commission spending transparency.
Where is all this going?
I can see a world where the execution decision is about the trade outcome, distinct from research payment obligations. Given the increasingly narrow line dividing high- and low-touch trading services, it's not unthinkable that high- and low-touch commission rates will merge into one "market flow" rate for the bulk of standard trading.
A recent Greenwich Associates report reflects the notion that coverage models are already converging. "The barriers between high-touch and low-touch flow were created fifteen years ago as algorithmic trading began to take hold and brokers needed experts to explain to clients how electronic trading worked," the report said. "While that separation of duties made sense then, the divide is somewhat artificial today."
In a world where the value of research and the value of trading are viewed independently and on merit, this opens up other value-adding propositions within the trading environment. For example, buy-side firms increasingly lament that the art of finding a block is being lost by the average sales trader, so it's not surprising that specialist block desks at some banks, as well as the established electronic block-crossing networks, are gaining market share.
It seems clear that the buy side values three distinct services from the sell side: execution performance, sourcing of block liquidity, and research. What's less clear is the value ascribed to each service in a muddy mix of traditional bundled commissions on one side and a more transparent world on the other. However, it does appear that transparency is set to become the new world order, even if it takes a while for everyone to join the march.
Though the sell side continues to operate a two-desk service model, a future split may be based on market flow (combining electronic tools with human trading coverage) and block trading, as opposed to the incumbent high-touch versus low-touch model. At the very least, the continued move to a more transparent world should help us understand what is really valued and drive services that make a positive difference in buy-side performance. This will produce a sell side better equipped to add value to the buy side, and the industry will be stronger for it.Mr. Corcoran is responsible for client management and sales across the Asia Pacific. Over the past ten years with ITG, he has managed business development in Hong Kong and in his native Australia. View Full Bio