Raising the Bar on Low Touch
Electronic trading typically covers Direct Market Access (DMA) and Direct Strategy Access (DSA), the latter being where the buy side deploys an algorithm to break up a larger order into smaller slices seeking execution.
As market structure changed and liquidity fragmented over time, banks and brokers have competed on innovation within their algo platforms, together with the unique forms of liquidity or venues they may have access to. But with these developments happening in the algos themselves, little focus has been given to the overall management of the client order. While the algos have become more sophisticated, the function of receiving the order and passing it to the algo has remained fairly linear.
Fast forward to today. Investment managers need to comply with more regulations, they want to be more involved in the execution of their orders and they are under the gun to contain costs. The upshot is that more order flow is being sent through electronic channels (even if via a high-touch trader), and managers’ flow-handling requirements are more complex and onerous.
On the sell side, broker trading desks need to better differentiate their offering and exceed client expectations. And like the buy side, they are resource-constrained.
“Day-to-day support in electronic sales trading used to be just that – support,” said Brian Suth, Head of Electronic Trading at Evercore ISI. “That support is now at a deeper level; it is about working with the client to understand their objectives and how they are looking to execute the order, taking into account market-structure nuances and stock-specific characteristics.”
Investment managers are holding their brokers to a higher standard. “An interesting concept that is starting to take hold with the buy side is the wheel, where you can normalize your various electronic providers and their respective strategies,” Suth said.
“A buy-side firm might say, here are my five or ten brokers — their VWAP, their liquidity-seeking algo, their dark algo — and pit the brokers against each other using all the same high-level parameters,” Suth continued. “This is a way to standardize performance and execution quality, to determine who is providing best execution”.
Brokers need to raise their electronic-trading games in order to stay relevant.
“Low-touch platforms tend to be thought of as a combination of connectivity and an algo platform, with the OMS component seen more as a trader’s tool to track and manage client orders” said Chris Monnery, U.S. Head of Product Marketing for Electronic Execution at trading-technology provider Fidessa. “Both of these pieces are essential in handling low-touch business, but neither gives you the flexibility to handle the increasingly sophisticated demands placed on electronic flow.”
Monnery characterized the longstanding workflow as a “set-and-direct” execution approach, noting that sell-side platforms simply enable a routing path to a targetable pre-defined set of algos. “Today, the buy side is looking for greater involvement in the execution of their orders, and greater flexibility from their broker to support their needs. Once, if you were important enough you could ask for customization of an algo — this is turning to a more real-time requirement, and for a greater number of clients.”
The changing dynamic represents both a challenge for current workflows, and an opportunity for optimization. “We engage clients to help create custom solutions based on their specific trading objectives,” ISI’s Suth said. “Having flexible technology is crucial.”
“Low touch is without question changing,” Monnery said. “What was previously a story solely about algo routing, has pivoted to one focused on the flexibility to provide service, to accommodate the buy side’s needs, and to compete where everyone is pushing to provide best execution.”
“As a broker, you differentiate based on the quality of your execution and your ability to service a client’s need for customization,” Monnery continued. “The smart way to do this is to leverage your algos, piecing these ‘LEGO blocks’ together in a framework that provides systematic oversight throughout the order’s lifecycle.”
Monnery concluded: “What a low-touch trader needs to compete is an extra layer of workflow between the connectivity layer and their algos. Put simply, low touch no longer means low sophistication.”
With Eugene Kanevsky, James Redbourn, and Joanna Wong, CLSA
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