Transparency To Rule Buy-Side Front Office

Shanny Basar

Transaction cost analysis will dominate front-office discussions this year due to increased pressure on budgets and new regulations aiming to increase transparency according to consultancy Aite Group.

MiFID II, the regulations which came into force in the European Union this week, require the buyside to provide more evidence of best execution to their clients. In a report, Top 10 Trends in Institutional Securities & Investments, 2018: Regulatory Roulette, Aite said increasing regulatory pressures and the need to justify performance have greatly enhanced the role of transaction cost analysis for asset managers.

“MiFID II’s changes to the European market structure will likely trigger increased fragmentation, change buyside to sellside relationships, and introduce new challenges that will force the buyside to adopt more electronic trading, TCA, and automation,” added Aite.

However the consultancy also noted that the overall quality of TCA output and the resulting interpretation needed to improve. Two key limitations of traditional TCA are its ineffectiveness in accurately incorporating opportunity costs associated with unexecuted orders and order cancellations, and the fact that real TCA needs to be enhanced to evaluate execution performance based on the portfolio manager’s order intentions.

Aite predicted that MiFID II will create buyside demand for TCA across asset classes that improves the investment process. In addition, the unbundling of trading commissions from research  payments required under the new regulations means buyside trading desks can focus on best execution and adding to alpha.

“The trading desks with chops should shine and are likely to embrace TCA innovation that helps them improve,” added Aite. “But mediocre trading desks will eschew TCA and, over the long term, these funds will remain at a competitive disadvantage.”

In addition, pressure on fees are leading to asset managers wanting transparency on the true cost of ownership of their trading technology including the direct and indirect costs associated with the purchase, implementation, and ongoing maintenance and support of the system.

“Game changers such as Software-as-a-Service and the cloud, managed services, big data and alternative data, and system hacks are forcing the buyside to rethink and at times pivot its approach to IT selection and management,” added Aite. “Most buyside firms Aite Group speaks with have either recently changed their front-office technology systems or are in the process of adding or replacing systems within the next 12 to 18 months.”

One of the challenges for improving TCA and complying with the MiFID II best execution requirements is finding the right data, especially in less liquid markets such as fixed income. Aite said: “Firms’ entire operations from front to back office will need to engage in a program of work to source and aggregate the correct data to populate the high number of reporting fields, as well as to ensure these data items are properly maintained over time.”

Aite continued that the long-term effects of MiFID II will take time to emerge, but the combination of transparency requirements, research unbundling, and new technology will create significant structural changes in the data sphere.

Kevin McPartland, head of research for market structure and technology at consultancy Greenwich Associates, said that one of the top 10 trends for this year is that “data matters more than trading.”

“After years of debating trading protocols and what should be counted as “true” electronic trading, the debate will shift to who can provide the best data and derived insights that ultimately help both liquidity-makers and takers get their jobs done,” he added.

He also included a soft launch for MiFID II amongst the trends. McPartland said MiFID II is so wide-reaching that European regulators are unlikely to crack down on imperfect compliance at the start of this year.

“We should expect some short-term hiccups that include some counterparties not interacting with one another because of incomplete processes or legal work, non-European firms opting to interact with other non-European firms, and manual work-arounds involving junior staff where technology isn’t yet built,” he said.


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