The shifting sands of execution in today’s markets
The electronic execution landscape has undergone a slow but steady transformation over the past decade.
Increasingly seen as a commodity, execution infrastructure provides essential functionality without which it would be impossible to operate, but few brokers see it as a means of gaining any real advantage over their rivals. Today’s differentiators are found higher up the chain; sophisticated algos, execution consulting capabilities and other innovations that sit on top of the execution infrastructure.
More crucial than ever to the bottom line, execution is now something that brokers need to get right. But getting it right has become a lot more difficult.
The costs associated with execution have ballooned during a period when brokers’ margins are already under tremendous pressure. As markets continue to grow and diversify, the execution landscape has become far more complex too. Electronic trading has spread into new regions and new asset classes, each with their own regulatory dimensions. The increasing need to be everywhere and support everything, and yet still do this in a controlled and consistent manner, will define the battle for supremacy between global and super-regional brokers.
The last decade has seen a staggering proliferation of new venues around the world, and the trend is set to continue. In Europe, for example, there were 175 markets registered at the end of 2007 and this has risen to around 280 today. Including the 60 or so markets that have come and gone in between, that’s more than 160 new venues – nearly double in just seven years. The increase globally has been gradual, but stark, and all of these venues come replete with their own subtleties and idiosyncrasies. Additionally, each venue typically makes one or two mandatory upgrades a year – that alone means brokers are running pretty hard just to stand still. But the world isn’t standing still.
Regulation has compounded the issue. A new regulatory consensus has emerged in the years following the crisis, focused on transparency. The regulators’ belief that lit markets are good and OTC is bad means they aim to push trading away from OTC and dark pools and onto lit markets – a trend that shows no sign of slowing down. This will put further pressure on margins, especially for the scale players, and will accelerate the spread of electronic trading to new asset classes.
In the US the move to push OTC derivatives trading onto exchanges has resulted in the creation of over 20 SEFs (Swap Execution Facilities) since 2013. No doubt this number will fall, but at this stage brokers have no way of knowing for sure which will make the cut in the long run. In the absence of a crystal ball, they need the flexibility to switch in and out of new markets with speed and ease, and the ability to test the waters of new markets with minimal risk.
A number of European reforms underway, such as Mifid II, serve to further highlight this global regulatory trend and place execution quality firmly in the spotlight. Even though decisions about when and where to trade are made above the execution layer, brokers will need to make major changes to their execution infrastructure in order to support new monitoring, control and transparency requirements.
This shift in landscape has been dramatic, but because it’s been gradual many brokers’ electronic execution capabilities have evolved in a patchwork manner. Extending an existing system beyond its original intended scope carries its own risks, and often the cost alone is prohibitive. Instead, market access infrastructure – whether developed in-house, outsourced to multiple vendors, or some hybrid of the two – has been bolted together piecemeal as firms have expanded their capabilities and moved into new regions, new markets and new asset classes. The upshot is a multitude of systems underpinned by different technologies, duplicating routes to market in some areas, and failing to provide any route in others – with all the resulting inefficiency this entails.
A realisation is dawning that this approach no longer suits the vastly different trading environment that brokers now find themselves in.