Greenwich Associates recently published a free-to-access research paper on the silent evolution within the world of Equities Low Touch trading. While I talk about this as an evolution, in fact it’s more revolution – changing the way the buy, and sell sides think about electronic trading.
The simple fact is this: The buy side, whether from want, or need is becoming more involved with how their brokers are executing their orders. Regulation like MiFID II’s unbundling of execution from research, and the wake-up call delivered by Michael Lewis’ Flash Boys has meant that no longer can the ‘how’ of execution be ignored. The broker’s algo suite has moved from a commoditized tool box that often times was simply a white-labeled version of another broker’s offering, to the new battleground broker’s use to compete for business. This shiny new thing has taken the form of customization, or to quote Greenwich, the ‘ability to say “yes” to their client’s request’.
As I noted previously, algo customization has always been present provided you were big enough to warrant your broker dedicating the right resources to the quantitative analysis, build, and running of that customization., But this simply doesn’t scale to the mass market. And for the sell side, it’s been limited to those with their own in house algo suites. But now we’re not really talking about the old form of customization, we’re talking about a wider-spread need to manage the order in the specific way that’s been requested, which will vary by client, market, size of order, time of day, or pretty much any variable you’d care to think of. While this is a less complex ask from the buy side than the algo customizations of old, it places a different burden on the sell side to handle what is essentially a higher level of care related to managing the order.
Taking a step back for a moment, Low Touch trading and the functionality we’re used to, has grown out of FIX connectivity platforms, with close to half the firms questioned in the Greenwich survey still utilizing separate technology stacks across High and Low Touch. If you were a player you had your own algo container (the ‘box’ that your team of quants use to build and run your algos). If not then you used the same service from the firms that did. FIX has always been that layer to massage the incoming messages, potentially allowing for subtle forms of defaulting or manipulation, but at the end of the day, you were still targeting an underlying algo, and only had dials of the related parameters to adjust to how you wanted to execute the order. If you had sent a VWAP order, you were going to end up with a VWAP, and on the most part both sides were happy.
Then things changed. Those with the algos became increasingly clever. New tags appeared as additional levers to change the way those algos behaved, and many times the cacophony of OMS, EMS, and connectivity networks were slow to adapt. Brokers addressed this gap by providing customization in the FIX layer, appending these new levers onto the client’s message. But if you had a VWAP, then you still had a VWAP, but maybe you had a new overlay of an “I Would” price (the price at which you were willing to trade the remainder of your order and forgo the rest of the time targeting the benchmark). This was just plugging a hole between the development of functionality and its adoption, but was in fact the first pigeon-step down the path of customization for all.
Coming back to the present, Greenwich show that the buy side is putting more flow out through electronic channels, and the expectation is that this is going to increase to around half the order flow in 3 years. And that’s before you consider how those high touch orders are finally executed.
The shift of control over how the order is executed is now presenting the sell side with a problem. How do you successfully say “yes” to each client’s specific and varied demands? Greenwich cite that 94% of electronic trading executives now see offering a customized order handling to their clients is key to their business, and additionally more than ¾ said they see customizations that involve the combination of algos. So this shift is recognized. But how is it being achieved?
The delivery of a broker’s algos comes through one of the following, In house developed, white-labeled off of another broker, or via a technology vendor, be that an algo specialist or within the firm’s OMS/EMS. If you own your own algos (or outsource to a specialist vendor) then you have the control to make the changes to adapt an algo’s behavior to the client. The challenge is that this creates a technical overhead related to the number of client specific configurations you’re operating in a system that was likely not designed to manage it. It’s a debt that needs to be paid back with every system upgrade and needs to be fully understood by both the techs and Low Touch traders in equal measure. If you’re outside of this group, then your options to provide an enhanced service are limited, as the brokers who’s algos you’re accessing are unlikely to help you out with some bespoke work.
What this points to is that the Low Touch OMS needs to have its Ronseal moment (for anyone not growing up in the UK in the early 90s hopefully this explains). It needs to actually manage the order, rather than simply process risk and be the window on your trades. Bringing a layer of order handling workflow into the Low Touch OMS brings with it an ability to think of the algos as building blocks at your disposal and truly define your own service – whether solely using another’s algos, or supplementing your service to fill coverage gaps, delivering a seamless service to your clients.
The time of low expectations in Low Touch is drawing to a close. The buy side’s search for increased service through the cheaper Low Touch channel is the factor driving this change, and becoming a prerequisite for winning business. And as Greenwich’s research piece concludes, as the tools at the Sell Side’s disposal evolve, so too will the demands of the Buy Side.
Chris Monnery at Fidessa