J.P. Morgan Asset Management’s Head of Trading, Kristian West, shares the role technology plays on the trading desk, including the time given to technology, evaluating tools and conveying that value to portfolio managers.
IT and the Trader’s Diary The technology function in many firms was previously seen as a necessary evil, whereas now it is seen as part of the core function of what we do. At J.P. Morgan Asset Management, we have eight technology specialists on the trading desk, so quite a lot of time is spent working with IT by virtue of them being on the desk. The trading function has become much more technology intensive and we wish it to be at the forefront of what we do. As a percentage I probably spend around 30% of my time specifically on IT related initiatives. We spend a significant amount of time thinking about and planning technology initiatives for their effectiveness and value as well as best practices.
In addition to this, there are a variety of obligations that keep me away from the desk, such as regulator meetings, compliance meetings, customer presentations, broker meetings, client reviews, TCA reviews, etc. We also have to ensure we have the relevant oversight and controls over our trading practices, which requires us to focus on relevant due diligence measures. Due to MiFID and various other potential regulatory changes, we spend a lot of time making sure that we have oversight and knowledge of all available options. We then take a view of what we think will be the likely outcome and focus our attention accordingly. Again, this requires the business and technology to work very closely together.
Communication with Portfolio Managers The central trading function is responsible for achieving the best possible outcome for the customer. There is no specific guidance from investors on how to trade or where to trade. However, from a communication perspective, there is a great deal of dialogue when we have an order on the desk. Certainly, if it is a multi-day order, then as much communication as possible is encouraged so that there is a fluid relationship between the investor and the trader, maximising our trading opportunities. More formally, we have monthly and quarterly reviews with all the CIOs and investment teams to discuss market activities, flows, broker relationships, transaction costs, etc.
We are able to optimise our performance when we understand the intentions and motives behind the orders. This allows us to adjust our level of participation in the market. In addition, we need to consider upcoming events or corporate actions, as acting quickly helps reduce market impact and slippage.
Active or Passive? When to Pick up an Order We have a defined flow process which is focused on liquidity, so if we have flow that meets certain criteria, it is automated and no trader is involved with it. The characteristics of the strategy that is chosen can actually be defined by the investor, allowing them to define how aggressive they want to be. With regards to allocation of flow, the OMS knows which area of the trading desk to send orders to and the automated engine will take orders that it feels it can execute. The automated engine then takes over and will alter its behaviour over the life of the order, depending on what is happening in the market.
A large chunk of business is fully automated, but if it does not fit defined criteria, it will go to the program trading team who will try and use their liquidity and the liquidity exposed to them to minimise market impact. If the order is too large (we have certain thresholds) or there is no natural liquidity in the market, then it will go to the single stock trading team. At that point we speak to specialists in those names. As a result of this process we have changed the way we interact with the market. We take on a lot more ownership and responsibility for the quality of execution and thus, less is left to the discretion of the broker. So whilst our execution process is not fully automated, the allocation process almost always is.
At the Mongolia Today – Opportunity To Reality event hosted on the 20th March in Hong Kong by professional services firm PwC, the passage of the new Mongolian Securities Law, which has been under consideration for some time, was the focal point of the day.
The law contains a number of key provisions which will enhance the openness and efficiency of the Mongolian Stock Exchange and the ability of foreign investors to dual list, trade, and open up the depository receipt market.
Mongolia is a rapidly growing economy, seeing growth of 17.5% in 2011, and over 12% growth in 2012, on a nominal GDP of $9.9 billion in 2012. With the economy increasingly opening up to foreign investment, reform of the capital markets and the mining and agriculture sectors have been high on the agenda. With commercially viable quantities of more than 80 elements on the periodic table available for mining, Mongolia has taken giant leaps up the international ladder of commodities producers. However, the market is in desperate need of capital.
“I think this roundtable proved to be very useful. It provided the regulators with an opportunity to get together in search for an optimal mechanism of how to collaborate and what essentially needs to be accomplished to expand the market and continue promoting foreign institutional investors participation in Mongolia. Obviously, the amount of work that needs to be done in order to support the new initiatives is immense. Nevertheless, those initiatives certainly must be put in practice in order to be fully successful in reaching our end goals. We’re not reinventing the wheel. We are taking the wheel and applying all necessary adjustments to make it much more “polished” in tune with local standards. We need more liquidity, thus, more inward investment. As I understand, Mongolia has already come on the radar of a number of global investors, and, provided that we make necessary amendments in our legislation to promote opening of our market to foreign investors and foster investor confidence, and strike the right balance between domestic and foreign investors’ interests, we may truly become the next remarkable story of dynamic growth and development.”
Saruul Bulgan Director General, Securities Department, Financial Regulatory Commission of Mongolia
“This is the first time that the regulator, exchange, and foreign and national banks have got together to discuss the new business that is due to enter Mongolia in the second half of 2013. The major takeaways from this session were that all parties involved in this business understand the requirements and needs of international investors because the custodian business is there to invite and drive international investment into Mongolia – investment that is very much needed in Mongolia. This has been an excellent starting point for future collaboration between the parties.”
Andrew Economides, Head of Market Development, Mongolian Stock Exchange “It was a well-organised event and it was very interesting to bring together the Mongolian and the international players. At the moment, one of the major things missing from the Mongolian market is the post-trading infrastructure. We are working on bringing that infrastructure to the market. However, as the market is so new and the people involved in the market lack experience, it is very important for the international players involved to be on our side and to help the market moving forward. It’s also important for foreign institutions to consult with local institutions and the regulators in order for the latter to utilise international experience and expertise. I’m very happy to see that the Mongolian stakeholders, the regulators, the facilitators and the banks, are very keen to listen to what the international community has to say. So I think that all these factors will lead to a positive move forward when the right infrastructure is in place.”
The day itself was split into two segments, first a roundtable, attended by key Mongolian stakeholders, including the stock exchange, the regulator, the central bank, major domestic banks, and foreign banks and brokers looking to enter the market. The conversation was a frank exchange of views, covering what the domestic market wants and needs, and what the foreign banks want and need from the Mongolian regulator and exchange.
The one word summary of the roundtable would be liquidity. The creation of liquidity, and the protection of liquidity providers were key concerns for all parties.The second, larger, part of the day focused on custody and the importance of the relationship between local banks and foreign investors in providing custody services. The balance of protecting Mongolian interests and the wish-lists of foreign banks will be an ongoing debate, but the open discussion at the event was at least good natured.
Are the markets crumbling or multiplying? With Josephine Kim, Director, Asia Pacific Electronic Sales – Global Execution Services, Bank of America Merrill Lynch.
How is market fragmentation changing and developing across Asia? Japan had the first mover advantage in Asia as the first to welcome fragmentation, but it has not really blossomed, compared to Australia where we have seen a lot more volume growth on the new venues and execution channels. Hong Kong is quite interesting because most people really want to get fragmentation into that market, but there are limitations such as regulation and the proliferation of fees. Brokers do offer internal crossing engines, so a lot of clients are benefiting from those.
India is also interesting because it had two exchanges for years and recently got a third. We do not see that much activity, but at least it is creating a lot of buzz in terms of how fragmented the market is. It will be interesting to watch.
How are other Asian markets developing? It typically depends on how the exchanges are preparing themselves. If you look at Japan for example, they opened up to various alternative venues and were pretty open-minded in terms of sharing their liquidity with other independent venues. But then the exchanges decided to merge to be more competitive as they realised that liquidity is something they want to keep. Australia is forcing the exchanges to share liquidity with best execution rules.
Korea and Singapore are the two markets most likely to come next, although there are other venues like Indonesia and Malaysia where a few broker-dealers offer limited crossing engines. Korea is a very active market, especially for futures and options, so a lot of people are interested in trading, but then again, they do have the investor ID restrictions and they are trying to implement a financial transaction tax so that is going to kind of hinder the attractiveness of trading.
Singapore is slightly different because the market depth is not as attractive as Korea. Singapore used to be a hub for US and European-based high-frequency trading firms, but it just seems to be losing its ground as a hub. Having the longest trading hours in Asia may open more doors for investors from different time zones but without the market depth, it will still be a challenge for Singapore to attract investors and independent liquidity providers. Minimum crossing rules also draws interesting opinions from people as some believe this will enhance and control the market participants and reduce toxicity of the pool albeit the overall reduction on actual crossing opportunity.
How does that variation across markets affect the trading environment? The buy-side used to choose an execution broker based on the level and quality of research and their trading ideas. Today, the buy-side tends to go with the broker that has the liquidity. So, the buy-side traders are often watching the market and watching their stock, so they can see who is on the order book panel, and they tend to put their entire orders on the brokers with the most liquidity. A lot of this change is tied to unbundling, but it is also to do with the liquidity and facilitation as they often find it difficult to trade when there is less liquidity available in the market.
Are changes such as CSAs enabling that unbundling and enabling that separation between research and execution? Are these tools coming into existence to meet that desired change or are these tools enabling that change? These tools are definitely opening the doors for the traders to choose from. It is simply an option that, because of this policy, the buy-side head traders have the independency to choose the best execution brokers and feel less obligated to trade with the best research providers.
On the sell-side everyone is becoming more liquidity sensitive. The buy-side trading instructions are becoming more complicated; the buy-side still want to have the baseline of a simple VWAP or POV as their first and second algos, but when the liquidity comes in, they do not want to miss out that opportunity, so a liquidity seeking type of smart algo, with a combination of base benchmark, seems to be being used more commonly.
How are the liquidity profiles of those venues changing? Let’s use Australia, as an example. It is mandatory there to provide best execution to the client. That means that it is the broker’s responsibility to find the best execution price, across the dark or lit; it is not a choice anymore, it is an obligation. So, because of that, we started looking at the quality of liquidity pools. The number of liquidity pools has gone up a bit such as Chi-X Australia launching in 2011; and there are numerous exchange provided dark and lit pools – see Table A-1. The quality of each venue has risen as various enhancements or improvements have come online. We now care more about where orders are getting crossed within the dark liquidity, whether it is getting crossed at mid or better, or whether it is having any price reversion after the fill has been made. So, I think that quality is top of mind now.
If you look at the market share, we are still talking about a small portion of the pie – see Table A-2. One has to also have context of this and understand how dark liquidity is performing in the US and Europe – see Tables B1 and B2.
Asia’s market structure creates demand for increasingly granular trading information – as Kent Rossiter, Head of Asia Pacific Trading Allianz Global Investors and Michael Corcoran, Managing Director ITG discuss, FIX can help.
Asia Pacific faces different liquidity challenges to other regions, particularly given that spreads are often much wider and are therefore an even more significant contributing factor to overall trading costs (See Chart). As the trading environment evolves in the region and the focus on managing costs grows, the requirements for transparency and feedback on trading increases. This is happening in parallel with the evolution of new trading venues in the region, particularly dark pools. Buy-side traders now want a greater level of detail on their dark pool fills to help them understand the behavior of their orders and manage their execution venues proactively to get the best trading result.
Kent Rossiter heads up the Asia Pacific trading desk of Allianz Global Investors, and is constantly looking for ways to improve the efficiency of their process and minimise the costs of trading. From his perspective, while post-trade TCA is now well-established, a particular growth area is the requirement for more detailed data on a shorter timeframe. He explains “We as buy-side traders are now trading an increasing amount of our orders ourselves using the electronic tools available, and when we do so we want more granularity and data fed back to us: which venues are our orders being executed in, at what price, and how aggressively. We want information that helps us adjust strategies on the fly for better trading outcomes, or quickly review the results so we can manage our future performance.”
One result of this is new demand in the region for analysis of maker/taker indicators on orders so that a trader can identify how often they are crossing the spread to find liquidity. Allianz Global Investors has been working with ITG and other brokers in the region to implement support of maker/taker analysis to help the trading desks improve their insight into market conditions and get more transparency into the behavior of their orders in dark venues.
Understanding Maker/Taker Understanding whether an order is making or taking liquidity is important, particularly in wide-spread environments such as many of the Asian markets. Michael Corcoran, Managing Director of ITG, says “Traders want to know instantly whether they are providing liquidity or taking it, instead of retrospectively needing to compare fills and timestamps manually against what the market was trading at. This can be very useful information to help them adjust the trading strategy in real-time to the market conditions and the liquidity available. It can also help determine what kind of ‘throttle’ they should put on their strategy or their algo to find the right level of aggressiveness for the orders they are working. In addition to that it can also be a very valuable tool for sell-side firms, helping to refine the development and rules of algorithmic strategies and improve strategic ideas that will work for certain clients or order types.”
This is of growing relevance in a multi-venue environment, for example in Asia where over the past few years a lot more broker dark pools have been developed. Many buy-side firms now choose to use a dark aggregator to help improve their efficiency in accessing multiple venues, and here some kind of maker/taker liquidity analysis can be a helpful data point for assessing the type of outcome a trader is getting in those pools. Corcoran explains “Both ITG as a dark aggregator, and our buy-side clients themselves, want to understand whether orders are consistently making or taking liquidity in a specific dark venue so that the impact can be assessed – for example if our client’s orders always take liquidity in a certain venue we would review that to understand why. If we can pass that data directly back to the clients they can then make a decision about whether they want to be removed from that venue or change the distribution of their order flow across different pools. Likewise, if we see orders taking liquidity then see an unexpected change in the stock’s trading profile, this can be a useful warning indicator about the participants in a specific pool.”
FIX Tag 851 – a Potential Solution A specific FIX Tag, 851, or Last Liquidity Indicator, has been developed by FIX Protocol Ltd (FPL) as an identifier of maker/taker behavior. The US appears to have the most established support of liquidity-indicating tags with exchanges able to pass the data back to brokers and most of those brokers able to pass that on to clients. In Europe, likewise the large exchanges and brokers can support this, although there is less among the mid and smaller brokers.
However, in Asia the tag is sparsely supported, if it all, by the exchanges, alternative lit trading venues and many of the broker dark pools. Firms therefore have to come up with interpretive solutions and workarounds to give their buy-side clients a higher level of detail and transparency on their trading, particularly in dark pool aggregation.
Rossiter would prefer an industry-wide approach to improving transparency and the availability of maker/taker data which includes vendors, brokers, and most importantly the exchanges “Typically the actual FIX tag for this information is supposed to be generated by the exchange or trading venue, and it is passed to the brokers who need to be able to identify and accept that tag and then pass it into the vendor EMS or OMS platform that the client is using. So there are a number of parties within the workflow who are affected and they need to collaborate to bring in changes. An industry-wide adoption of the relevant FIX tag would definitely be a good solution”.
Adrian Fitzpatrick, Head of Desk Central Dealing at Kames Capital expresses strong opinions on the current state of fixed income market structure. What needs to be changed to improve the market?
What is driving managers into equities? A lot of it depends on which market you’re looking at. If you look at the European markets, there has always been a high weighting in bonds. There’s never really been the equity culture to the same degree as you have in the UK. Obviously in the UK a lot of it is driven by the insurance companies that have actuaries to dictate where the split between equities and bonds lies. Before these pensions’ time bombs, the safest investments for most people were bonds. However, we are all working on the assumption that bonds are currently completely overvalued, but as long as there’s Quantitative Easing they are going to hold these abnormally low levels of yields.
The other thing is institutions don’t want to stand out from the crowd. If everyone’s in bonds and bonds fall then you are going to fall together. There’s so much short term-ism in the market, you can’t afford to be an outlier for a long period of time and then not be right. I think risk assets now are relatively cheap; you look at the yields on risk assets compared to the yields on government assets, some of the credit assets like high yield are still quite reasonable. The bond markets are over valued , but it’s probably not going to change until the QE bubble bursts.
So the macro economics is feeding into that bubble? Yes definitely. It’s like we said about the dotcoms: Why are you buying things that are at that level? We all know if you go back historically and look at bond yields in the UK, they should be around 4½/5%. But at the current level, it’s only sustainable as long as the Bank of England and the government are prepared to keep rates abnormally low because of the state of the economy. So can we see that carrying on to 2013? Definitely. (See diagram on next page)
You’ve got the government printing money, so all you have to say is, “Where are you going to put your assets?” Unfortunately in the environment that we are in you just can’t stand that far away from the crowd for a period of time.
What is the main problem with the fixed income market? Effectively the market is not transparent, unlike the equity markets, which are. In equities you can see commissions, you can see the prices, you can see what gets printed. In the bond market you can’t. Platforms have been around for a long time, the likes of Tradeweb, Market Axess, and Bloomberg Tradebook, etc. These will keep gaining more traction because you can send them multiple requests for quotes and they are creating a virtual marketplace, which the regulators will like.
It’s not uncommon to send a trade down electronically to one of these platforms, and for all the banks to just pass; there’s no obligation to make a price or to make a marketplace. They make the price when it suits them. Personally, having traded multiple asset classes, that, to me, is not a marketplace.
You end up working with the fund manager to try and find the other side of liquidity. It’s such a captive market that effectively sooner or later, there has to be some outlet valve that gives institutions the opportunity elsewhere. Obviously, when you look at equities you had the establishment of crossing networks many years ago, of which Liquidnet and E-Crossnet were forerunners. Now what you are seeing on the bond market, through Blackrock’s Aladdin and UBS PIN, are various other brokers trying to get that same result.
What they are trying to do is encourage the institutional investor to create more of an electronic market. The biggest problem is in equities you have, for example, Vodafone, but in corporate bonds you can have 12 credits for the one stock; therefore it’s very difficult to identify a specific one and find a natural cross against it. So it needs to be a slightly different approach for bonds, just because it is a different discipline. You have different variables in bonds, the spread, which obviously a lot of fund managers work off, and you have the underlying Government bond.
The banks are going through what happened in equities. But equities aggregation is now the key; tools have been created that aggregated across the different dark pools to allow you to send one order to many venues. I think that what is needed is an institutional crossing network similar to Liquidnet. We need to create competition away from the banks. However, this isn’t necessarily all the bank’s fault because they say “we provide the risk and therefore we should be able to choose when we make prices.”
However, the biggest institutions are very close to the banks; they can dictate when they want to trade.
For us as an institution, it becomes incredibly difficult not just sourcing liquidity, but being able to trade out liquidity when we need to, because you are totally at the behest of the investment banks. In equities you can trade by program, by algorithm, you can ask for a risk price. You may not like the price, but the market will always make you a price and you can decide whether you actually want to take it.
In bonds, a broker will send out what’s called an “axe”. The axe is effectively the bond equivalent of the IOI. You’ll phone to follow up on the axe but they can back out. There’s no obligation.
In government bonds, where the electronic systems are more established you can trade more effectively, and it is getting there, but the credit part of the market is just completely arbitrary.
Who is going to drive reform? It will have to be driven by the regulators, in the UK by the Bank of England, and it has to be driven by institutions. The problem is institutions aren’t members of the market. Institutions don’t have the IT infrastructure or the IT spend to be able to create new platforms unless you are a Blackrock or a Pimco.
In the US they use TRACE, and we need a similar system as we need to establish ways for institutions to understand who is doing what, so you can target business to the broker or investment bank. And if not, there should be some form of platform that allows institutions to cross up against each other.
Mark Goodman, Head of Quantitative Electronic Services, Europe, Societe Generale Corporate & Investment Banking writes on venue and algorithm analysis in a low volume environment.
The initial stages of the financial crisis were characterised by highvolatility and high-volumes. The post-Lehman environment was difficult to navigate for many reasons, but low market volume was not one of them. To some extent this continued up until early 2011, but since then we have seen a steady decline in trading activity, albeit interspersed with moments of fear-driven volume peaks such as last August.
However, since the focus of the financial crisis moved from institutional to sovereign risk, European markets have been primarily characterised by a lack of activity combined with moments of significant volatility. The markets have settled into a directionless drift with no strong conviction to stimulate more activity; as a result a low volume environment is becoming the norm.
Whilst there are few signs that volumes will increase, there are some indications that there may be further downward pressure. Some of the core proposals of MiFID II could have a further negative impact on market activity. There is often heated debate regarding the positive or negative impact of high frequency on more traditional market participants but the fact is this activity is responsible for around 35% of European exchange volumes. MiFID II does not seek an outright ban on these counterparties, but efforts to better regulate them is likely to result in a reduction in their activity, and thus market volumes, at a time when markets are already struggling. Specifically the removal of credit/debits and the imposition of market making obligations will reduce the profitability of some strategies. There is clearly a distinction to be made between volume and liquidity when trying to understand the impact of this legislation on market activity but the initial outcome of lower market turnover is indisputable.
Faced with this environment the buy-side trader has to work harder to get trades done – even trades which previously may have been relatively simple. Actively managing access to liquidity and an in-depth understanding of the micro-structure of the market have become a necessity. In addition, algorithms which worked in an environment of higher liquidity need to be reassessed and in some cases rebuilt.
More Venues, or Right venues? In terms of managing access to liquidity, one aspect of this is ensuring you can get to the maximum number of venues. Whilst this has been a core topic of discussion with our clients since MiFID I kick-started the process of fragmentation, the discussion has evolved from maximising the number of venues to a more cautious approach focused on using the right venues. There is clearly an inherent contradiction that in a low liquidity environment a trader would restrict their venue selection, but where the perception is that the shortfall is being made up of predatory, short-term alpha seeking strategies then this concern is justified.
This change of approach can be seen in the widespread adoption of the FPL execution venue reporting guidelines released last May. Whilst these guidelines have been published as recommendations, we feel this level of transparency should be mandatory for brokers; clearly showing where an order was executed, including ensuring the end venue is correctly identified when orders are “onward-routed”, is not an unreasonable demand from the buyside whose order it is being worked. Buy-side traders are analysing the minutiae of venues and associated impact on their trading, execution by execution, in order to exclude those venues where they are vulnerable to adverse selection.
As the issues surrounding dark liquidity grow more and more contentious, Steve Grob, Fidessa’s Director of Group Strategy, looks at the Australian trading landscape, how this type of trading has evolved and what the dark future holds.
Over the past few years, much attention in Australia has focused on the competition between ASX and Chi-X. But, in fact, multi-venue trading (via dark pools) was available to Australian investors long before Chi-X ever opened its doors back in November 2011. The term ‘dark pool’, however, has now become a catch-all phrase that describes a variety of activities that match trades but do not distribute pre-trade prices. Partly because of their name and partly because they are misunderstood, dark pools have attracted great controversy worldwide, and Australia has been no exception to this. So, what does the Australian dark landscape really look like, who is in it and what value does dark trading really bring to the market?
In 1997, ITG launched POSIT, a pre-market VWAP cross, Australia’s first alternative venue. However, it wasn’t until 2008 – anticipating the end of the ten-second rule1 – that Liquidnet followed with its buy-side crossing network, and finally Instinet with its BLX crossing network in 2011.
Likewise, broker dark pools were also around before Chi-X was born. UBS PIN (Price Improvement Network) launched in 2009 with other major brokers quickly following. These days most of the big brokers in Australia operate dark pools, although UBS PIN remains the biggest.
Finally, ASX’s own dark pool, Centre Point, was launched with much fanfare in 2010, and it is thriving (see diagram 1); it in fact has greater market share than Chi-X. To illustrate the complexity of these issues though, at a conference in Melbourne in May 2012 ASX chief Elmer Funke Kupper warned of the dangers dark pools presented to the Australian trading landscape, even though ASX earns 0.5bps on the AU$100 million-odd worth of trades executed on its venue every day.2
Genesis of Dark Pool Trading Institutional buy-sides have always preferred to cross their order flow with other buy-sides that have the ‘natural’ other side in the stock they are looking to buy or sell. The reason for this is anonymity, or not divulging their trading intention to the market at large. The larger the order size the greater the value placed on this anonymity. Dark pools provide exactly this – but have they always been available or are they a new luxury brought about by the wonders of electronic trading?
In the days before widespread computer usage, if an institution wanted to move a big line of stock, and didn’t want to send it down to the exchange for fear of moving the market, they’d call their broker. Often the broker would call their internal counterparts to see whether they, or a client, was buying or selling a similar block and would execute an ‘upstairs’ trade at an internally negotiated price. Depending upon the skill of the broker, this provided a high degree of anonymity and certainly more than would be achieve by just dumping the order on a lit market for all to see.