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.
Citi’s Salvador Rodriguez and Daniel Mathews explain how best execution has evolved alongside MiFID and how the latest proposals are likely to affect buy-side and sell-side trading desks.
How is best execution under MiFID II different from MiFID I and from pre-MiFID? Where have we come?
Daniel Mathews, Citi: Although we are referring to MiFID II, we are at the early stages of the MiFID II legislative drafting process. The European Commission (EC) published its proposals last October,T and there will be a number of amendments proposed by the European Parliament over the coming months. The Council of the European Union (EU) will also table amendments and ensuing agreement between the EC, the European Parliament and the Council of the EU (27 member states) will then be required. It is not yet clear what MiFID II and MiFIR will look like in final form as there are a number of key areas which are acknowledged by both sides to need addressing. What is clear is that there will be significant changes to the drafting that is on the table at present.
Salvador Rodriguez, Citi: With the MiFID II process we have seen closer alignment between buy-side and sell-side interests. There is more cooperation between the buy-side and sell-side with a view to what may or may not come out of MiFID II; and this in itself, is a clear improvement from the earlier iterations, which is encouraging for the business at large.
DM: Certainly, the meetings we have had with the buy-side indicate that they are taking far more interest in what MiFID II will mean for them; they want to participate in the debate and are keen to understand what we are doing from a sell-side perspective.
Tools and strategies that have become accepted best execution for many brokers are now under review (e.g. broker crossing and the Systemic Internaliser (SI) regime). How difficult will it be to provide comparable offerings within the SI framework?
DM: One of the current challenges is understanding how the SI regime will operate under Ferber’s proposals and understanding the unintended (or intended) consequences of the amendments, such as ‘all OTC trades must be conducted under the SI regime’. The scope of the SI only extends to liquid stocks, so what happens to non-liquid stocks? Can we trade them outside an SI? Will all risk trades need to be executed within SI and therefore within published firm quotes, even though a risk trades to client may warrant a price outside firm quotes? At the moment, there are many unanswered questions raised from Ferber’s proposals concerning what the SI regime actually means for us and our clients.
SR: As Dan has alluded to, many of the requirements have fallen into the lap of the sell-side. From a trader’s point of view, the tools, strategies and decisions around how to execute a trade will probably not change significantly. Traders will continue to send VWAP or participate with volume-type orders. Naturally, there are pending questions around how risk is employed and whether firm capital can be used within an OTF environment. As a broader business, how clients and orders interact with risk, and how we internalize house flow, are wide-ranging questions. There is no one clear answer; it is a multi-layered problem and there are still grey areas to be resolved.
From which of the MiFID updates will institutional investors notice the biggest change in execution quality and/or strategy?
SR:The MiFID proposals will clearly affect everyone. Under the Commission’s proposals, a BCN would be an OTF and an SI is not a venue. I think this needs to be unpacked. Legally the classifications are fairly clear – you can trade on either a trading venue (RM, MTF, OTF) or OTC and if the latter then to the extent the trading is systematic and frequent then the firm must be an SI. As Dan says though, Ferber’s amendments have muddied the waters so that it’s not clear how an SI is intended to function. Our job is to figure this out through dialogue with our buy-side clients, and we have been seeing many of them recently on market structure road shows, explaining where the current process is at and the areas still to be resolved.
Michael Thom, Equities Trader, Genus Capital Management offers a look into the Canadian equities world, including perspectives on dark pools as well as algo implementation and usage.
Inverted pricing models
We have just seen the introduction of more innovative pricing models in Canada, essentially since the launch of TMX Select. For most buy-side participants like me, we do not see our tick fees as rebates because they are bundled into the commissions we pay to our brokers. This is an exciting development for participants that thrive on different market structures, but I would not say that we particularly benefit from this market model. From an intellectual perspective, it is interesting to wonder what will happen as a result of these developments, but I would not say it has any immediate net benefit to us or our clients.
Trends for Dark Pools in Canada
Canadian regulators have taken the right approach. There are lessons to be learned from other jurisdictions where dark liquidity was left to develop and regulators then had to play catch up. I applaud the Canadian regulators for giving their approach to dark liquidity critical thought before it gets to the point of significantly damaging market quality. Regulators in Canada are at a point now where if they change the regulations significantly, venues and firms would be able to adjust. The debate over the trade-at rule in the US shows that whole business models are built around sub-penny pricing and trading not at the touch. I do not think that is where we want to go in Canada.
I am a little cautious around some of the regulators’ specific proposals on minimum size. I am more in favor of the minimum increment being set at a half penny. The minimum size is the more difficult concept because anything that functions around a single pivot size, either in value or number of shares, can disseminate information through trading around that pivot point.
Although to my knowledge very few participants choose to structure their orders in such a way, it should be up to market participants to build into their orders the minimum execution quantities for dark pools as they see fit. I do not think a lot of buy-side participants are currently building their orders or customizing their third party algorithms to that level of detail. From where I sit, it is not a perfect solution, but this compromise might be the best of the difficult alternatives.
It is important to point out that they are not putting in a minimum size right away. The architecture is built to allow the regulator to, on very short notice or if they start to see some compelling data points, put limits in place without going through the full comment and review process, which is all very prudent. They are giving themselves the tools to deal with all possible market outcomes. Flexibility does not come easily to regulators. Typically, they adopt very specific proposals and if those proposals fail, it is back to square one, whereas here they have given themselves a degree of latitude which is commendable.
Simplifying Algo Implementation The algo and DMA providers who are winning our business are those who can give us transparency right down to how they are interacting with each individual venue, what order types they are using and how they are implementing venue specific idiosyncrasies. If a venue has very unique order types, our providers should say how they are using those and why they made the decision to use the order types they did. Providing a transparent, empirical basis for decisions regarding algo structure, architecture, order types and routing is really important. Many decisions go into building quality algorithms and routing, and those who will share the data behind it are my providers of choice. Algo providers seem to now be more willing to tailor and be empirical about constantly improving the product to fit a firm’s or a trader’s trading styles. That is where algorithmic trading is headed, as it relates to buy-side, and we are just starting to see the leading edge of that in Canada.
AllianceBernstein’s Global Head of Quantitative Trading, Dmitry Rakhlin, discusses the problem of fragmentation and what makes a good aggregator, along with Ned Phillips of Chi-East, Greg Lee of Deutsche Bank, Steve Grob of Fidessa and Instinet’s Glenn Lesko.
Dmitry Rakhlin, AllianceBernstein
How does aggregation improve trading and best execution? Institutional traders usually demand (remove) liquidity from the markets, which in turn creates market impact. Being able to interact with aggregated liquidity (e.g. all available liquidity) lowers this market impact. Aggregated liquidity also gives a trader the ability to interact with many more liquidity sources randomizing the way the liquidity is taken from the market. This decreases the amount of information leakage and protects the trade from being exploited by predatory strategies.
Does aggregation spell the end of fragmented markets? No. The US equity market is highly fragmented, yet all liquidity centers are interconnected, which allows traders to build various aggregator strategies. No doubt, there is cost and complexity associated with this. Fragmentation also introduces so called latency arbitrage and a potential increase in information leakage (the information leakage can be drastically reduced by using appropriate trading strategies).
The positive aspect of fragmentation is that it creates rich market microstructure (traditional exchanges and exchanges with inverted fee structures, block crossing networks, auctions, conditional order types, aggregators of retail liquidity, etc.). These choices give the buy-side the ability to match their investment strategies to the appropriate liquidity sources and ultimately benefit by being able to trade more nimbly and at lower cost.
From your perspective, is aggregation about greater access to liquidity or reducing trading costs? Both.
Ned Philips, Chi-East
How does aggregation improve trading and best execution?
A good aggregator brings order to fragmented markets by concentrating order flows, and liquidity, from a large number of matching venues. It is a tool that allows all participants to access multiple venues from one easily accessible point, reducing the technology costs and other difficulties involved in monitoring different trading venues.
Does aggregation spell the end of fragmented markets?
No. Even if one good aggregator attracts a majority of trading flows, it would not represent a throw-back to a single exchange monopoly. Aggregators are there to make the process of using multiple markets easier and more efficient and can only exist as long as participants have a choice of matching venues.
What are the risks inherent in aggregation and how can an aggregator ensure improved execution?
Theoretically there is a risk that an aggregator will be so successful that it monopolises the market but competition and risk management would keep things in check.
An aggregator ensures improved execution by concentrating liquidity which reduces spreads and improves execution.
DATAROAD’s David In-hwan Lee shows how Korean traders are utilizing FIX to improve both domestic and international trading capabilities.
How has FIX adoption improved Korean trading?
It was at the end of 2002 that Korean institutions were able to process orders from foreign institutions using the FIX Protocol for the first time. During the following years the FIX Protocol in Korea developed very fast over almost a decade of use.
Before the adoption of the FIX Protocol, approximately 60 securities firms, 40 institutional investors and multiple foreign institutions had been processing orders using telephone, FAX and emails, which were very inefficient means of one-toone communication. Now, most sell-side and buy-side firms are able to place orders conveniently and promptly, and receive execution reports realtime using the FIX Protocol.
After adopting the FIX Protocol and Order Management Systems (OMSs), both institutional investors which place orders and securities firms which receive orders and execute them at the exchange were able to improve their internal trading tasks noticeably. Korean securities firms were now able to connect via networks with the trading systems of overseas institutional investors more efficiently, in contrast with the past. Moreover, since they are actively using the FIX Protocol in connection with outbound orders such as FX transactions and overseas future trading, as well as inbound orders, the adoption of FIX greatly contributed to the internationalization of the Korean securities market.
What is the opinion of Korean brokers toward algorithmic trading?
As OMSs are adopted along with the FIX Protocol, Korean securities firms perform basic algorithm trading using the automatic order system provided by their OMS. Although they currently support simple types of algorithmic trading only, I believe that more diverse algorithm trading functions will be necessary as the Korean securities industry goes through environmental changes.
The Korean securities market is expected to go through a major systemic change in the near future. Although it has not been finalized yet, securities exchanges in Korea are expected to compete with one another starting from the second half of 2012 because the establishment of an Alternative Trading System (ATS) in the Korean securities market will be allowed by then.
Also, the Korea Exchange (KRX) announced a plan for developing a next-generation trading system EXTURE+ in late July 2011. More specifically, KRX plans to develop a new system aiming for two-digit microsecond latency for its trading system. I believe that Korean securities firms should expand the functionality of their own algorithm trading for brokerage business and adopt ultra-high speed DMA systems in order to be able to perform low latency trading demanded by the algorithm trading systems commonly used by buy-side firms. As a result of the changes in the environment of the Korean securities market, High Frequency Trading (HFT) and algorithm trading are expected to develop quickly during the next several years.
What benefits have Korean buy-side firms seen since adopting FIX?
It was the buy-side that received the greatest benefit after adopting the FIX Protocol.
Before discussing the benefits of adopting FIX, it is important to know the relevant circumstances before the adoption of the FIX Protocol. During the early 2000’s (right after the IMF crisis), Korean asset managers’ systems for managing funds had several problems. For example, the distinction of the roles between fund managers and traders was unclear, the compliance system was not established and people processed orders (placing orders and confirmation of executions) manually, often using telephone, FAX or email. Moreover, although there were back office systems for calculating NAV (Net Asset Value) and accounting, they were not prepared with OMSs for their trading systems.
Brown Brothers Harriman’s Garvin Young explains the decision to adopt a Software as a Service (SaaS) trading system in lieu of traditional on-site architecture.
In its capacity as a global custodian, Brown Brothers Harriman (BBH) takes a holistic view of its trade execution process. This view includes front-end connectivity and execution, all the way through to settlement. The firm continually assesses the current and future needs of its clients to ensure that its products and solutions fully meet their requirements.
Searching for a Cutting- Edge Solution
In late 2010, given the rapidly changing landscape of the brokerage industry related to connectivity, regulation, algorithms and back-office efficiencies, we initiated a RFP process to identify an order management system that could best position its clients for the future.
Specific details of the project included a buy versus build analysis, cost/resource considerations, client retention rates, etc. Given the timeframe that we had set for implementation, it became clear that a build-from-scratch solution would have been both costly and impractical. Such a solution would have required BBH to add staff, incur IT spend, expand occupancy space, and bear significant ongoing maintenance costs.
Through the RFP process, we looked for a provider with a reputation for stability. In an environment of microsecond execution, an OMS must be reliable, stable and flexible. The ability to customize the solution was also important. The solution had to include a robust front-end while also keeping with BBH’s requirements of high-quality middle- and back-office processing. Our integrated execution and settlement product required a solution provider with strong expertise around maintaining high straight-through processing levels and real-time client reporting.
As a privately held organization, BBH maintains a high focus on risk management, which meant that a strong track record of regulatory reporting and risk management tools was also critical. The firm’s global and sophisticated client base has complex connectivity requirements, such as Reuters, Bloomberg, ULLINK, SWIFT and virtual private networks (VPNs), to name a few. Further, its clients have specific FIX tag requirements and run multiple versions of the FIX Protocol. We required a solution that was able to meet all these demands.
Identifying the Right Provider
BBH narrowed the search to six top providers of equity execution platforms and went on to select Fidessa. BBH’s Investor Services clients recognize us as a leader in technology solutions, with the capability of offering them a sustainable, long-term and flexible solution that allows them to access new markets to grow their business. We determined that their platform aligned well with these needs, and offered an ideal complement to its existing proprietary solutions.
Gen Utsumi, a longtime member of the Japanese electronic trading community, talks about how the events of 11 March 2011 may indicate the future direction of electronic trading in Japan.
When I was a teenager, I loved computers. Back then it was really exciting to wait for the release of a new personal computer every year. My first PC was the NEC PC-6001MK2 which was the first Japanese PC with synthetic voice speaking ability – it had 64KB of memory and a cassette tape player. For more than 20 years, the world of computers was a very exciting place. There were always new technologies evolving in the industry and so many talented people shared that excitement.
Now, computers are even more advanced, but people are not as excited as before. The computer industry seems to have matured. Could we say the same for electronic trading?
Nine years ago, when I started to sell FIX engines in Tokyo, ‘STP’, ‘Electronic Trading’ and ‘FIX’ were the buzzwords. Having a FIX interface was an exciting thing and sometimes when an exchange introduced their FIX interface based on real needs, they also used it as a marketing tool. Electronic trading was a frontier of the financial industry and I met a lot of people with ‘frontier spirit’. Once an electronic trading link was established via FIX or other means, new services and strategies started to emerge, such as Proprietary Trading Systems, algorithms, Smart Order Routers (SORs) and dark pools.
These, along with technological advancement, brought a wave of colocation and low-latency products and the race is still going on. Now it seems that having ‘microsecond’ latencies is not surprising anymore. Would latency be exciting again if it were in nanoseconds? My guess is, probably not. While there are still ways to make money in electronic trading, the industry seems to have matured.
Allow me to make another analogy: Japan. Japan has also matured socially and economically. Infrastructure is well established yet Japan’s boom period has long since passed. General sentiment is gloomy due to government resignations, a low birth rate, low economic growth, huge government debt, and reduced trade profits because of global competition.
Then the earthquake hit on 11 March 2011. Surprisingly, people were relatively calm in Tokyo, considering the magnitude of the event. There were many rumors circulating regarding the Fukushima Nuclear Power Plant, but people continued doing business as normally as possible. I will not repeat the grave details here, but I would like to point out that many people are starting to say that this event was a sign of change.
Now three months later, there are signs of recovery here and there. With disaster of this scale, it is obvious that help from the government is not sufficient to respond to the needs of all those people affected. Refugees are being supported by volunteers, families, neighbors and friends. There are over 2,000 refugee camps and some camps are better equipped than others.
One particular refugee camp I know is getting considerable support including food, trucks, bicycles and other living needs as well as comics for the kids – all of which are brought in by supporters. People visit the camp every weekend from Tokyo and the people in the camp welcome those supporters whole-heartedly. There was a strong mutual ‘trust’ established between the people in the camp and their supporters. The camp next to it is not doing so well; they accept donations and goods at the gate, but they do not welcome volunteers and supporters to visit their camp. There was no ‘trust’ here.