Richard Nelson, Head of EMEA Trading for AllianceBernstein, shares his perspectives on navigating volatility, prospects for developing exchanges, new regulation and the balance between transparency and best execution.
FIXGlobal: How much does volatility affect the way that you trade and what are you using to measure volatility on the desk?
Richard Nelson, AllianceBernstein: We use an implementation shortfall benchmark, so the longer we take to execute an order, the wider the range of possible execution outcomes. Volatility, in particular intraday volatility, increases that potential range, so you could see very good or very poor execution outcomes as a result. In reaction to that, we take a more conservative execution strategy or stretch the order out over a longer time period. And, for instance, if we get a hit on a block crossing network, we will not go in with as large a quantity as we would in a less volatile market. In that way we try to dampen down the potential effects that volatility might have on the execution outcome.
FG: How is AllianceBernstein using technology to improve performance and cut costs on the trading desk?
RN: It plays quite an important part and has done so for quite a while. We are pretty lucky in that we have a team of quant trading analysts. Most of them are in New York, but we have one here on the desk in London, and they help us to analyze the changing market environment and recommend the best ways we can adapt to it. Our usage of electronic trading has increased in the last year, we benefit from the quant trading analysts looking at the results we are achieving with our customized algorithms. We are more confident about getting good consistent execution outcomes because they are monitoring the process and making the necessary changes to ensure the results are what we are expecting. This, in turn, increases the productivity of the traders I have on the desk. They can place their suitable orders into these algorithms and let them run which allows us to focus on trying to get better outcomes on our larger, more liquidity-demanding orders.
On top of that, as market liquidity has dropped significantly, we are trying to make sure we reach as much potential liquidity as possible, and ideally we want to do that under our own name rather than go to a broker who then goes to another venue. We believe that going directly into a pool of liquidity is better done under your own name rather than via a broker because we can then access the ‘meaty’ bits of the pool rather than the ‘froth’. We are looking into ways of doing that but one of the problems is that, potentially, you get a lot of executions from a number of different venues, which results in multiple tickets for settlement. Our goal is to access all these potential liquidity pools, yet also control our ticketing costs, which are a drag on performance for clients.
FG: Was it an intentional change to increase electronic trading or was it a byproduct?
RN: It was a little of both. Our quant trader has been with us for two years and when he first arrived he had to sort out the data issues that exist in Europe and to clean things up. Once the data integrity was sorted out, we looked at different ways of employing quantitative analyses. Having somebody here who is constantly monitoring the execution outcomes means we can proceed down this path with real confidence. As a London firm, we were a little behind in our adoption of electronic trading, but now we are in the middle of the pack in terms of usage. It makes sense from a business and productivity perspective that there are many orders that do not need human oversight, which are best done in algorithms.
Nomura’s Jeremy Bruce summarises the current state of play in terms of European liquidity venue fragmentation, and focuses specifically on venue ownership and geographical concentration of equity execution venues.
Ownership and Location of European Equity Trading Venues
In the past few two years we have seen not only increasing liquidity fragmentation in Europe, but a significant change in the pecking order of exchange and venue size. The diagram below lists all venues with a market share of greater than 1% as well as referencing other smaller venues. As can be seen, it shows both the rise of venues, such as Chi-X Europe and BATS, as well as the proliferation of light and dark venues owned by the preexisting exchanges. Chi-X Europe in particular, is now comfortably the largest pan-European venue. There are currently two proposed mergers on the table, firstly between NYSE Euronext and Deutsche Boerse, and the second between Chi-X Europe and BATS.
The old model of a country having a primary exchange located within its borders (normally in the main financial district), where its companies’ stocks almost exclusively trade is no longer relevant. As corporate ownership of the manifold liquidity venues becomes more complex and blurred, it is perhaps more meaningful to look at the actual location of the exchange. When we say exchange, we are actually referring not to the administrative or corporate headquarters of the exchange firm, but to the location of the IT infrastructure that runs the actual live exchange matching engine. This location is then a physical data centre building, with an additional failover backup site.
Otkritie’s Tim Bevan describes the intricacies and idiosyncrasies of the Russian markets, and offers suggestions on how to effectively access the deep liquidity there.
How would you profile the firms that are interested in DMA to Russia?
There is an interest in DMA to Russia from prime brokerage desks because many of the hedge funds that use the global prime brokers have expressed interest in Russia, now that the liquidity has reached the point it has. It is worth pointing out that the liquidity in the local equity market is approximately $2.5 billion a day, and the derivatives market turnover is $10 billion notional a day. These are very significant and deep pools of liquidity. We are certainly seeing client pressure from different areas hitting Tier 1 banks, which in turn is reflected onto us. We are also seeing the big global electronic brokers looking to add Russia to their coverage.
There is sustained sell-side interest, but the other big pocket of interest we are seeing is from the low-latency, high frequency funds that utilize proximity hosting and co-location, who want to place hardware in Moscow and run their strategies in the electronic order books that are available there. There are many more of these types of participants now and they are often in London, New York, Chicago, Amsterdam, Paris and other parts of Europe.
How extensively are algos utilized in Russian DMA?
Obviously for a high frequency fund, the algo is the strategy. This is clearly different from execution algos, like VWAP, which are used to execute orders in a certain manner. Most Russian brokers have the most basic execution algos like VWAP, TWAP, icebergs, etc. It is a relatively new trend (i.e. 6-9 months old) for the big sell-sides to enter Russia, and many have not yet deployed their more sophisticated suites of algos into the Russian market.
Additionally, the Russian market itself, is quite unusual in that there is a lot of programming skill in Russia. The average Russian retail trader is quite often running an algo through an Excel spreadsheet with $10-20,000 worth of capital, so as regards alpha strategies, there is a lot of algo activity in the Russian market. In terms of execution algos, however, I think it has not penetrated this segment yet. As the sell-sides continue to move into the electronic market, the second phase will be to deploy their own execution algos and offer them to their main clients, but we are at the beginning of that part of the process.
With the majority of liquidity isolated in a dozen stocks, how would Russian DMA fit into a firm’s overall trading/investment strategy?
Liquidity is very concentrated in Russia. The top ten names account for the vast majority of liquidity, and even the top two or three probably make up 50% of the market. DMA is possible beyond the top 15 or 20, but it drops off fairly quickly thereafter. Obviously the big blue chip companies are where most of the interest is. Taking Sberbank as an example, there is no liquid Depository Receipt (DR) and there is an unsponsored DR trading of about $2 million a day in Germany. If you want to trade that stock, you have to trade the local market, where it trades between half to a billion dollars a day notional, so there are some very deeply liquid companies that are only available in the local market.
What other asset classes are being attracted or will attract DMA interest?
The biggest interest is in the RTS Index futures, which is an incredibly powerful product. Trading over $5 billion a day notional, more than double of all of Russian equity instruments (both DR and local), sometimes by a factor of two. RTS Index futures trade from 0700 UK time right through to the US close and are among the top ten most liquid equity index futures in the world. This instrument has generated the majority of interest from the quant funds, but interest is increasingly coming from more standard hedge funds and buy-sides where they are allowed to trade futures as it provides an instant hedge or leverage tool with an almost bottomless liquidity pool for any one player.
OLMA Investment Company’s Alena Melnikova and Valerian Zamolotskikh assess the Russian exchanges and comment on DMA and algorithmic trading.
Are algorithms widely used by Russian trading firms, and what asset classes are they used for (options, futures, ForEx, bonds, commodities)?
Algorithmic trading on the Russian market is relatively well developed. According to average estimates, about 60% of trading volume in our market is created by algorithmic trading systems. We use strategies similar to those used in Western markets: market making, arbitrage, pair trading, stochastic methods. However, algorithms for minimizing impact costs are not very popular, because there are few participants who can sufficiently affect prices. Algorithms to minimize market impact will be more popular with the advent of large participants and new funds. Trading firms widely use market making and arbitrage strategies, while stochastic methods are widespread amongst common traders.
Algorithmic trading in general and stochastic methods in particular are widespread amongst traders because the share of traders with strong mathematic skills is relatively high. These traders use stochastic methods for developing strategies and program algorithms for them. On the other hand, brokers meet traders’ requirements and develop trading platforms for the opportunity to connect traders’ applications with their platforms by API, internal programming language and so on. Algorithms are mostly used for futures, and slightly less for options, but the most liquid instruments in Russia are futures on the index RTS; the majority of algorithms use this asset class.
Do you see an increase in DMA to Russian markets, and if so, will it come through equities, derivatives, ETF’s or other products?
It is difficult to say if DMA is developing in some specific products. Often, it depends on the exchange that provides the DMA. DMA is developing in equities on MICEX and in derivatives on RTS through the RTS Standard (equities T+4). DMA will develop proportionally alongside current liquidity. Futures on the RTS Index and Sberbank shares (on MICEX) remain the most interesting for algorithmic traders. As for ETFs, they are a new product on our market and are not very popular at this time, although we do expect development of DMA in this asset class.
How will data centers and increased connectivity, within Russia and out to London and international exchanges, affect high frequency and algorithmic traders?
We think data centers and increased connectivity will have a positive impact on our financial system generally, and on HFT in particular. First of all we expect increasing liquidity in commodity, currency and index futures. Second, narrowing spreads will result in an increase in trading volume and more arbitrage strategies, for example ADRs-equities. Third, with the advent of foreign HF traders, local traders have to improve their technologies, equipment and strategies, all of which certainly will have a positive effect.
Are Russian exchanges’ trading architectures ‘fast enough’ and what do RTS or MICEX need to do to meet Russian traders’ demands?
From our point of view, the Russian exchanges’ trading architectures are considered fast enough. An average round trip is 10-20 microseconds for both RTS and MICEX. What is more, RTS makes continual efforts to improve the trading environment. Last year RTS launched a new protocol Plaza II, which aims to improve and accelerate trading conditions. RTS is much more mobile, determined and creative, fast to meet investors’ requirements and ready to discuss improvements to their current work. Technical failures, however, can happen on RTS. MICEX is stable, but tends to develop slowly, which limits its appeal for HFT clients. HF traders seem to choose RTS, which offers halved fees for intraday trading and allows them to place their equipment in RTS’ data center on more attractive terms.
What is your impression of Moscow’s future as a financial center?
I would have to say that much remains to be done. However, in recent years, market professionals with the state’s support have made important steps in this direction. For example, the taxation of derivatives adopted last year. Of course, it is difficult to compare Moscow with other financial centers now, but the prospects are very encouraging.