Eric: While building our global multi-asset trading capabilities we looked at our existing equities structure, took what we liked about it and translated that into what we wanted to achieve. But extrapolating that to, for example, the rates market is not a simple ‘copy and paste’ operation. There are areas within fixed income which can be handled like stock trading (primarily the super liquid government markets), but for anything that is not primarily traded electronically, the blueprint doesn’t fit well enough.
In Europe we already trade 85-90% of our fixed income flow electronically. The plan is to do more than that as a result of all that we have learned in equities. In order to be scalable, we must be technologically savvy – we need to have all the systems we need, but not too many to support. We can already extrapolate some market infrastructure information: questions around best execution and TCA policies, order aggregation and separation which we know from our equity history. But the market infrastructure within fixed income is so different to equities that it requires considerably more thought.
One lesson learned in our equities operation following the fall of the exchange monopolies and arrival of competition in the form of alternative execution venues, was the need to re-aggregate the liquidity.
This is precisely the task ahead of us in fixed income because this whole market is still very much a phone and text-driven, bilateral market.
Electronic execution and trade supporting tools are moving ahead fast but it is surprising how focussed on bilateral trading the fixed income market still is. We strongly believe in technology and especially in the transparency and scalability benefits of electronic trading. It is certain that going forward, fixed income will be traded on more than one venue and on several platforms so without good technology on the trading floor you will fall behind.
Christoph: Before the introduction of global dealing across our equities business we were happy having our executions done through brokers when we were outside our time zone. We had trusted brokers and gave them instructions on how to execute the trades.
It was only after moving the trades into the regions and trading ourselves that we learned that the execution quality (measurable through our TCA tools) improved considerably. This showed us that we can trust our brokers, but when it comes to execution, we would rather have our own traders do it themselves. We would rather give a fixed income trade to one of our fixed income traders in New York or Hong Kong to get better results than giving it to a broker and asking them to trade it overnight. This was one of the main drivers for our decision to go global outside of equities.
In addition, MiFID II has put much more emphasis on traders and on the execution for clients. This means that areas which historically we were able to leave to brokers, we now have to monitor much more directly. MiFID II will require buy-side traders to take far more ownership of all parts of the value chain of the execution services than previously. This will require additional resources on the buy-side.
Integration of the portfolio managers
Christoph: Twenty years ago, portfolio managers were frequently making trades themselves. When centralised trading desks were installed, the portfolio managers were encouraged to leave those trades to our discretion. Trading has come a long way since then, but our main focus, along with best execution is how we better communicate with the portfolio managers. Our aim is that a portfolio manager receives information from the market but also that traders are in a position to advise the portfolio managers on what to make of that information. This process is still evolving but the feedback from our portfolio managers is that it is highly appreciated.
Eric: Fixed income traders, almost by definition and by the nature of their asset class, have to be a little bit more embedded into portfolio management compared to equity traders.
Looking at fixed income trading in our firm 15 years ago, traders ran portfolios and did execution trading, so the model was much more hybrid. Fixed income portfolio managers now require a different level of expertise from their traders; they need more communication, colour and consultancy so traders have to be more embedded.
Christoph: In fixed income we have to appreciate that the asset class as a whole is more complex than equities. Trading US treasuries could be run from virtually anywhere. The requirements of emerging market bond trading, for example, which trade across time zones, include FX in various forms and potentially derivatives are inherently more complex. Then there are areas like credit where knowledge of the market itself is already valid and important for portfolio managers and traders in their communication because it is not cross regional.
The question is how to slice up that big fixed income execution pie. We are still in the process of finding out what the best execution set-up for certain parts of our businesses is.
Eric: Our traders, if they still want to be a relevant part of the investment process, have to be able to prove their added value. We have always been very keen on monitoring and documenting the quality of our trading, using internal as well as external work and systems.
Christoph: When we rolled out full global equity trading in 2004, our global trading policy was expedited. We had to revisit the policy with the advent of MiFID I and now are re-examining it every two years because of ongoing changes to our processes. Our trading policy not only describes our goals but also our processes – we are actually describing the way we want our traders to deal and how we monitor that.
Our clients are also stipulating how they want their orders to be monitored and analysed. The same is true for consultants and regulators. In order to stay ahead we must introduce new products and concepts as soon as they are on the market. We were amongst the first to test fixed income TCA from various vendors (and so found out that they were not yet delivering what we require).
Eric: We were one of the first firms in Europe to implement electronic RFQ trading for equity derivatives. This was simply because we thought it would make our lives easier and we were able to remove a number of best execution requirements by having RFQ trading instead of the old style mail and phone check systems. The data we can analyse now helps us a lot in improving our broker selection and trade analytics.
Currently our fixed income staff are analysing the potential execution platforms coming onto the market in Europe. They are exploring which ones might work and trying to get ahead of the game in terms of technology. Unfortunately, because of the sheer number of new platforms coming to market, their job has become more difficult and as a result the pre-screening takes more time than a regular trading group can actually afford. At the end of the day, we are traders, not IT project managers.
Developing true TCA
Christoph: We are currently very much engaged in implementing MiFID II’s proposals. We know the direction it’s headed. The requirements will be refined but they are pretty much fixed from an asset class perspective. As a result, we will re-visit our best execution policy. We have to consider how we want to handle full unbundling and we have to make sure that TCA is operable outside the equity world as well; the need exists but the solution may not be that easy.
In the last decade we have been through several providers and various ways of looking at TCA; in fixed income and derivatives, we still need more. If we were to try to find a TCA provider for our whole multi-asset business. No matter what some vendors claim, there is still no one out there who can meet our expectations.
This leaves us with the question of how to do TCA until the market has developed sufficient providers to satisfy our own and our clients’ high end needs. This is an area into which we are putting considerable effort.
Eric: We need to work on translating or adjusting that to fixed income, derivatives and FX. With FX, once we have more transaction data available, it will be possible to run the same or similar mechanisms used in equities. In fixed income I think the approach will be more holistic and less number crunching. Some parts of derivatives, primarily futures, are close enough to equities in the way they trade, hence we can use the same, proven analytics.Options and swap markets pose more of a challenge.
In some asset classes we will have to come up with new ideas on how to define TCA. This is where we will be focussing our efforts over the next six months because it is an important part of improving trading and our client base is already asking for more.
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