Current Evolution Of The Buy-side/Sell-side Relationship

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With Saku Sänkiaho, Senior Analyst at Pohjola Asset Management Execution Services.
The buy-side has a growing desire to take more control. Increasing scrutiny of buy-side trading and execution practices by the regulators, senior managers and clients is driving transparency and the need for greater accountability.
And there has been a growing suspicion from the buy-side that they need to take greater control in order to avoid suboptimal liquidity and execution. The buy-side has been working hard to increase their awareness and improve their skill-set when it comes to trade execution.
As a consequence of this growth in their knowledge, the buy-side increasingly demands customisation and acquisition of different trading tools and algorithms. When we developed our own buy-side smart order router (SOR) with ITG in 2011 the idea was to take full control of the routing and execution. The need for control is one of the most significant trends coming out of the buy-side at the moment in terms of technology and development.
Catching up with the sell-side
Also contributing to the increasing involvement from the buy-side, is the way that the buy-side is now better able to measure their performance. Using better developed TCA, traders can monitor comparative performance of algos and execution and have a more informed discussion with their brokers; the buy-side can tell their brokers what they would like to see and then of course the sell-side can help them deliver. The process will be more consultative because both have similar levels of understanding about market structure and the needs of traders. This means that there is more interaction between the two, which is a good thing.
Currently, many buy-side firms use external TCA providers, which gives them standardised, comparable TCA reports that they can use to directly compare their brokers. Relying on broker reports is difficult because different metrics are used; you end up comparing apples and oranges. Independent execution analysis that successfully combines macro and micro level TCA is a way for the buy-side to look under the hood to fine tune the car, so to speak; firms have to be able to capture and analyse their own data.
When we started the buy-side SOR user group, which currently consists of 15 different buy-side firms, the whole approach was to share ideas with each other. Because everybody has their own experience from the market, we can work better once we have shared these thoughts. Everybody has a different trading profile and different benchmark, but we can help standardise the data and conversation. The aim is to also give the members of the group more data to use in discussions with their brokers.
There is a definite evolution in the way that the collaboration has increased between the buy-side and sell-side, but maybe there is more that brokers need to do to move that forward.
What does the future hold?
It is a long term trend that the buy-side are taking more control. First one started to use algos to implement electronic trading strategies, then the focus was on the liquidity seeking algorithms. Now more focus is put on which venues to access; as the buy-side increase their ability and knowledge, they are becoming more demanding.
After increasing our knowledge on electronic execution and order routing, for us, the next logical step was to create the buy-side controlled SOR to offer an unconflicted way of interacting with the aggregated liquidity without unnecessary intermediation.
However, every firm develops their own methods in regard to how they would like to interact with the sell-side; what level of collaboration is required and on what frequency. But I think that there will definitely be even more involvement. The collaboration between the buy-side and sell-side will evolve towards more standardised practices, transparency and comparability of data.
Tightening regulation will also increase the execution quality that brokers provide and drive greater transparency between the buy-side and sell-side. When research and execution are unbundled, the trading team has more autonomy with whom to trade. In this case, the only way for an executing broker to win mandates is to provide order execution of high quality. Transparency is now seen as an integral part of a high-quality execution service.
As the buy-side increasingly take control, and collaborate more frequently with the sell-side, technological advances will be a fascinating area to follow. There will be a need for sell-side technology and market knowledge, but they do need to adapt to stay relevant.