The Changing Impact Of Best Execution Requirements

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A roundtable write-up by Rupert Walker, GlobalTrading

Collaboration is essential to meet the regulatory challenges affecting the trading process and to ensure technology integration is effective and beneficial.

The move towards connecting and amalgamating systems and functions along the trading process and across asset classes seems irresistible. Regulatory requirements, cost pressures, broader investment mandates and operational logistics are driving the integration of technologies both within and between brokerages and buy-side clients.

The objective is to achieve seamless and efficient trade order management, execution and settlement that minimises expenses for clients and reduces errors throughout the chain. However, the implementation of measures to attain this ideal outcome reveals new problems, raises questions about what is attainable and casts doubts on the linear nature of this apparently ineluctable trend.

In a fast-moving, but often confusing landscape, collaboration among all participants, including buy- and sell-side front and back offices, compliance and legal departments, regulators and vendors is essential. Although the industry is driven by competition, cooperation is needed to meet the challenges posed by expectations as well as the application of the technologies themselves, agreed panellists at GlobalTrading roundtable discussion hosted by Singapore Exchange (SGX) and sponsored by BNP Paribas Securities Services on 16 November 2016.

The changes underway cannot be underestimated. Integration is taking place horizontally across asset classes, which involves adapting to single sources of data yet multi-asset portfolio strategies; and vertically, making front offices more reliant on additional alpha-generation from back office information and efficiencies.

The catalysts are the globalisation of fund management, regulators’ insistence on best execution and transaction transparency, and higher buy-side expectations as it gains access to the types of technology that was previously supplied by brokerages.

Meanwhile, third-party service and product providers need to be more flexible. They can no longer assume clients will make an exclusive purchase across the whole order, execution and post-trade management system; instead they are more likely to mix-and-match from different vendors. Aggregation of systems might make sense if a buy-side client has full connectivity, but less so if its systems are already dispersed among several vendors.

Most especially, regulatory impositions, such as MiFID II, are transforming the working environment. Their all-encompassing nature leaves few departments within a buy- or sell-side firm untouched, so more internal stakeholders are involved in decision making processes, from strategy to implementation to monitoring.

Staff must also be flexible and learn new skill-sets to cope with an overload of information, to comply with new rules and understand the implications of the complex technologies that are being introduced. This creates pressures on time, distracting staff from their areas of expertise and increasing the potential for errors. One response is for both buy- and sell-side to be more ruthless: reducing their number of vendors and counterparties. Meanwhile, firms are tending to develop human capital internally rather than buy expertise from outside.

Recognising Limitations
Another reaction is perhaps more fundamental. It is easy to think that the amalgamation of systems is inherently desirable because it is predicated on an assumption that technology consolidation will lead to perfect trade processes. However, there is a growing acceptance that the ideal cannot necessarily be attained and that idiosyncrasies among asset classes and the diversity of pre- and post-trade procedures in different markets mean that complete integration is neither desirable nor feasible.

For instance, in Asia buy side execution is not flawless. Success typically relies on local market knowledge and the skilful use of tactics by individual traders, especially in the bond markets. Although the changing dynamics must be accommodated, it makes sense to keep things simple and perform those tasks well. In the past, the emphasis was on installing the biggest and fastest systems, but now the focus is on filtering, ensuring that systems are adopted that are most suitable and relevant for both sell-side and their clients. Some firms are using multi-asset platforms, while others prefer to retain single-asset platforms which might be less efficient but are less vulnerable to error.

Nevertheless, regulation is driving a shift towards consolidation and cannot be ignored despite practical experience that suggests that separation might be best. In Asia, there is state of flux as stakeholders try to determine the best systems to meet regulatory requirements yet ensure operational effectiveness. These will also have to accommodate new disruptive technologies, such as machine learning and AI, as well as compliance with evolving mandates for “green” or other corporate governance investments. In any case, trading desks are now central to the investment process. Once considered a cost centre, they are now a potential source of value.

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