Changing The Question
Martin Ekers, EMEA Head of Dealing, Northern Trust looks at trading, benchmarking, technology and what the buy-side can do to keep themselves up to date.
Sharp practice on the trading floor
As a long only trader, I have concerns around some trading where illusory liquidity is being provided. Some short term trading behaviours are not conducive to optimal market structure, for instance the posting of liquidity in multiple venues with an immediate cancellation of orders in the majority of those locations, once one location is interacted with. They understandably have to post in all the venues to ensure they make the transaction, and that, in itself is obviously defensible. But I suspect what often happens is that, as well as cancelling the other orders, they then go and buy many more than the 100 shares they sold irrespective of whether it is a small loss, to position themselves in the market to be able to offer more stock at higher prices. This behaviour doesn’t help anyone other than the high frequency traders who are trying to make some money on the back of a perceived genuine order.
The free market side of me says that in an open market place if somebody buys something and sells something they take on risk and they make some money out of it. If they’re buying stock that I should have bought and selling it to me at a higher price because I am giving them the opportunity to do so by sending signals and behaving like an elephant in a china shop, there’s no shame on them but shame on me.
I also have concerns that the markets may trade for a longer period of time than is optimal; even the US market, which is open for six and a half hours a day, has significant lows in its trading patterns and yet London and most of Europe are trying to hang on to eight and a half hours a day. I would argue that the genuine order flow that is looking to trade on any given day would participate at a higher level in a reduced trading day, and actual liquidity would be improved significantly.
A decade ago people were speculating if we’d be able to trade 24/7. Now you can trade many things 24/7, but the price you have to pay in terms of impact and spread increases significantly. If you want an optimum market then you want all the buyers and all the sellers in the same place at the same time, it obviously makes sense to have that period to be relatively small.
The role of new technology
Clearly, we have to use technology to help us avoid being caught out. What you can’t do is legislate for other people’s behaviour. There is some behaviour that is clearly either illegal or certainly morally questionable. I think the regulators should continue to challenge and investigate the people with dubious short-term trading behaviours because they are the ones that are likely to be detrimental to market structure. What other investors need to do is to make sure that they are using the necessary tools to make sure they don’t leave themselves open to abuse.
We use technology to make sure that if we are going into a dark pool, we want a minimum order size. We might use limit prices more than we would otherwise, By way of example, if a stock is showing at 5/6 and you’re happy to buy at 6, by sending that order “at market” you risk buying 100 shares at 6 and the other 19,900 at 6½ or 7, due to someone with questionable ethics and some very smart technology spotting that you are starting to buy the 20,000 at 6. They then beat you to the venues offering the vast majority, and take them to their own account. This enables them to position in the market to sell them back to you at a fractionally higher price. So we will often use limits to ensure this doesn’t happen, on what might have previously been referred to as a market order. This in itself is sometimes fraught with difficulty, as if you’re unable to buy your 20,000 at 6, (because you put a limit over it), with the added pressure of the fund manager following up with “Did you manage to buy my stock at 6?”, you may have to admit, “Actually no, I got a hundred shares but now it is being offered at 9.” So clearly this approach has made the trader’s life more challenging, just for them to continue to execute, what you would have regarded as straightforward orders.
The differences between large and small buy-side firms
It’s always hard to know but I would imagine that a small asset manager almost certainly won’t have invested in a technology of his own, but uses tools that are available from the brokers and banks to empower them. There are a variety of broker neutral platforms out there that allow you to use their own algorithms or those from brokers. So you could be a relatively small asset manager with a relatively small trading team and provided you’ve looked at what’s available, you’ve pretty much got all the tools that you’ll ever need.
Benchmarking – the next challenge
One of the fascinating things to me about trading is the fact that it’s not so much the results you get or the performance number you produce. It’s not so much how did I do versus arrival point, or how did I do to close; the real question is, why are you trading to a particular benchmark? Why are you trading these to a closing benchmark, why are you trading VWAP, or why are you trading implementation shortfall?
The challenge should be around asking why somebody has chosen a particular benchmark and why it is a valid benchmark for that order. So the regulators might be better focused challenging not so much buy-side desks performance numbers but challenging their strategies and their benchmarks. It’s so easy to say you averaged the same as everyone else did today, but the question should be asked why were you buying them over a day when you could have done it in 5 minutes or an hour? People spend a lot of time trying to tell me that their algorithm is better than somebody else’s and I always say that I think the differences between one person’s shortfall algorithm and another person’s shortfall algorithm is so negligible as to not matter. The key is why you were using a shortfall algorithm or volume participation algorithm or a closed algorithm or alternative.
The unintended consequences of regulation
The biggest challenge for the regulator is the unintended consequences of regulation, but I think that they’ve learnt lessons from previous actions. By way of example, we can look at commission unbundling and the FCA crack down on managers’ use of commission dollars to pay for research and pay for corporate access. Active managers may decide actually that they don’t need to be taking anywhere near the amount of research that they have been taking.
I don’t think the buy-side can fix these problems, all we can do is make sure we are not leaving ourselves open to abuse. You’re always going to have challenges in any market place of any nature where people are trying to make money. A consolidated tape would definitely be a benefit. However regulators have to be very careful. To illustrate this point, the US regulator wanted a consolidated tape in place and to some extent, they have it. But it’s practically meaningless due to the sheer amount of data, and the regulator’s insistence that market participants interact with the best price. This is irrespective of the size and quality of the order and the location of the venue. The potential information leakage from venues, has meant that, in the US’s very fragmented environment, it’s actually become harder to trade in any meaningful block size in the US.
Considering where I would like Europe to be: all the buyers and all the sellers in the same place at the same time, with that exchange not being a profit entity but being effectively owned by its users. The more money the entity makes, the cheaper it becomes to transact on it.It may even be that the profits generated there are paid out to users would be a perfect scenario. I can’t think of a way we would get back there, but if the community all decided from the 1st of September we were all going to instruct our brokers to only place our orders on one venue(and everyone did it) that would work! The alternative venues would dry up and it would then seem to be a very efficient market with everyone resting on the same place. The risks are that the one venue you go to starts abusing their monopoly, or that participants break ranks and post elsewhere “just in case” This would creates pockets of activity elsewhere that you feel you have to interact with because you don’t want to miss out. Let’s just say it’s a tough one.