Indicators Of Trust
UBS’ Ross Hutcheon Explains How Redesigned IOIs Help Modernise Liquidity Distribution.
Indicators of Interest (IOIs) were one of the first things traders used the FIX Protocol for, long before automating trades. It has been around the longest, but development has slowed the last few years. In the interim the focus switched to the order execution process: orders, execution reports and ultimately, trading algorithms.
Historically brokers sent out high volumes of IOIs, both naturals and also those indicating a willingness to trade. There was a large amount of resulting ‘noise’ and as a result the buy-side had struggled to gain as much value from IOIs as originally hoped for. As a result, some firms like Capital Group decided to turn off the traditional IOIs.
However, IOIs have more to offer. Investment banks and brokers are working out the best way to distribute merchandise and attract the other side of the trade. More than redesigning IOIs as a product, considerable effort has been given to the liquidity distribution infrastructure, with the goal that each IOI contains more information that is useful to our clients. To this end, we developed our centralised risk book (CRB) to centralise and hedge our risk and subsequently distribute liquidity to our clients. We are live with aspects of our CRB in all regions (Asia, Europe and the US) and we are piloting the use of aIOIs in the US, with plans to extend further.
This covers the spectrum from:
a. Natural IOIs – traditional order: a buy-side order in one hand the broker wants to match,
b. Risk unwind actionable IOIs (aIOIs) – the broker is showing liquidity that they are trying to unwind,
c. Brokers sending aIOIs, quoting risk/stop prices – the broker is making a market; taking on risk and unwinding it (e.g. subsequently trading out of).
The three scenarios above are treated differently by the buy-side. No single type of IOI is necessarily better than the other, but providing the added information empowers the buy-side trader.
This concept ties in to what some of our more forward thinking clients are doing with their internal processes. This can help clients determine, on an order by order basis, if they would benefit from interacting with that liquidity.
An IOI is a mechanism to distribute liquidity to your key partners; it is not a product in itself. Conveying more information in IOIs better enables the buy-side to decide whether to interact.
The fundamental business of stock broking is still the same; matching buy-side traders with the liquidity they want. The aim of the new infrastructure is to efficiently centralise liquidity and provide more transparency; we believe that is something the buy-side wants. Any process we put in place does not replace the trust and relationships developed over the years, but rather helps to systemise the process.
The last two scenarios, where the broker is making an automated risk price and unwinding risk, can be automated. In the first, where brokers actually have a traditional order in hand, those IOIs are always going to lead to a conversation. We would typically not send out an IOI showing the full size of an order, but typically show part of the order, to start a conversation. Net result is that we could end up trading substantially more than what the IOI shows.
Bottom line, you can augment that human relationship with technology but not replace it.