The Global Trading Perspective: An AllianceBernstein Case Study
Richard Nelson, Head of EMEA Trading for AllianceBernstein, shares his perspectives on navigating volatility, prospects for developing exchanges, new regulation and the balance between transparency and best execution.
FIXGlobal: How much does volatility affect the way that you trade and what are you using to measure volatility on the desk?
Richard Nelson, AllianceBernstein:
We use an implementation shortfall benchmark, so the longer we take to execute an order, the wider the range of possible execution outcomes. Volatility, in particular intraday volatility, increases that potential range, so you could see very good or very poor execution outcomes as a result. In reaction to that, we take a more conservative execution strategy or stretch the order out over a longer time period. And, for instance, if we get a hit on a block crossing network, we will not go in with as large a quantity as we would in a less volatile market. In that way we try to dampen down the potential effects that volatility might have on the execution outcome.
FG: How is AllianceBernstein using technology to improve performance and cut costs on the trading desk?
RN: It plays quite an important part and has done so for quite a while. We are pretty lucky in that we have a team of quant trading analysts. Most of them are in New York, but we have one here on the desk in London, and they help us to analyze the changing market environment and recommend the best ways we can adapt to it. Our usage of electronic trading has increased in the last year, we benefit from the quant trading analysts looking at the results we are achieving with our customized algorithms. We are more confident about getting good consistent execution outcomes because they are monitoring the process and making the necessary changes to ensure the results are what we are expecting. This, in turn, increases the productivity of the traders I have on the desk. They can place their suitable orders into these algorithms and let them run which allows us to focus on trying to get better outcomes on our larger, more liquidity-demanding orders.
On top of that, as market liquidity has dropped significantly, we are trying to make sure we reach as much potential liquidity as possible, and ideally we want to do that under our own name rather than go to a broker who then goes to another venue. We believe that going directly into a pool of liquidity is better done under your own name rather than via a broker because we can then access the ‘meaty’ bits of the pool rather than the ‘froth’. We are looking into ways of doing that but one of the problems is that, potentially, you get a lot of executions from a number of different venues, which results in multiple tickets for settlement. Our goal is to access all these potential liquidity pools, yet also control our ticketing costs, which are a drag on performance for clients.
FG: Was it an intentional change to increase electronic trading or was it a byproduct?
RN: It was a little of both. Our quant trader has been with us for two years and when he first arrived he had to sort out the data issues that exist in Europe and to clean things up. Once the data integrity was sorted out, we looked at different ways of employing quantitative analyses. Having somebody here who is constantly monitoring the execution outcomes means we can proceed down this path with real confidence. As a London firm, we were a little behind in our adoption of electronic trading, but now we are in the middle of the pack in terms of usage. It makes sense from a business and productivity perspective that there are many orders that do not need human oversight, which are best done in algorithms.
FG: With new regulation in Europe and forthcoming changes in the US, what is the biggest change you will have to make in your trading: e.g. broker crossing, HFT, access to dark liquidity? Will this change be made internally or by your brokers?
RN: We are in a very interesting stage here in Europe, as MiFID II is frequently talked about and discussion papers circulated. The review has changed from the first things that were mooted and I think it will change again by the time it actually becomes law. There is still quite a way to go to put flesh on the bones.
We have moved in a positive direction, however, in some aspects. The new Organized Trading Facility (OTF) regime is going to be something the brokers have to integrate with their Multilateral Trading Facilities (MTFs) and Systemic Internalizers (SIs), and that is something they must deal with and work out how it all fits together.
One area that concerns me is what may happen to waivers for block crossing networks. As a larger institution, these play a very important part in how we execute our orders, so we would not want to see that change in a way that disadvantages how we can participate in these venues. The other area that concerns me is the intention to increase the speed for reporting trades, which is great on an agency basis, but may not necessarily be so good in a situation where we have used the brokers for a principal trade, where the brokers provide a principal price for us to get some volume in a particular position. At this stage it is unclear how the regulations might affect the need to report that straight away. Agency trades are fine because they are third party to third party trades, but in a principal trade the broker has risk on their books and they need time to reduce or hedge that risk. It would be detrimental if those types of trade were required to have instantaneous reporting like agency trading probably will.
FG: Price discovery helps all participants, but large institutional investors benefit from greater anonymity when trading. What is the appropriate balance between these two concerns? Does it involve shorter reporting periods or increased reporting of unlit trades?
RN: An institutional investor is, by and large, an organization that represents pension funds and mutual funds; basically, it is the retail public bundled up into larger shapes. We have similar interests to the man in the street in terms of his investments. Pre-trade transparency and price discovery are popular discussion points, but we rarely discuss the fact that posttrade is as important as pre-trade transparency. There is a great deal of information to be discerned from a post-trade tape, because we can get an accurate picture of volume for specific names each day. It is good that regulators are tightening up the reporting regime for post-trade, and it is particularly helpful for agency trades, but there is still work to be done on the risk trades. The proposal for a consolidated tape would be beneficial as well, because at the moment trades are reported on many platforms and it is difficult to get a full picture in real time as to what is going on in the marketplace.
As regards to pre-trade and price discovery, even for institutional investors who trade in dark pools and block crossing networks, we still use those pre-trade markets as a reference point for where we trade in the dark or in block. The amount of business that is going through these dark pools and crossing networks is not large enough at all to detract from the price discovery that is occurring in the lit markets. Any crossing that a broker does in Europe is reported as an over the counter trade, but that is not entirely accurate. Even crossing networks use the pretrade markets as reference points, so it is something of a misnomer.
FG: As more markets modernize their platforms and increase speed and capacity, will trading volumes spread more evenly between traditional market centers (London, New York, Frankfurt) and emerging markets (India, Korea, Brazil, Russia, etc.)?
RN: It certainly helps when markets modernize their platforms and a growing GDP obviously attracts more funds, but the trading and clearing processes are still critical to a market’s success; for instance, many markets require investor ID numbers. This is often perceived as unnecessary bureaucracy. In the Middle East, you have Euroclear and Clearstream and you need to let the broker know who your clearing agent is at the beginning so that you go through the appropriate means of execution and settlement. In Russia, they are making some major changes this year, but until these changes they have had no Delivery Versus Payment (DVP) settlement system, so you have had to use free of payment settlement to trade local shares. Some people are less comfortable with this form of settlement.
The fundamental processes of how they go about trading make it difficult and these will not be cured by increasing speed or capacity. If the bureaucratic aspects are not addressed it does not matter how big they get, their instruments will be listed on more established exchanges for trading.