Turning a corner?
In the world of equities, the global buy side have highlighted various different concerns in each region. Some of the standout events in the last few months include the publication by both the FCA and French regulator AMF of consultation papers regarding MiFID II unbundling procedures. ESMA has also published a Q&A covering the same subject. This is the first time we see a non-UK national regulator indicating a stronger stance on MiFID II challenges. At the same time, one can identify areas of future regulatory arbitrage between the UK and the EU.
In Asia, the top buy-side concerns are the impact of MiFID II globally and budgeting commissions. The buy side suggested that commission management is the biggest issue. They do not want the quality of services from the sell side to decrease as a result of falling commissions. The buy side wants to ensure there is adequate research commission generated which can be redistributed. There is a need to standardise rates, but at the moment all that can be done is to standardise those that are most commonly paid.
At the same time administrating, compliance continues to be a challenge. Notably, many buy-side firms are required internally to explain to their compliance department why they have paid more than the usual commission. In response to falling turnover and commission rates, competition over block liquidity has increased and some firms are now willing to pay full commission rates for blocks, to ensure the broker does not go to a rival.
In the United States of America, similar concerns dominated the Alpha Trader Forum debate in Boston and New York in H2 2016, where the buy side primarily highlighted concerns over how to implement a Research Payment Account (RPA) and how to manage research payments. On a related note, in Germany the buy side highlighted the Swedish model, which is considered one or two basis points more expensive but considered much more efficient than having hundreds of different Commission Sharing Agreement (CSAs). Likewise in France, the buy side noted that the UK FCA has a different
approach to corporate access versus ESMA and the AMF in the EU. The key concerns in the Alpha Trader Forum (ATF) Paris in H2 included the budgeting process, CSAs versus RPAs given that France’s regulator is CSA-friendly, and VAT on research.
In London, the buy side community has shown some support for the Swedish model of complete unbundling; one of the appealing factors of this approach is that without CSAs there is no need to set up any separate RPA – rather some firms are planning to simply pay for research from their own budget.
Some firms are clearly going execution-only; however, others think that MiFID II doesn’t go far enough, and one trader in the London ATF Equities in H2 objected to having to make payments for research at all. K&KGC also published a 2016 commission management report based on input from Asia, Europe and U.S.A. in November 2016. This report explored how commission rates should be approached on a global basis, and whether cents per share is a more cost effective model than basis points.
In addition to all of the above, the buy side continues to be concerned about broker selection, scoring criteria and review, regulatory demands in Europe for more detailed best execution policies (which many firms fear may compromise their ability to be flexible) and to what extent broker lists should be cut, given cost pressures on the industry. Also in Europe, the buy side is debating whether it should outsource trade and transaction reporting, or place it in-house. Some firms are trying to delegate all trade reporting.
In the US, there is some scepticism about the effectiveness of the SEC’s tick pilot which aims to boost small and mid-cap stocks by changing tick size increments. There is also a feeling that there are too many venues; there is some support for IEX, which was created to appeal to long-only institutional investors.
Across all regions globally, there was also concern that the cumulative effect of global regulation could
disadvantage smaller buy side houses and hand an unfair advantage to larger players that have the resources and scale to cope more easily.
Rewriting the rulebook
In fixed income, one of the core concerns of the global buy side is whether technology can support in the formation of a reference price. Attendees at the Paris and London Alpha Trader Forums are determined and claim that they must become price makers and take charge of their destiny to become less dependent on the sell side to find liquidity. In Asia, one of the primary topics was which fixed income platforms to invest in, and what a fixed income execution management system might have to offer the buy side, especially one with open architecture. From a best execution perspective, K&KGC has helped the buy side to map the buy side's feedback on how many brokers are needed in each region.
In European fixed income, as with other asset classes, the buy side is concerned that compliance departments could become too zealous, disrupting the ability of the trading desk to do its job. Another concern is that transparency requirements could be damaging to the market, depending on how stringent these are.
The existence of live tradable data was questioned by one participant in the London Alpha Trader Forum (ATF) fixed income debate in October. The buy side is also irritated by regulatory focus on Transaction Cost Analysis (TCA). As one buy-side trader at the same meeting stated, "Why turn down a line of business just because you’re worried the TCA is going to be basis points off the market and look bad? Yet you’re achieving your overall business objective which is to get portfolio movements done. In my mind, if you do that, that’s best execution. Why turn that down because of the TCA?”
A different but equally negative outcome is the practice of not trading at all, because of compliance. Due diligence requirements are becoming tougher, obliging the trading desks to dig deeper into each trade and provide more detailed explanation than ever before. This may have an impact on how aggressive traders are willing to be in the market when they do trade. Some participants object to the level of granularity required by regulators, questioning why this is necessary. One trader felt that unless the firm is an HFT, the level of granularity required is excessive.
In London, the buy side has divided opinions about the merits of some new fixed income liquidity initiatives, with some traders dismissive while others are more optimistic. One obstacle to the growth of new platforms is the potential reluctance of banks to support something that may ultimately reveal their hand and may even disintermediate themselves. However, given the major drops of sell side inventory and constrained sell side resources especially in Europe, there may be little choice but to adopt these initiatives.
In Germany, there is concern about hidden fees among trading platforms when making price comparisons. The DACH buy side also note that using TCA in fixed income is difficult, as the peer group analysis is skewed as the buy side are both buyers and sellers. There are also too many factors for the provider to consider given the complexity of the market.
In France, the buy side are concerned about transparency – they don’t want the fixed income market to become like TRACE, the consolidated tape in the USA. The community also highlighted a need for predictive data for block trading, including pre- and post-trade data.
Buy-side firms note that end-clients are also taking much more interest in execution quality than they used to. This leads to the subject being discussed in client board meetings, where clients are demanding explanations.
Building a modern FX desk
In foreign exchange, the main concerns highlighted by the buy side in the second half of 2016 include
relationships with counterparties, broker selection and relationships with custodians. In Europe, there is frustration on the buy side that platform vendors sometimes don’t understand the banks and banks don’t understand the platform vendors, leaving a void of knowledge between the two that can leave the buy-side trader in a difficult position with no clear source of help. Some participants are doing more FX hedging than previously, and there are also more hedge funds active in FX than before. The buy side is concerned about being ripped off by custodians; however, one participant at the 5thAlpha Trader Forum in London in October said his experiences with custodians have been better than with third parties, in terms of fewer trades being declined.
In terms of relationships with the sell side, banks are sometimes reluctant to stream to platforms; there is a
perception that they would rather stick to the Request For Quote (RFQ) model. In terms of automation, the buy side has expressed a preference for automating smaller trades and spending more time on the larger trades that can make the biggest difference for the firm. One obstacle to automation is that those using an algo should know who the underlying client is, but most participants don’t so they use a prime broker instead. However, doing so often involves using Electronic Communications Network (ECNs), some of which may no longer exist in the near future due to competition. That presents a risk.
As for venues, some players expect to see a price war between the ECNs and the prime brokers. For example,
if the prime brokers feel that their trading is being undermined, they could increase the fees to the ECNs to
get the flow back. In Asia, buy-side dependence on the sell side is expected to decrease with the increasing transparency and electronification of the market. The buy side has also highlighted that trading with a dedicated trading desk is a significant cost saving in Asia as custodians charge a high number of basis points in auto FX. The buy side also believes that netting is preferable compared to increasing the number of counterparties to gain access to additional liquidity.
In London, the buy side are dissatisfied with the number of algorithms available in FX and especially with the names such as Sniper and Guerrilla that are applied to these algos. Such names are considered inappropriate and confusing. There is a demand from the buy side for clearer names that more accurately reflect what the algorithm does.
At the same time, the UK FCA wants asset managers to identify the difference between the time the trade
entered the market and when it was executed. The lack of a central clearer for FX is another potential pitfall of the market, given the mandating of clearing under Dodd- Frank in the US (although given the election of Donald Trump, the future of Dodd-Frank is now uncertain).
There is also some concern on the buy side about the MiFID II requirement for best execution policies, which some participants feel could limit the traders’ ability to exercise discretion and adapt and engage with a
changing market each day. Traders are also frustrated by attempts from the regulators to bring equities concepts to FX without sufficient adaptation. “FX is a different market, and it should be treated as such, and not treated as just another equity market,” said one participant at the recent Alpha Trader Forum FX in London in October.