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“In the past, the implementation of new platforms was mainly sell-side driven, which didn’t necessarily fully favour the buy-side and the interests of investors. 

We need the buy-side and the sell-side to work together.”

“We take our responsibility to deliver Best Execution very seriously. It’s not just a case of having a TCA on the shelf that says we did fine – it’s about ensuring our traders have the skills, tools, market access and relationships to achieve the best possible outcomes for our clients”

The future of trading lies not only in the distinction between different asset classes, but also in a new model which divides the world between high-touch and low-touch execution – across all asset classes, according to Christoph Hock, head of multi-asset trading at Union Investment. 
“We won’t organise the trading desk by asset class,” said Hock. “Instead, we will have a high-touch team and a low-touch team. The low-touch team is for liquid names and small trades with very little market impact. It will be fully automated and individual traders will cover all asset classes. At the same time the high-touch desk will be for very sensitive trades, decent size notionals and less liquid assets. And the skill set between the two will be very different.”
Hock’s proposal is soon to become a reality at Union Investment, where reorganisation is already underway and is due to be completed within the coming months. Traders on the low-touch team are now expected to hold expertise in how to optimize customised algorithms, how to use TCA, how to monitor the toxicity of trading venues, and how to achieve the best connectivity. In this group, individual traders will trade in all asset classes. 
Conversely, the traders on the high-touch desk will have a very high degree of specialist knowledge by asset class, because the complexity that comes along with these particular tasks demands it. For example, a small-cap Spanish stock is very different to a high-yield corporate bond.
Union Investment estimates that it can automate between 20-30% of its number of orders across the whole business. The company’s plan is ultimately to use these freed-up human resources to additionally focus on the high-touch trading to generate best-in-class trade executions for its investors. 
Speaking of adding value, these days one doesn’t have to go far to hear reports of the wider shift of the securities markets towards passive investment strategies. The growth of ETFs reflects this, as these baskets of securities essentially combine securities from a variety of different indexes in a given region or class to give investors quick and easy access to the market. “As an active manager seeking to identify alpha, and thereby outperform our benchmark, the role of our trading desk at Union Investment is to ensure that we effectively capture the alpha for our clients. We can be more flexible than a passive fund on when and how to execute, and our traders have the expertise and confidence to exploit that flexibility.”
One of the benefits of bringing multiple asset classes together is sharing of market intelligence and making use of the combined knowledge in cash equities, fixed income, FX and derivatives. Traders in different asset classes can learn from each other. 
For example, Hock says that in equities, due to fragmentation and other factors, traders are used to dealing with a variety of different types of venues and sources of liquidity and also execution benchmarks such as implementation shortfall calculated versus arrival price or VWAP (volume weighted average price) and PWP (participation weighted price). There are also specialist block trading facilities. 
By contrast, in fixed income and FX, business has traditionally been done by RFQ, asking brokers for prices, while the concept of arrival price was not well known in these asset classes at all. There was a lack of data and a lack of transparency. Now that these asset classes, especially FX, are shifting towards trading more like equities, fragmentation, electronification  and TCA are becoming features of the new trading landscape and block trading venues are entering the market; algos and dark pools are also entering the market. A trader coming from an equities background may have a valuable perspective that can be applied to the non-equity asset classes; conversely, fixed income and FX traders can benefit from a greater understanding of how the equities market has changed as a result of MiFID I back in 2007/8, in preparation for comparable changes in their own market.  
“Similar things that have happened in equities over these past few years are now happening in fixed income and FX as well, and we need to be ready for that in the very best interests of our portfolio managers and our investors,” said Hock. 
One of the other major shifts in the market is the development of new market models based on collaboration between buy-side and sell-side firms – for example, Project Neptune in fixed income, and the Plato partnership in equities. “In the past, the implementation of new platforms was mainly sell-side driven, which didn’t necessarily fully favour the buy-side and the interests of investors,” said Hock. “We need the buy-side and the sell-side to work together.” These new platforms are part of a new wave of platforms built with active buy-side participation. Others include Turquoise’s block crossing services, as well as new services at exchanges like Bats Europe (formerly BATS Chi-X Europe).   
The other impetus for change is provided by regulation. The current regulatory agenda, which is largely being driven by the impending introduction of MiFID II in January 2018, has been criticised for placing transparency obligations on participants in the fixed income and FX markets which some participants fear will damage liquidity. 
“Transparency is a fine line,” said Hock. “In a regime with very high transparency, one needs to be careful not to destroy liquidity and the pricing mechanisms in the market. For example, full size disclosure in a principal-driven fixed income markets immediately after having traded is a massive disadvantage, because anyone can replicate the trading book of the broker in that case and ultimately gain advantage from it. Transparency is in general a good thing, but has to be seen in relation of the functioning of markets. I still hope for a good compromise and resolution on this from the regulator.”
Hock added that because regulation is a game changer for the whole fixed income industry, the buy side has to be very proactive with market structure, electronic trading tools. “We take our responsibility to deliver Best Execution very seriously. It’s not just a case of having a TCA on the shelf that says we did fine – it’s about ensuring our traders have the skills, tools, market access and relationships to achieve the best possible outcomes for our clients”, he said. 
Speaking of regulation, some buy-siders are uneasy about the way aspects of the market operates. For example, ETFs can cause wild swings in the market during stress situations as seen on 24 August 2015. During that day, Hock estimates that some ETFs were trading more than 40% below their net asset value with a massive impact on markets overall. So should the regulator step in? Hock doesn’t think so – instead, it is an issue of education. “As an investor, also as a trader you are faced with new situations every day. So it’s a constant learning curve,” he said. 
Fortunately, also through valuable input and developments from buy-side traders, these days there are more tools available than ever before to help the trader make informed decisions. Transaction Cost Analysis has been increasing in popularity and sophistication for years, and is currently growing in fixed income and FX after becoming well-established in equities. Opportunities exist to make the most of this information to improve the trading process, but Union Investment does not compensate its traders solely on their TCA performance. Instead, the focus is on matching the needs of the portfolio manager, the “internal clients” of Hock’s trading desk – a goal which is not necessarily always directly aligned with TCA. 
“TCA measures you versus a certain benchmark, which means it doesn’t always capture a holistic picture,” said Hock. “For example, if you are measured versus VWAP. You might trade steadily because of your benchmark, and look good in the TCA results – but it may not be what the portfolio manager  wanted, because you could have traded a block which would have been a far better result for him. So TCA is just one part of the measurement. Therefore we make sure that all of our traders have the incentive to act in the very best interest of our portfolio managers’ objectives”.
In the same vein, Union Investment has its own approach to automation of trading, which differs from that of some of the other major buy-side firms. While some large asset managers are seeking to maximise automation, Hock feels that a more nuanced approach is preferable. 
“Automation should not just be a means to cut costs and reduce head count,” he said. “Automation has to be in the interests of clients and providing a better service. Simply making cuts doesn’t necessarily support our goal of providing the best service and achieving the best outcomes for clients. I’m happy to have electronic tools to help me decide, but I don’t want the process fully automated. I am convinced that a combination of human traders and smart electronic tools can deliver better performance. The tools should help the trader, not replace him entirely.”

Impact of Brexit
 

On the night of Brexit, Christoph Hock and some of his traders of the team arrived at the Union Investment offices in Frankfurt at 1.30AM UK time. As the votes came in, Union Investment’s traders were already active in the market. As the night’s results turned in favour of a result that few had predicted even hours earlier, it became clear that something momentous was taking place: the UK had voted to leave the EU. 
“I would have preferred there was no Brexit, which will cause lots of additional uncertainty in the months to come,” said Hock. 
One of the questions arising from the UK referendum is the impact on MiFID II. After more than six years of development, the regulation now faces a less certain future, especially in the UK – but the impact may not end there. Hock points out that the UK’s FCA had a major impact on the drafting of MiFID II, particularly in areas such as payment for research, where the continental regulators such as France’s AMF have a very different perspective. Now that the UK is no longer part of the EU’s future, it remains to be seen whether these controversial parts of MiFID II might be amended – although at present, there is no formal indication that this will be the case. Until the UK invokes Article 50, formally exiting the European Union, much remains uncertain, both in the UK and beyond it. 

 

Breaking barriers

Christoph Hock, head of multi-asset trading, Union Investment 

Elliott Holley
Head of Global Buy-side Research
eholley@kandkgc.com
+44(0)7759 476779

K&K Global Consulting Ltd

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