The gathering of brilliant minds before the new dawn
Key findings from: the 15th Alpha Trader Forum Equities in London June 2017
The buy side at the Alpha Trader Forum in London were generally debating two themes. Firstly, do the head traders have all the necessary information to make sure that they covered all requirements ahead of 3rd January 2018 with the implementation of MiFID II and what the FCA is likely to be interested in if there would be an audit. Secondly, how will the new market structure look in 2018 and which services can (and should) the buy side avoid from day 1?
While the first iteration of MiFID was primarily focused on the sell side, the UK Financial Conduct Authority (“FCA”) have reviewed a number of buy-side firms and publicly announced their concerns and future focus supervising asset management firms. The buy side are concerned that the FCA’s theoretical best practice guidelines are not always practically suitable for all types of buy-side firms.
Processes of monitoring, review and documentation of such requirements needs to be suitable but also flexible enough to cover the majority of situations. There needs to be a quick and flexible exceptions process as traders should focus their time on the best outcome for the clients. It is not feasible to try to cover every possible exception in a documented policy.
While the compliance officers are interested in a shorter counterparty list, the head traders are debating to what extent the end-tail of specialist brokers adds value to the costlier trades. Technology fees and the unbundling and consumption of research is straining ad-hoc counterparty relationships. There are varying approaches of reviewing the counterparties but best practice is a whole-firm approach if the firm has sufficient resources for it.
From a best execution perspective, the execution factors are an interesting topic. The first step is to identify the overall liquidity and participation levels. Thereafter price and size are the most important execution factors. Once a suitable strategy has been determined, the right types of counterparties can be chosen. Down the liquidity chain, the likelihood for settlement becomes an increasingly important execution factor. The overall price is more important than individual fills.
The selection of trading counterparties, at the point of trade, is an interesting area for improvement. To what extent can technology and historical data be leveraged efficiently for a more objective and automated process? How can the buy side ensure that a statistical approach is not leading them towards a biased self-fulfilling process?
In 2018, the brokers will have broader access with their Smart Order Routers and the buy side will need to get more involved in the brokers’ venue selection process to avoid exposure to toxic venues.
From an unbundling perspective, the buy side recognise that the broker needs to be paid a premium execution rate for trading advice and risk capital when applicable. As predicted, there is a trend towards an increasing number of execution rate categories which compliance departments are less willing to accept. The FCA’s final guidance on “Inducements relating to research”, released as part of Policy Statement PS17/14 in July 2017, was highly anticipated to deliver further details into the remaining areas of uncertainty. An increasing number of firms are venturing the route of paying through the P&L to simplify the complex unbundling process.
The details of the upcoming MiFID II reporting requirements still have areas of ambiguity. The majority of firms are arranging direct relationships with APAs to cover the needs of trade reporting.
Looking forward at the revised market structure from January 2018, the buy side are generally preparing to leverage banks’ block service specialists and there will be an increasing need for more granular due diligence around the counterparties block capabilities. There is also a more positive outlook at new types of exchange driven block services that will gain further success. The buy side will need to make the right decisions if orders are to be placed simultaneously or sequentially at the broader range and types of venues. The buy-side’s market outlook for 2018 is anticipated to be the key theme of discussions at the Alpha Trader Forum roadshows now running in London, Frankfurt, Paris and Stockholm this autumn 2017.