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August 31, 2004

The Buyside in Command

By Peter Chapman

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The buyside can out-trade the sellside. At least that's what some buyside traders told the Tabb Group. With the advances in equity trading technology, many on the buyside now look to themselves for best execution before handing their orders off to brokers.

ECNs, electronic crossing networks, direct market access front-ends, order

management systems, FIX connectivity and algorithm servers all make it possible for the buyside trader to take more control of his orders. That's good because performance pressures and legal and regulatory scrutiny are practically forcing him to do so.

The Tabb Group interviewed 52 buyside desks - large, medium and small - to find out which systems they used; how often; and why. Some of the results were surprising.

For instance, large buyside desks, with over $50 billion in assets, were less likely to use ECNs than small and mid-tier firms. And, despite their relative newness, fully 60 percent of all desks already use algorithmic servers to feed orders into the market.

Traders Magazine Technology Editor Peter Chapman spoke with Larry Tabb, founder and chief executive of the Tabb Group, about the findings of his survey, "Institutional Equity Trading in America A Buyside Perspective."

Traders: The buyside feels they can out-trade their brokers by using all this new technology?

Tabb: To a certain extent, they feel their brokers are not giving them the kinds of executions that they'd like.

Traders: So, they think they can do it better themselves?

Tabb: Right. Now, that could be hubris. Or, it could be true. Or, it also could be issues with market structure on the New York [Stock Exchange] where they feel like they are getting hosed.

Traders: The increase in buyside control over trading is due to legal and regulatory scrutiny as well as cost considerations?

Tabb: Yes. Portfolio return as well as regulatory and management governance/oversight.

Traders: Why is ECN use less common at large buyside shops compared to smaller and mid-tier firms?

Tabb: Medium and smaller firms have smaller orders. It's easier to manually execute through an aggregation tool or an ECN when orders are smaller. You don't have to break them up. You're not looking for big blocks or large liquidity. The really large guys are looking to do tremendous size. So they need a wider array of options.

Traders: Your data shows only 40 percent of the 88 percent of the buyside who trade on ECNs use aggregation platforms. That means most buyside traders still access ECNs through ECNs?

Tabb: Yes. But that will change as aggregation tools become more popular. All the brokers are vying to have some sort of aggregation tool. Because all the large buyside shops are serviced by a large broker that number will increase. It makes a lot of sense. It lets the buyside trader access liquidity evenly across all of the different ECNs. And lets them use a consistent set of order types across all the ECNs whether they are supported or not. It makes the life of the buyside trader a bit easier.

Traders: The survey states small and mid-sized shops get their DMA (Direct Market Access) from brokers while larger ones are more likely to buy or build their own. The smaller ones are mainly hedge funds getting DMA through prime brokers?