Commentary

Anne Plested
Traders Magazine Online News

Bottlenecks Ahead

Anne Plested, head of Fidessa's EU Regulation Change programme, has written a short blog arguing that although we should be thankful that ESMA have taken a pragmatic approach to moving things along, more bottlenecks could appear in the future.

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November 8, 2005

VWAP Debate Divides the Trading Industry

By Gregory Bresiger

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  • VWAP Debate Divides the Trading Industry

Guaranteed Volume-Weighted Average Price trades, in the wake of regulators' investigations, are coming under heavy fire by brokerage execs and academics.

"We encourage closer scrutiny and examination of these trades," Brian Devere, director of sales for Piper Jaffray's Algorithm and Program Trading group, told Traders Magazine. "We've long questioned how some of our competitors do these transactions at close to zero," he said.

Guaranteed Volume-Weighted Average Price trades, in the wake of regulators' investigations, are coming under heavy fire by brokerage execs and academics.

"We encourage closer scrutiny and examination of these trades," Brian Devere, director of sales for Piper Jaffray's Algorithm and Program Trading group, told Traders Magazine. "We've long questioned how some of our competitors do these transactions at close to zero," he said.

Trading officials and others have jumped on the anti-G-VWAP bandwagon in the wake of announcements by the NYSE and the NASD of investigations into the pre-hedging activities of certain brokers conducting G-VWAP and blind bid portfolio trades. The G-WVAP critics-many of them agency brokerages who do such trades on an agency basis-maintain that pre-hedging results in poor fills for money managers. But they contend that many managers don't comprehend how they're shortchanged.

G-VWAP transactions, sometimes completed at dirt cheap prices such as a half cent a share or less, should give clients "pause to wonder what is going on."

That was the warning of a trading official who declined to be quoted by name and whose firm sometimes offers guaranteed VWAP execution on baskets of stocks. He claimed his firm now declines to bid on some of these transactions when it seems impossible to make money risking its capital.

"We've seen transactions in which it seemed inconceivable that the broker could make money," the exec said

So how do firms make money on big transactions offering a half cent or, in some cases, nothing for the execution? The trading official said some brokers using guaranteed VWAP are manipulating the market.

"We've seen transactions in which principal guaranteed VWAP trades are priced at a discount to an agency trade," the trading official complained. He added that the broker, because of his knowledge, can change the course of a market. That raises the average execution price, he added, but the broker still delivers the promised VWAP average so the client is happy.

Several trading officials said guaranteed VWAP, like blind bids, is popular with clients. They believe they are getting a good deal. Critics of guaranteed VWAP say they don't appreciate the dangers of information leakage.

Typically, a brokerage offering guaranteed VWAP will be approached by an institutional client that wants to move a basket of stocks without disclosing the stocks or on which side of the market they lie. The broker, though, can guess the component stocks, or highly correlated ones, based on a trade's characteristics.

With a good idea of the nature of the stocks traded, there is then little risk for a broker providing a low basis or zero basis point quote. The broker's pre-hedging has put it in a good position to gain from the impact of the transaction, trading officials explained.