They’re no more than electronic messages at this point. But a growing number of trading executives argue that indications of interest should be looked at as firm quotes that can be automatically traded against by the buyside.
“The nirvana is executable IOIs,” says Robert Moitoso, head of the FIX division at NYFIX, an institutional broker and technology provider whose IOI dissemination product has been distributed via the NYFIX Marketplace network for more than two years. “The sellside can spend a lot of money distributing IOIs to their client base. They want to know if they’re getting bang for that buck–and executable IOIs would let them measure that.”
An executable or electronically actionable IOI is a message containing trade data that can be clicked and executed immediately by its buyside recipient. As such, it would take on some of the characteristics of a firm quote sitting on an exchange or ECN. In comparison, traditional IOIs are indications, or messages, from a broker to buyside firms that invite a telephone call and a negotiation. Demand for executable IOIs is coming from segments of both the brokerage and buyside community. On the buyside in particular, interest in clickable IOIs is part of traders’ need to source block liquidity more efficiently.
Moitoso, who spent two decades at AutEx, the granddaddy of IOI distributors, recognizes that what’s being asked for now is a tall order. “Actionable IOIs are an elusive target,” he notes. “No one really has their arms around how to execute on an actionable IOI.” He observes that an IOI is essentially “a message, a feeler that says, If you want to trade give me a call and we can probably do something, but we have to talk about it first.'”
Albert Lojko, head of institutional equities at Tradeweb, which owns AutEx, agrees that interest in making IOIs electronically actionable is flourishing. “That’s probably where the path will lead, because brokers then can better correlate their return on investment for a particular message,” he says. But he too doesn’t expect actionable IOIs to take over the world of block indications.
Some buysiders are ready to auto-execute on indications. “If the IOI delivery systems improve and IOIs are more specifically targeted and contain good actionable information, we’ll use them,” says Joan Stack, trading manager at the Ohio Public Employees Retirement System, an $84 billion pension and health-care fund.
“Actionable IOIs is where the IOI space is headed,” says Robert Shapiro, executive director of trading and execution analysis at Morgan Stanley Investment Management, which has $597 billion in assets, including $300 billion in equities. “Interacting with clean, strategically desirable IOIs will be a much more important part of our liquidity-sourcing endeavors in the future.”
Joe Cangemi, co-head of electronic trading sales at agency broker BNY ConvergEx Group, notes that some buyside traders are eager to auto-execute IOIs. “There is a segment of the population that’s moving toward electronic trafficking and execution,” he says. But it’s not the entire population. He adds: “Those executions will never supplant the broker-assisted block liquidity sourcing that is the mainstay of our agency business and necessary for many customers.”
Indicating Out
The IOI arena includes various types of electronic messages from brokers to their customers, ranging from IOIs with just the name of the stock and general size to more detailed IOIs with side, size and price information. At the top of the totem pole are natural IOIs-indications based on an agency order from a broker’s buyside customer.
Traditional IOIs represent big business. Large brokers can easily spend hundreds of thousands of dollars annually sending IOIs to their customers. AutEx was for years the only player of significance, but competition now reigns between AutEx, Bloomberg and Reuters–the three biggies–as well as a growing number of smaller or newer players. Many brokers also use the FIX protocol to route IOIs directly to their buyside customers.
According to research firm TABB Group, 93 percent of fundamental buyside traders surveyed for a recent U.S. institutional equities trading report said they use IOIs every day. Even among quantitative firms, that figure was 54 percent. The firm found that 88 percent of fundamental, quantitative and combined-style traders expect their use of IOIs to stay the same or increase over the next two years.
The number of trades based on an IOI is also significant in the current era of electronic trading. At fundamental shops, according to TABB, 16 percent of trades come off the back of an IOI, while quantitative firms say 8 percent of their executions are based on an IOI. Overall, almost 30 percent of the traders surveyed said what they would now most like to see are “electronically actionable” IOIs.
Getting Real
Actionable IOIs would make sourcing block liquidity more efficient. But for that to happen, brokers must be able to tier the IOIs they send customers more finely than is currently the case.
Chris Kelley, executive vice president for product marketing at Fidessa, a sellside order management system, notes that brokers must generate IOIs more intelligently,”directing IOIs tospecific recipients and sometimes using smart tiering systems to expose interest differently, and at different times, to different groups of targets.” Keeping IOIs current is also critical. Dynamic links between IOIs and a broker’s underlying customer order can ensure that this occurs automatically, he says.
Against the backdrop of increased electronic trading, IOIs with more details and information are also likely to be taken more seriously, even if they’re not clickable. “For some traders, what’s considered actionable could be a natural priced within certain parameters of the NBBO for a stock,” says NYFIX’s Moitoso. “They would pay attention to those IOIs, but they would still have to pick up the phone to negotiate the order.”
For some large brokers, the idea of actionable IOIs is moot. David Weisberger, head of global electronic market access at Citi, notes that traditional IOIs are likely to become more automated and more electronically actionable over time. But in terms of IOIs having firm prices, he says, the largest bulge-bracket firms are already there. “We on the sellside are held to a standard where IOIs are always actionable,” he says. “Almost every IOI is firm.”
If a big brokerage firm that commits capital sends an IOI and “doesn’t stand up to that IOI, that firm is going to have a serious business problem,” Weisberger says. However, “most IOIs are the starting point for a block trade negotiation,” he adds. “As a result, they tend to be a little away from the market and are therefore not often executed directly.”
What’s Lost
That manual, phone-based (or sometimes IM-based) negotiation process that results from IOIs is an important vetting opportunity for both brokers and institutions. Both sides want to know as much as possible about why the other side is trading. And for those IOIs that move into electronically actionable territory, that dialogue could be curtailed.
“Some customers that execute electronically want actionable IOIs,” says BNY ConvergEx’s Cangemi. “But for long-only asset managers looking to buy into or sell a significant piece of liquidity, a follow-up conversation to an IOI is almost mandatory for a prudent execution decision.” One size doesn’t fit all.
Some market participants observe that with sales trading desks being pared down, conversations that result from IOIs partly fill in the gap. IOI providers haven’t yet reprised the old AT&T slogan “Reach out and touch someone,” but IOIs essentially do just that. “As the market gets more electronic, we talk less to counterparties on the phone,” says Ohio’s Stack. “IOIs are an important way to keep current with information.” She adds that while her desk would use clickable IOIs, they wouldn’t be the default method of executing blocks.
Hit Size
The IOI message is also just the first step in opening up to the other side. Rarely will a broker ship out an IOI for the full size available. The broker may start with a piece of an order and, if the other side calls and is comfortable with a price, may then broach a larger-size discussion.
As a result, the ability to execute larger size than what’s sent out in an IOI message could fade with executable IOIs. “If the hit size is shown on a hittable IOI, the buyside could end up with residuals or smaller trades when ideally they want to do fewer trades but execute in larger blocks,” says Paul Scott, co-founder and a director at FIXCITY, a software vendor and IOI-services company based in London.
Buyside traders may also be choosy about what they auto-execute. NYFIX’s Moitoso notes that buyside traders may be happy to interact with IOIs electronically if the IOIs are for stocks with a lot of liquidity or if it’s the tail end of the buysider’s position. But in his view, that conservatism would run both ways. “Before brokers provide point-click-done functionality to institutions,” he says, “they would want to know who they’re dealing with, and they would want to understand the other side of the trade.”
Info Glut
The push to make IOIs more electronically actionable is occurring as IOIs continue to command buyside attention. IOIs are used and checked frequently because buyside traders need to source block liquidity. Decimalization, the decreasing average order size on exchanges and ECNs, and the fragmentation of liquidity have made the search for large natural liquidity more critical to reducing information leakage on big orders.
At the same time, the IOI world is riddled with useless messages. Buyside traders are deluged with IOIs. Many say the vast majority of them are irrelevant to their trading needs or are simply come-ons–the industry’s equivalent of spam. Worse, they can be fishing expeditions. Buyside traders frequently complain that when they pick up the phone in response to an IOI message, the broker doesn’t actually have the other side, or the size is too small. Alternately, the broker may have broadcast the message to attract business or test interest in a particular name.
Electronically actionable IOIs are seen as a partial solution to the problem of information glut and IOI fishing. Industry participants point out that making a segment of IOIs auto-executable would shrink the magnitude of the problem. If IOIs were hittable, brokers would have to be more cautious about the IOIs they send-and, more broadly, they would perhaps rethink their IOI habits once buyside traders expected to see more hittable IOIs.
In recent years, the level of complaint about IOI spam rose enough that NASD (now called FINRA) issued a memo to member firms in September 2006 reminding brokers of their “obligation to communicate accurate information when using services to communicate trading volume and trading interest to the marketplace.” The bulletin went on to specify that published information “must be truthful, accurate and not misleading.”
That may have tamped down some of the gross distortions relayed to buyside firms, but market participants and IOI publishers say IOIs remain a largely self-policing enterprise. According to TABB, almost 50 percent of buyside firms report that they avoid IOIs from brokers with whom they’ve had a bad experience in the past.
Other efforts are now under way to ensure that only IOIs likely to be deemed meaningful reach the buyside. IOI distributors and OMS or EMS (execution management system) vendors can filter IOIs for buyside traders by message type, security, broker and so on. Buysiders can limit the IOIs they see to naturals. They can also choose to see only IOIs with specific detailed information about orders they are working or with certain attributes that, effectively, establish a quality hurdle.
AutEx’s Lojko says IOI suppliers are working with buyside OMS vendors to integrate naturals into the blotter and “bring IOIs closer to the point of execution.” The benefit of this is that a trader looking at his blotter can see if there’s a natural in that name. This can be done via a column or row in the blotter, an alerting mechanism for names the trader is actively working, or a desktop application that commingles IOIs from multiple brokers, along with advertised trades for those names. A number of vendors have systems, repositories or other means of tracking IOIs and trade adverts.
This is not a small problem. A number of OMS and EMS vendors have a hard time taking in a large volume of IOI flow. Stack of OPERS notes that her desk uses IOIs from Bloomberg and Reuters, but had also received indications via FIX directly into its OMS, before the volume of messages overwhelmed the OMS. OPERS is transitioning to another OMS this year. “One consideration was that the system could handle IOIs without performance degradation,” Stack says.
IOI of the Beholder
More generally, the shift toward actionable IOIs is likely to change the industry in another way. As IOIs become more automated and executable, interest in quantifying their quality and usefulness is expected to increase. “The IOI message is becoming closer to a quote when we talk about it being actionable,” says FIXCITY’s Scott. “Once that happens, the buyside will want to measure the execution quality they’re getting.”
In Scott’s view, this is a natural progression. “If a broker has no responsibility for what’s in an IOI, then measuring the value of executions is of less value,” he says. “But if it’s hittable, the execution can be measured against the IOI.” He adds that this information can contribute to best-execution stastistics.
As IOIs become electronically actionable, their increased execution and information value could lead to further fine-tuning of the interaction between brokers and buyside firms. If brokers tier and segment their customers further to reflect better-quality IOIs, buyside firms will want to manage their IOI data by tracking how good the liquidity they’re seeing is and which brokers are showing it to them.
This shift could also compel the buyside to step up efforts to streamline the gush of incoming indications. “Some trading desks are quantitatively evaluating the level of success they have with each of their brokers from an IOI standpoint,” says BNY ConvergEx’s Cangemi. “Any excess information that’s clogging their ability to get to more relevant information is inefficient and at some point is going to be filtered out.”
Shapiro of Morgan Stanley Investment Management agrees that the IOI-related interaction between the sellside and buyside is likely to change. He summarizes the impetus: “Tiering is simple. Brokers decide that certain clients will get IOIs because they essentially are paying for the privilege of receiving them.” With IOIs becoming more valuable and actionable, that idea prompted MSIM’s desk, under the aegis of former sales trading exec Ray Tierney, to recast the way it looks at IOIs.
The desk is now tracking how it manages incoming IOIs to see if and when traders respond to them. IOIs are also being integrated into the desk’s OMS. As IOIs move toward becoming actionable, MSIM is considering whether to proactively pay for high-quality IOIs with agency trading flow. These metrics will help the desk decide how much to trade with certain brokers. “Electronically actionable IOIs are essentially binding invitations to trade,” Shapiro says. “Buyside firms will want to ensure they’re in touch with this type of liquidity.”
SIDEBARS TO MAIN STORY:
Sidebar #1: IOI Robots
Out of IOIS came crossing systems. Now, out of crossing systems will come IOIs. AutEx, launched in 1969, spawned a generation of products, from the FIX protocol (initially conceived as an alternative to AutEx’s communications network) to Liquidnet. These competitors tackled the idea of matching large natural interest in a security from different angles and altered the trading landscape.
While traditional IOIs are becoming more automated and potentially executable, a new crop of real-time, executable IOIs has already emerged. These are IOIs sent from some dark pools and crossing systems to the servers of participants, in an effort to suss out the other side of an order. The IOIs interact with machines, not humans.
FIXCITY’s Paul Scott notes that as dark liquidity becomes more prevalent and brokers internalize more flow, dark pools will become a bigger source of IOIs. This could happen in two ways, he says. Brokers could take the residual piece of orders from their dark pools onto their book and send out IOIs to find the other side, with the resulting order executed in the dark pool.
Alternately, Scott says, clients could “tag orders going into the dark pool if they’d like the broker to try to find the other side of the trade through automated IOIs.” In that case, IOIs would be generated automatically and sent to other users of the pool. “On the buyside, what [a person] would be shown is pure natural business, since it’s coming from a pool of liquidity,” Scott says. Any contra-side order would then be sent to the dark pool to execute.
Other IOI developments on the horizon are the ability of algorithms to automatically send out IOIs to a targeted list of a broker’s customers, and automated negotiations between an algorithm and a person or another algo, says David Weisberger of Citi. “That will take a while, but it will almost certainly happen,” he says. He notes that “most algos are time-dependent” and that IOIs could potentially effect executions more quickly.
by Nina Mehta
Sidebar #2: IOI Landscape
AutEx sends out about 1 million IOI messages every day, 15 to 20 percent of which are naturals, according to Tradeweb’s Albert Lojko. The average size of those naturals is 75,000 shares. BlockDATA, a communications service for post-trade advertisements, is AutEx’s industry-standard counterpart, used by buysiders to try to discern who has the ax in a name. Tradeweb now owns both services, along with the vast Tradeweb Routing Network.
Bloomberg and Reuters also send out tremendous quantities of IOIs and trade adverts. FIXCITY, a London-based, newer competitor in the IOI space, has gained a strong foothold in this space since it was established in 2002. NYFIX, which built its indications product on top of its routing infrastructure, sends out 100,000 IOI messages daily and is now building a trade-adverts product.
But what’s considered key to an IOI platform’s growth is the growth of the naturals, as opposed to general indications that a broker wants to trade a stock. “The buyside is looking for natural inventory,” Lojko says. He notes that AutEx has had “double-digit growth in the number of naturals coming into the system in the last couple of years.” Buyside traders, however, frequently complain that while AutEx established the industry 40 years ago, its message flow has become a bit of a grab bag.
IOI distributors nowadays have different strong suits. Some have vast order-routing networks of buyside and sellside firms. Some, like AutEx and Bloomberg, have become a core part of the industry’s communications fabric. Some tend to be more global, while others service more niche brokers.
These IOI distributors also have different payment systems, which can encourage a wider or narrower dissemination of messages. These range from per-message sellside charges to monthly per-destination fees for brokers, based on the number of buyside firms to which they connect. Unlike the others, Bloomberg doesn’t charge for IOIs, but its terminals are considered costly. The basic network idea is that the IOI provider must have a “community” of institutions and brokers looking to trade, says NYFIX’s Robert Moitoso. NYFIX Marketplace, he adds, includes 350 institutions and 400 brokers. The Tradeweb Routing Network has 400 institutions and 350 brokers using its network, according to Lojko.
by Nina Mehta
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