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Best Execution and the “Electronification” of High Touch Trading

Traders Magazine Online News, November 26, 2018

Michael Mollemans

The unbundling of research brought about by the Markets in Financial Instruments Directive (MiFID II) put the cost of execution into the limelight with many buy-side traders responding by increasing their use of low cost, “low touch” algorithms (algos). Best execution policy disclosures also brought quantitative performance and qualitative service factors into focus. As best execution regulation and service expectations evolve, so too do the traditional “low touch” and “high touch” roles, with the road ahead leading to an electronification of “high touch” client service partnerships.

Liquidity issues in certain names, and on certain days, are always a source of frustration for buy-side traders. Markets are dynamic and liquidity in small- and mid-cap names can be here today, gone tomorrow, and a few illiquid names in a “basket” or “program” can destroy overall performance numbers. A sales trader’s ability to combine expert advice on liquidity-seeking algo parameter settings with a breadth of counterparty relationships gained through experience makes all the difference when aiming to achieve the highest possible ranking in a client’s execution performance scorecard. Buy-side traders are increasingly taking  a multi-factor approach when evaluating brokers against their peers, with value-added service and other qualitative measures weighted highly next to execution quality. A “high touch” approach, in an otherwise “low touch” algo business, not only helps achieve a superior weighted average performance result, but also helps move up in the performance scorecard ranks.

Block crosses can help enhance trading performance but can also damage client trust if crosses are sourced without consent, or if the client’s unique qualitative parameters and constraints are not properly followed. Sales traders certainly need to interact with electronic crossing venues selectively while seeking to utilise the breadth of counterparty relationships. When crossing stock at a price, however, there is no substitute for skilled technical analysis of stock trends to estimate the periodicity of alpha so as to minimise the chance that stock prices trend into you only after executing your block at a relatively unfavourable price. Timing contribution of executing a block at a price, and the opportunity cost of not executing a block, must be carefully considered. Information leakage costs must also be considered when reaching out to counterparty relationships. Block executions provide an opportunity to minimise impact but if unnecessary information leakage is created they can also hurt overall performance. Automated “smart IOI” (Indications of Interest) processes, geared to targeting known holders of a name, can be very helpful when trying to minimise leakage.

Reliability of execution across a robust trading platform that can sustain any type of system failure is often cited by the buy-side as a key qualitative factor when it comes to making broker routing decisions. Availability of backup algo networks is valued because the last thing clients want to hear an hour into the trading session is “trade away please.” Market data issues, network outages, database failures, algo engine issues, etc. can happen, but the ability to fail over to a parallel backup algo infrastructure makes all the difference when it comes to providing reliability of execution. A sales trader’s ability to provide clients with quick and detailed communication about the nature of a system failure, and an informed estimate on when systems will return to normal, is always appreciated.

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