Dave Weisberger wants to make it clear: Nasdaq trades done on a riskless principal basis are superior to those done on an agency basis.
That bit of wisdom from the Salomon Smith Barney managing director in charge of trading systems may be fightin' words for some of the big broker's competitors. But it represents Salomon's interpretation of the new rules of Nasdaq trading. It was also the starting point of an effort to improve its market making technology
Weisberger began the project earlier this year. His team retooled Salomon's front-end and order management system so that the Nasdaq desk could effect trades on a riskless principal basis.
The job was just the latest Weisberger has undertaken since 1999 in support of Salomon's market makers. That year he was picked to lead the development of GATE, or Global Advanced Trading Engine, Salomon's next generation Nasdaq trading system. GATE has automated much of the small-order work on the desk and given traders new tools to efficiently execute block orders.
Weisberger, in charge of Salomon's non-dollar program desk when he was picked for the GATE job, was that rare trader: one with a background in technology. In addition to spending eight years in sales and trading, he had seven years of systems development under his belt.
He joined Salomon in 1995 after spending 11 years with Morgan Stanley, both in New York where he developed that firm's worldwide program trading systems and in London where he traded customer programs. Weisberger also manages Salomon's quantitative equity trading department. He discussed his latest project with Traders Magazine technology editor, Peter Chapman.
Traders: Salomon Smith Barney is recommending riskless principal trades over agency trades to its customers in the Nasdaq market. Why?
Weisberger: Riskless principal delivers all the benefits without the restrictions. As with agency-based transactions there is transparency. The customers can see every print if they want. They can do their time and sales analysis. Also, all of the agency-like transactions are soft dollar eligible. Unlike agency trades, however, you don't have to ignore sources of liquidity. You can access a market maker's pre-existing positions or tap into other sources of liquidity on the floor such as positions from our portfolio and convertibles desks in the same transaction. The part of the trades which come from principal accounts are not soft dollar eligible, but the system can distinguish that after the fact without losing the convenience of a single settlement.
Traders: What are the minuses of agency trades?
Weisberger: Agency trading does not allow for the provision of liquidity at all. A pure agency trade cannot be stopped out or completed on a principal basis. As a result, if you want to provide these services in an agency system, transactions must go through two different accounts.
Traders: How have your customers reacted?
Weisberger: The vast majority understand. They are comfortable with the way we're doing it. However, there is an ongoing education process to explain that proper "riskless principal" trades provide the same protection to the client as agency trading.
Traders: Are you doing any agency trades?
Weisberger: We're doing a fair amount of agency cross trading, but our trading in the market is almost exclusively riskless principal.
Traders: You have not set up the system to handle agency orders?
Weisberger: No. But we plan on developing the functionality in order to support the small set of clients that demand it or require it because of ERISA restrictions.
Traders: What are the major execution sources for your Nasdaq desk?
Weisberger: There are five. The Street/active where a market maker goes out and takes liquidity; the Street/passive where his quote is executed against our retail order flow; other trading desks on the floor; and natural customer crosses.
Traders: Nasdaq allows brokerages to construct omnibus accounts for use in divvying up executions. Have you built an omnibus account?
Weisberger: We have an agency or omnibus account which we currently use for cross transactions only. For most of our transactions we use a flow account. It is not designed for holding large positions. Most executions go in and then go out. It is a pass-through with P&L. In that sense, it is different from an omnibus account. An omnibus is always flat. The flow account is mostly flat with some P&L.
Traders: What happens to a typical execution?
Weiberger: An execution will go right into the flow book. Most will go either right out again to the Institutional Book or directly to a customer order if it is riskless principal.
Traders: In what instances will an execution go to your inventory or Institutional Book?
Weisberger: If there are no customer orders or if the order is on a net basis or if the customer is not interested in seeing his prints.
Traders: Do customers want to see print-for-print proof?
Weisberger: Some do. We have electronic connectivity with several large customers so that all the executions go to them automatically while others only want to see the fills netted by price level. In all cases, we have the ability to generate time and sales information and can send it electronically or by fax.
Traders: Have you gone about this differently than the rest of Street?
Weisberger: We do not fully know what the rest of the Street has done. At Salomon, we have built our riskless principal trades so that all executions can be systematically allocated to the orders directly on what is in the system at a point in time. There is no separate riskless principal account. We utilize the flow account to process the allocations.
Traders: You said you "married" your Manning engine with EDTS, your order management system. What do you mean?
Weisberger: As a large retail broker, we have a well developed engine for handling the Manning requirement. This engine looks at every eligible inbound execution and will allocate executions to pre-existing retail orders if they are at or better than the price level of the execution. In order to support riskless principal trading, we extended this engine by allowing EDTS to send institutional orders directly into this engine. The result is that customer orders can get executions allocated to them directly from our flow account before they are moved to our institutional account.
Traders: What was the most important part of the job?
Weisberger: That was to create the ability to register the individual customer orders with the automatic execution engine so they would be allocated executions directly when they occur.
Traders: What is the registration process? How do market makers "register an order with the system?" There are times when they must "unregister" it? Such as if the sales trader and customer decide to temporarily stop working the order?
Weisberger: The market maker creates a "child order" from EDTS, our order management system, and sends it to the engine. From that point on, all executions done at or better than the limit price are allocated to the order automatically. To unregister the order, the trader just cancels the child order in EDTS.
Traders: A child order represents a portion of the entire, or "parent," order?
Weisberger: That's correct.
Traders: The execution engine was used primarily for retail orders before?
Weisberger: Yes, the engine was originally built to provide liquidity to our retail system from our market makers. It was extended to handle the Manning rules several years ago and extended this year to handle riskless principal orders.
Traders: The flow account is part of the execution engine?
Weisberger: The flow account is not part of the engine per se. It is the account that all inbound executions are applied to first and is the account used by the engine for its auto-executions. The engine uses our agency account, however, to process agency crosses.
Traders: Does the new fee-based trading regime mean more clerical work for market makers?
Weisberger: As the market changes, it does complicate their jobs. But they have gotten used to it. We have been steadily improving the systems so that it is easier to handle riskless orders. Working orders have always involved clerical work. Traders have always had to calculate average prices and allocate to multiple orders. That can be a difficult process. As a result, the riskless principal method can actually save work since the system does the allocations and average pricing automatically.
Traders: Does the market maker trade differently now?
Weisberger: Not really. We have tried to make the system as unobtrusive to the trading as possible. The added step of creating "child orders" before trading replaces the step of calculating and entering average prices after trading. The trading should be the same. The exception is when the order must be 100 percent soft dollar eligible. In that case, the market maker cannot commit capital or cross with another desk. The system would not apply those executions to the order in any event.
Traders: How long did it take to build this functionality into EDTS and GATE?
Weisberger: The systems team delivered the core functionality in three months. It has been in production since March. It's still a work in progress with on-going work to make the front-end nicer.
Traders: Thanks, Dave.
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