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.
"We believe," the trading official said, "that the broker is gathering information from the order so he can advance the interests of his proprietary desk." He said that clients often don't understand the complicated process and, more importantly, "could care less as long as they get their VWAP." An agency broker echoed the source.
"The original order may be internalized, shopped, hedged or redirected to a market center," according to Frederick Graboyes, president of Algorithm Trading Solutions. He said some agency-only firms will also re-direct an order to a prop desk.
Several trading industry executives-who didn't want to speak on the record-defended the guaranteed VWAP, saying their firms were not manipulating prices. One argued the practice may need tighter regulation, but that ultimately it is something that customers want.
"Guaranteed VWAP removes the uncertainty of price. It is for people who want a benchmark price," he said.
"Certainly, we have to be concerned with the potential for gaming, but the VWAP, when done right, is the best thing for some people. They shouldn't outlaw it. They should monitor it better," he added.
Another trading official at a big firm that offers G-VWAP, who also declined to be quoted by name, said that "money managers want this. This is keeping their costs low."
Some trading officials have said they are contemplating ending the practice because of potential regulatory problems. Others say VWAP guarantees are legitimate, but they should be more tightly overseen.
