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FTSE Global Markets - Autobahn - Deutsche Bank

US TRADING ROUNDTABLE

LESSONS FROM MARKET CHANGE:

WHO WINS, WHO LOSES IN THE

NEW TRADING PARADIGM?

Photograph © FTSE Global Markets, supplied July 2012.

Attendees

(From left to right)

CURT ENGLER, quant and automated trading, JPMorgan Asset Management

JOSE MARQUES, global head of electronic equity trading, Deutsche Bank

ROB KAROFSKY, global head of trading at Alliance Bernstein

MIRANDA MIZEN, head of equities research, TABB group

FRANCESCA CARNEVALE, director, FTSE Global Markets

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 1 2

Supported by:

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TRADING ROUNDTABLE

WORKING IN A NEW PARADIGM &

HOW BEST TO FIND LIQUIDITY

JOSE MARQUES, GLOBAL HEAD OF ELECTRONIC

EQUITY TRADING, DEUTSCHE BANK: The markets

today are as challenging as I’ve ever seen in my career, not just

from a pure execution and quality of execution perspective, but

in really understanding the liquidity landscape and how to

navigate it in a way that allows my clients to really exploit the

limited liquidity resources that are out there, and how as a

broker we can create value for them in that process.

CURT ENGLER, HEAD OF QUANTITATIVE AND

AUTOMATED TRADING, JPMORGAN ASSET MAN-

AGEMENT: We are focused on optimising the trading

process. That includes understanding the portfolio manager’s

process and researching the trade data which allows us to

automate a significant amount of our flow. That also means we

have to monitor both the macro and micro segments of the

market, to better understand what is going on with volume

and volatility. Many of our automated strategies are in house

algorithms that we can tune to specific portfolio managers as

well as market conditions. For us business is now about having

to be on top of the portfolio manager’s process, the characteristics

of the orders, and the market conditions.

ROB KAROFSKY, GLOBAL HEAD OF TRADING AT

ALLIANCE BERNSTEIN: There is also another element in

play: that is, the trader is getting closer to the investment

decision-making process in a world where liquidity has

become a scarce resource. The ability to react quickly is

dependent upon understanding which way your portfolio

manager is going to zig and which they’re going to zag. It is

about taking the trading and execution business directly

into the investment process; and this trend is relevant and

essential because of the difficulty of finding liquidity. In a

highly volatile and highly correlated environment there’s a

tremendous amount of alpha that can be extracted through

the trading desk.

We are in a new paradigm and I don’t think that it is

necessarily cyclical. Certainly, it is unlikely that we will

revert back to the 9bn shares a day that we used to trade

in the United States. In part, this is because everything

we’re living through now is a by-product of the two crises

that have occurred during the last three or four years. In

part, it is a function of a trend where equities as an investible

asset class are out of favour. Year to date, we have

seen in excess of $70bn in outflows and it is a continuing

theme and this money is moving into fixed income. When

you have global monetary authorities telling you that rates

will be low through 2014, it’s an issue that will keep us out

of equilibrium for some period of time, whether it’s artificial

or not. Moreover, it is destructive to the liquidity in the

equity markets. For that reason, I don’t believe that

liquidity in the marketplace (and hence volumes) will pick

up until money begins to flow back into the equity asset

class. That will only happen when rates, particularly short

rates, begin to rise and force people out of fixed income

and into equities.

MIRANDA MIZEN, HEAD OF EQUITIES RESEARCH,

TABB GROUP: Our role is to look across the industry as

objective observers. We spend an enormous amount of time

talking to the market practitioners that make up the marketplace.

We see a huge amount of changes are both currently

visible and some that may happen that will change the

makeup of the market and liquidity patterns. Regulation

and technology have both become equally challengers and

facilitators in the market and are both developing at a very

fast pace but the hunt for liquidity is not getting any easier.

ROB KAROFSKY: One more thing: if you look over the last

several years, the absence of retail in equity trading has significantly

exacerbated the situation. If the retail component

is gone and if you’re talking about liquidity between one

large asset manager selling and another buying, it is like

ships passing in the night. You then are dependent upon

finding that other large institutional holder on the other side

of the trade if you will; it makes the problem of sourcing

liquidity that much more complicated. So once again I say,

we are living in a new paradigm and this paradigm will

remain for the next couple of years, at least.

JOSE MARQUES: There has been a lot of press over the last

couple of years about the role of liquidity providers in the

market. There used to be specialists who were clearly identifiable.

You could walk down to the exchange and if you didn’t

like the other side of a transaction, you could challenge the

person directly. Nowadays, liquidity has become much more

anonymous. When we talk about liquidity, it really is about the

ability to convert cash into securities and securities back into

cash and how quickly and how fungible that process is.

In that regard, the role of the liquidity provider is greatly misunderstood

in today’s marketplace. When you look closely at

the dynamics of what’s going on, a buy side to buy side natural

match happens with such small frequency that it’s almost de

minimus. If there really was a buy side to buy side relationship

then platforms such as Liquidnet would have huge market

share. In reality though, this does not happen, simply because

if one buy side institution wants to sell, it doesn’t automatically

mean that there is a buy side institution that is willing to buy.

Instead there is an entire ecosystem of liquidity providers

that have evolved in the marketplace and they collect a toll

for their services. Having continuous liquidity has never

been free and it is certainly not free today. What you see on

the shortest horizons are the high frequency market makers,

and they are intermediating those trades a couple hundred

shares at a time and taking a tiny slice out of those trades.

Next on the horizon are the statistical arbitrage traders, who

are in fact intermediating the high frequency guys and they’ll

take inventory and keep it in mid-air for anywhere between

a few minutes to a few days. Then there are the slightly

longer horizon players, which include the hedge fund

community, which in turn will keep inventory in suspended

animation until a long-term player on the other side shows

up who perhaps wants to do the whole process in reverse.

It is this ecosystem that provides the liquidity and ultimately

intermediates a long-term buyer and a long-term

seller, which can show up hours, days, weeks, even months

J U LY / A U G U S T 2 0 1 2 • F T S E G L O B A L M A R K E T S


Jose Marques, global head of electronic equity trading, Deutsche Bank.

Photograph © FTSE Global Markets, supplied July 2012.

apart in time. Certainly, from a regulatory market structure

perspective, we need to understand how this works. We

need to know what the cost of this liquidity really is and

what structures ultimately make the markets more efficient

and maximise the amount of instantaneous liquidity

available for everyone. One interesting point is that the very

richness of equities as an asset class that drives the diversity

the ecosystem which in turn delivers the tremendous

amount of continuous liquidity we see.

CURT ENGLER: We have had such an interesting period of

a rather volatile macro environment; when volatility comes

down, liquidity is going to come down. At the same time, we

have had such deleveraging out of a lot of strategies that

were called more intermediate term—as Jose explained—

that everyone used to be leveraged a lot higher than they are,

particularly as banks are also lowering their leverage ratios.

Whether this really is or is not a new paradigm, I cannot say.

I don’t know what the headlines are going to be tomorrow

that might completely change this set up.

ROB KAROFSKY: This is an interesting point, that volume

and volatility are linked. Volatility goes up, and volumes

obviously increase and as we have seen, a larger percentage

of that increase is going into ETFs and not individual stocks.

When (and if) we do get into a better paradigm where

volumes pick up, we need to see that link between volumes

and volatility break. Would you agree? We need to achieve

healthy volumes without market volatility.

CURT ENGLER: You would have a lot of happier people in

the industry rather than the other way around. It is certainly

better than the alternative where volatility spikes and

volumes remain low; that’s a double whammy.

ROB KAROFSKY: Actually, we do have that.

CURT ENGLER: Liquidity can still be fleeting in the shortterm

if you are too much of a liquidity demander and that’s

going to lead to higher costs. If all else is equal, volumes stay

the same and volatility goes up, leading to higher costs. So,

if we could ever get that sweet spot where volatility stays relatively

constant and volumes start picking up, then correspondingly

trading costs should come down all else being

equal and I would welcome that. The question of course

hangs around how we make that happen.

ROB KAROFSKY: As I look at the world, I see would look

for the signal that assets (or money) are flowing into equity

assets and equity risk premiums are coming down, which

correlates with your comment about volatility. People will

have to feel much more comfortable in the equity space

and once that happens you can have volumes without the

volatility. We would, in that instance, turn the corner.

JOSE MARQUES: Another way of looking at this is correlation.

In the current high correlation environment you’re seeing

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 1 2

people coming into the market demanding macro equity

exposure. But they come in one day and they leave the next day

and, at the same time, you’re seeing a lot less of a stock

selection process happening. So you get exactly what you see.

MIRANDA MIZEN: Last year the combination of higher

volatility and the higher volume also resulted in a higher

percentage of high frequency trading. If we have lower level

of volatility and if we see assets coming back into the market,

we should see the participation rates of some of the participants

in the market change proportionally.

ROB KAROFSKY: Well, it increases the odds in a lower

volatility environment of two ships hitting each other when

they pass through at night.

JOSE MARQUES: The data there is pretty straightforward.

About 30% of liquidity is found within broker pools in general

or dark venues overall. You see that in the TRF volumes for the

US. The rest is found in the broad markets. The underlying

question there seems to be: do we need 48 different dark pools

and 17-plus lit venues? Clearly not. On the other hand, the

technology has gotten cheap enough and robust enough that

connectivity between venues is not the hurdle that it used to

be and in some sense, it has gotten cheaper.

One of the underlying benefits of our highly decentralised

marketplace is a tremendous amount of robustness in our

markets. It used to be front page news whenever NYSE had

a system outage and stocks could not trade for a whole

afternoon. When was the last time you saw a headline like

that, aside from May 6th 2010? There have been real benefits

to the fragmented structure, but like anything you can overdo

it and there is a selection process underway. Even so, the costs

are not outrageous; at least not for most participants.

MARKET EVOLUTION: HOW FAST &

DEEP IS THE RATE OF CHANGE?

FRANCESCA CARNEVALE: Miranda, has TABB Group

undertaken any research that looks at how the overall

market structure will look in a few years time? As Rob highlights

there is a paradigm shift in play. Surely, that must test

existing structures and institutions and firms to the limit.

How might it play out over the long term?

MIRANDA MIZEN: We have undertaken a number of big

studies around this theme, talking to long only asset

managers and hedge funds, both here and in Europe. In

January this year, we talked to 51 hedge funds and found a

perhaps surprising level of optimism in the market. Many

were thankful last year was over as they had found that

volatility around volumes was extremely testing. There was

a certain relief they had managed to survive a brutal trading

environment and ventured that (overall) this year would be

better, that early election fever would reinvigorate the market

and that commission wallets would increase. However, that

was early in the year and as the months have passed, that

optimism has not played out.

There are a number of trends coming in play as a function

of lower trading volume. Low commission wallets mean

there is not always enough to go round and broker lists are

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being scrutinized, especially as you look down the length of

the tail. There is not a major change in commission concentration

levels at the top. But brokers who are sitting on lists

and haven’t seen order flow from their client for a year are

very vulnerable and in some cases tails are being chopped

quite aggressively.

Asset managers are also re-examining some of the tools

they’re using and how they want to access the market. If it’s

obvious where liquidity is concentrating, the decision is how

to interact with that liquidity. But especially in the dark,

liquidity may be so scattered it’s hard to know if there’s

another ship out there, let alone if it’s passing you in the dark.

So there’s a constant demand for better tools such as those

that combine block trading with algorithms and that can

interact with the different types of liquidity, and duck and dive

electronically in the market like the traders do. But tools

aside, low volume markets and shifting liquidity patterns

due to both trading styles and investment decisions require

a re-think with regard to how to approach the market.

We have this paradigm shift and although we all hope

volumes will rise again, it doesn’t look likely in the short term,

particularly in Europe where the outlook remains poor and the

regulatory environment is undergoing a major upheaval.

FRANCESCA CARNEVALE: Jose what is the role of the

sell side in easing everyone’s pain?

JOSE MARQUES: In today’s environment, the role between

a broker and the buy side has turned back to the fundamental

value propositions brokers traditionally have offered. In

other words, if you ask: what is the role of the broker in the

marketplace? It is to source and aggregate liquidity for the

buy side and provide it to them in a cost effective way. By cost

effective, I am not talking about commission rates; that’s

really the total impact of trading. A good broker is going to

deliver execution, and not leak information; a good broker is

going to be able to provide you liquidity in whatever it is

you’re looking for in the cheapest way possible. Then if he

does it well, you’re going to reward him.

Over the last couple of years, there’s been a lot of angst

around the new electronic market structure and the problems

this structure has created for participants that haven’t yet

invested in the latest and fastest technology, whether that be

co-location, or the whole techno-parlance of the new world.

Ultimately, we have a pretty simple message to these folks,

which is: if you don’t like your executions, get another broker.

At the end of the day, the broker’s role is to provide technology

and smart, intelligent execution, to control information

and give clients a buffer on those hard to trade trades. If your

broker is not effective, you must find someone who will

move your business accordingly.

CURT ENGLER: There’s a lot in this conversation to synthesise.

I guess I’ll start by piggy-backing on two of the

comments Jose made about the broker’s role and (as well)

the trader’s job to understand the investment process better.

Both those comments were spot on. Certainly, as markets

evolve the buy side trader will increasingly be tasked with

being more strategic in the whole investment process. In any

case, it is incumbent on the buy side trader to better under-

Curt Engler, quant and automated trading, JPMorgan Asset

Management. Photograph © FTSE Global Markets, supplied July 2012.

stand the importance of the overall investment strategy that

determines his trades as well as to be more proactive with

regard to sourcing liquidity so that, if one of those ships does

show up, the buy side trade should to be able to filter that

trade in a way that is better for the portfolio manager.

On the electronic side, given that we make the effort to

better understand the portfolio manager’s process—whether

it is what factors they use for stock selection, or their portfolio

construction criteria—and understanding that process to

the point where the broker’s role is going to evolve further.

I actually think the broker’s role will become more difficult

and complex in future; particularly as technology is now one

more level of disintermediation of the sell side to the point

where we can now make all of our own order placements,

rather than just placing it one scheduled algorithm and

work on the basis of the anticipated outcome of that.

MARKET FRAGMENTATION: GET

OVER IT OR UNDER IT?

JOSE MARQUES: Execution and portfolio implementation

costs have come down over the last ten years. Over

the last six months, they’ve probably bottomed out and

maybe ticked up a little bit because of t`he dramatic fall off

in overall market volumes and liquidity. However, market

structure changes have driven a great deal of that drop in

terms of real trade implementation costs with tangible

benefits to investors.

FRANCESCA CARNEVALE: Hasn’t there been an

attendant cost in terms of connectivity, technology, investment

in new processes and linkages with brokers and

trading venues?

JOSE MARQUES: Collectively the sell side spends

hundreds of millions of dollars to develop and maintain its

technology, for sure.

ROB KAROFSKY: As the world has become far more

reliant and dependent on technology, both sides (and it is a

relative spend) have had to spend on technology and

become aware of measured tools and things like that. So that

the explicit costs that Jose mentioned have been coming

down and perhaps bottoming is true. Also, the costs of

being able to navigate the 40-plus dark venues and 17 or so

lit exchanges has also been an offsetting cost.

JOSE MARQUES: Yes, costs elsewhere in the system have

also emerged. TV cameras used to pan around the heavily

populated floor of the New York Stock Exchange, where in

the mid-1990s you could barely walk through the crowd. It’s

a very different picture today and that is the very real impact

technology has had. Of course, this has occurred at all levels

through the markets and in the trading process. We used to

J U LY / A U G U S T 2 0 1 2 • F T S E G L O B A L M A R K E T S


have tens of thousands of people to clear trades. As an

industry, those numbers have come down. There are efficiencies

that have been extracted, even though the technology

costs and people resourcing around technology have gone

up considerably.

WHERE DO YOU FIND ADDED

VALUE AS MARKETS CHANGE?

MIRANDA MIZEN: A major area of differentiation that is

being highlighted over the last six to twelve months is

coverage. Take algorithms, the most commoditised area of

trading. You often hear the buy side grumble there’s little real

difference between many of them. In fact there is, both in

terms of the algorithmic environment and liquidity accessed

as well as in the surrounding services. It isn’t necessarily

someone coming with a new algorithm that’s really going to

make the difference; it may be the coverage person stopping

by, taking off his jacket, sitting down with the client and

talking about how they access the markets and talking

through how they trade their orders, the kinds of algorithms

they need and are comfortable using, how individual algorithms

work with certain market conditions. Increasingly,

coverage combines both elements of high touch and low

touch services.

A major factor is trust, because there’s no way in a highly

volatile, fast-moving market that someone is going to use an

algorithm if he doesn’t know how it performs and exactly

what to expect. Partly this is a function of understanding

both the market dynamics and the technology and having

transaction cost analysis tools, but equally, there is also a

level of human interaction, in terms of providing the

knowledge to use those tools very efficiently. It’s the same on

the high touch side; you have to be able to trust the person

at the other end of the telephone if you’re doing a trade.

The buy side is demanding greater insight into how the algorithms

are working. Not everybody wants to look under

the hood and know where the fan belt is, but in terms of

order placement logic that Rob mentioned earlier, if the

order is being exposed in the dark, where is it being exposed

and to whom? In other words, I want to know where it

traded, but I also want to know where it is going and what

level of exposure goes with it. Who am I trading with and

what is the quality of liquidity at the other end of the order

that may help or not help my order flow? This transparency

is partly coverage, partly product. Ultimately though, they are

two halves of the same whole.

CURT ENGLER: If the buy side is going to make the effort

to understand what the portfolio manager’s process is (and

that the technology is available) we are doing our fiduciary

role to own the order execution process as well. We’re the

ones putting the fixed tags in place, because we want this

many shares placed at this location for this amount of time,

for example. In this regard, the buy side has been the biggest

winner on the transparency front to actually understand

that logic as well as then mine any resulting analytical data

for relevant analysis of orders. People may or may not want

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 1 2

to get into that minutia, but once you do, you learn from how

orders are placed at various venues, and where the margins

are made; understanding that entire process is now integral

to doing our job well.

FRANCESCA CARNEVALE: Is that typical though of all

buy side trading desks? Or, is that typical of large buy side

trading desks of the magnitude of your firm, and that of

Rob’s trading desk? It is easy for you, you have resources, and

you are huge asset gatherers, are you not?

CURT ENGLER: You are right, scale certainly plays into it.

We traded $250bn last year and a basis point matters on that

volume. If you’re a smaller asset manager there are likely

different investment strategies and other business considerations

involved. In that instance, the effort required may be

too onerous or high a hurdle. Even so, technology is almost

ubiquitous enough now and in that sense there is a really

low entry level that will allow you to do some of these things

quite easily.

FRANCESCA CARNEVALE: Jose, in this environment and

with that minute detail required, knowing your client very well

indeed is vital to a successful business strategy, isn’t it?

JOSE MARQUES: Absolutely, knowing your client as well

as every detail of their trading processes and trading technology

is essential. As Curt acknowledged, access to modern

trading technology is very democratic, even for small buy

side firms or even retail participants, due to the massive investments

made by the sell side. The key is helping clients

apply the appropriate technologies to their specific trading

problems. It’s not all about speed either. Some of the most

important technologies are all about quantitative processes,

down to the microstructure level, involving how you place

trades, how you read that order book, which venues you go

to and when, and understanding the intention behind that

order when it was sent.

Moving up the value chain, one of the things that both

Curt’s and Rob’s firms do extremely well is understand the

alpha of the portfolio manager and how to modulate trading

to maximize alpha capture. These are things that the sell side

can absolutely provide for all clients and do so by modulating

the behaviour of algorithms based on who’s trading on

the other side and the portfolio manager’s intentions. This is

becoming a very important part of the business because

capturing a few extra mills here and there adds up to percentage

points of incremental returns.

FRANCESCA CARNEVALE: Rob, there’s probably not

much any sell side trader can teach you. So where do you

look for value-add from your sell side provider?

ROB KAROFSKY: Actually, it is complicated navigating the

marketplace. Both Curt and Jose mentioned basis point

matters on a lot of notional trade and that’s absolutely true.

It is how you capture that basis point. Plus, to me that’s the

interesting part. It is not just being a liquidity provider versus

taking liquidity when you’re executing electronically. Where

the sell side truly helps us is in understanding when to

trade with more urgency and understanding when to trade

more slowly. It is taking advantage of liquidity when it comes

to your doorstep and trying to understand where the alpha

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is embedded in your order flow if by definition if it is a

value order and in that instance you should trade more

slowly. It is about helping us understand the subtleties and

complexion of the market.

FRANCESCA CARNEVALE: Is that a conversation that

happens before the trade or in real time?

ROB KAROFSKY: It happens in real time and it is ongoing

and it speaks directly to an initiative that many firms

on the sell side are taking where they’re trying to combine

both the electronic and high touch points and deliver

something to clients that hasn’t necessarily been delivered

up to this point. Now, you could argue that this has

happened through daily dialogue in the past. However,

there has been a sea-change; there is now a more

concerted effort by the sell side to be part and parcel of the

process. I am working slowly, trying to have minimal

impact in a particular situation, but if something larger

comes along, I am interested. It is about effectively

combining those different approaches that people are attempting

to achieve now.

FRANCESCA CARNEVALE: Can you measure the

efficacy of this approach in numerical terms?

ROB KAROFSKY: It is difficult to capture 100% of the

dialogue, the relationship that you have on a daily basis, but

it shows up in your performance and we’re constantly evaluating

how we’re doing. We evaluate it every day. And we

can directly attribute it to brokers that help us achieve the

numbers, whether it is through their trading pipes or

whether it is through a piece of liquidity that comes through

their high touch area.

JOSE MARQUES: At the end of the day, realised portfolio

performance matters. From the moment that a portfolio

manager decides he wants to buy or sell a security, at that

instant prevailing market prices are the most relevant

benchmark. Often arrival price, the prevailing market price

when the order is received by the sell side desk is used as a

proxy. When you look at the newest and most creative ideas

we have implemented, they are around creating opportunistic

liquidity-seeking algorithms that really go after alpha

directly and minimizing slippage to arrival price. When the

liquidity is there at an excellent price, clients take all they can,

and when it is not there, they fade the trade and become

patient. Doing that effectively is important.

Now that’s what we do at the end of the value chain, but

there is also an important piece in the middle of the value

chain - between the portfolio manager and the sell side - and

that’s the role of the buy side trader to finesse. We don’t have

complete transparency as to the alpha of an individual

portfolio manager. We have some if it is provided to us, but we

can’t pick up the phone and call the portfolio manager and ask

him: do you want me to be more urgent with this order?

That’s the role of the buy side trader who is to understand his

portfolio managers and what their liquidity needs really are.

I would say it is when all three parties are working

together on this value chain that delivers the best outcome.

A portfolio manager has to be sensitive to his own process

and know when he should be aggressive and communicate

that to his desk, and then the buy side desk can give the appropriate

signalling to their sell side counterparts. The

process works in reverse too. If you look at a portfolio optimisation

process, there are some implicit costs that go into

doing the optimisation. If all of the sudden I can offer a big

chunk of liquidity at a very cheap cost, the portfolio manager

might look at that and say: yes, that’s attractive if I can get

it on the cheap. Otherwise, he might not have done that

marginal trade. So, pushing that information back is very

important too. That speaks to the hybrid model Rob was

talking about, where we combine the smarts of the electronic

world with the sensitivity of the high touch world where we

really know the client; then we will be able to push that

alpha back the other way.

BROADENING THE SKILL SET:

ASSETS OTHER THAN EQUITIES

FRANCESCA CARNEVALE: All this understanding is

well and good. However, there are big macro forces in play

right now. As buy side trading desks, you’re at the forefront

really of the movement out of equities and into fixed income.

How, in turn, are these changes in asset allocation changing

the way that the buy side trading desk operates?

CURT ENGLER: Our desk definitely has a broader skill set

now than before. Historically I guess everybody would’ve

had experience on the single stock side, whereas now we

have two quantitative analysts that are on the desk full-time

now that are the ones who are helping craft the trading

strategies and fine tuning the strategy given the market

dynamics. Along the lines of having people who can speak

the language of the portfolio manager, we have three (CFAs)

involved too, all the while still having very experienced

traders we have hired either from buy side or the sell side on

the desk. However, I would say we have broadened the skill

sets on the desk considerably in response to the market

rather than any sort of shift in what asset class is in favour

or not So having that mix of those different and differentiated

skill sets has been the direction we have taken.

ROB KAROFSKY: I’d say two things. One based on what

I initially said about being in a new paradigm, there’s been

a shift, from the sell side to the buy side in terms of understanding

how to price assets better and how to source

liquidity. We’re definitely seeing that shift. It is a scarce good,

if you will, and the onus is on us to develop expertise in that

area. So, we have certainly moved in that direction and what

that means is staffing the desk appropriately with people

that have that type of experience.

The second thing in terms of dealing with the overall environment

as far as asset flows, that we absolute need to

scale our desks appropriately given the global volumes that

we have experienced and that we probably will experience.

That’s a similar exercise that’s happening on the sell side as

well. We have seen a lot of capacity come out and my guess

is we’ll continue to see more capacity come out.

As far as expertise across asset classes toes, the worlds are

correlated, more so than they’ve ever been. If you’re trading

J U LY / A U G U S T 2 0 1 2 • F T S E G L O B A L M A R K E T S


Rob Karofsky, global head of trading at Alliance Bernstein. Photograph

© FTSE Global Markets, supplied July 2012.

equities and you don’t have that vital understanding of how

credit markets will impact equities, you’re missing an

important step. Therefore, if the world is going to be more

correlated, you need to have an understanding of how commodities

and credit and things of that nature are going to

impact idiosyncratic moves in stocks.

One of the things that we have done is we have moved all

of our trading capabilities onto one floor to help enhance

that connectivity. It is important than having one person

trade multiple thing. Given our size, it is not realistic. With

smaller hedge funds or smaller asset managers, it is more

that they aren’t dealing with as many transactions so perhaps

it is more achievable, but I still think, at the larger institutions,

that you need a certain amount of specialisation in

order to effectively executive and more importantly become

embedded in the investment process.

FRANCESCA CARNEVALE: How much analytical work,

Miranda, is being or has been done on the long-term impact

of these changes in the way that buy side trading operations

are structured and the increased skill sets that are being

imported into the buy side? What ultimately might this

mean for the definition of sell side services?

MIRANDA MIZEN: As an average over the last couple of

years on the buy side, and taking in the biggest and the

smallest firms into account, we haven’t seen a huge amount

of change in terms of sheer numbers of people per desk. But

obviously the markets are a lot more complex so each person

is doing a lot more. The point Rob made about having to worry

about credit risk as well as credit markets is true. There is a far

greater need for and awareness of the influence of other asset

classes on equity trading or geographical influences. May the

6th Flash Crash was a classic example: one minute the events

in Greece were being played out on the television, the next

minute they were unravelling on our own trading doorstep.

To stay on top of so many different things going on has led

to investment in seamless toolsets on the desktop, reducing

any manual handoffs in the execution chain and expanding

and improving the capabilities of execution management

systems on the desk. There will never be a one size fits all

solution going forward, that’s for sure. There needs to be flexibility

and there are very few systems that do absolutely

everything extremely well that everyone needs. Nonetheless,

there is a very high attention being paid to how the tools

interact, both from the execution and into the order management

systems and back into all the way back up to portfolio

managers. Some of that is being driven by regulation and the

need to have new compliance procedures, reduce risk, add

new reporting standards and make sure that there aren’t

manual processes and file transfers that introduce risk

because it’s a break in the chain.

F T S E G L O B A L M A R K E T S • J U LY / A U G U S T 2 0 1 2

While the trading desk size hasn’t changed significantly,

the scope of what some buy side firms trade has. A small

hedge fund for example may have a trading desk of two

people; trading the US markets is one thing, but it is a

different story when branching out to trade markets on the

other side of the world in search of alpha. While larger

houses have local offices and have the choice of building

their own technology, most rely on their brokers for the

combination of access, information and execution tools.

JOSE MARQUES: A few years ago there was a lot of talk

about multi asset class convergence - where in the future

you’d stack every asset known to mankind, working with

geniuses who would be able to trade everything all the

time and never sleep. That’s simply not realistic in the real

world. The role of the specialist in asset classes isn’t going

away. There are a lot of idiosyncrasies, market microstructure

issues, regulatory issues that vary dramatically across

the asset classes. So what we’re doing and what you’ll see

broadly is that the specialisation function, both on the buy

side and the sell side, will remain and what is happening is

a convergence of tools and trading techniques across

different asset classes even as regulators drive for uniformity

of market structures. For instance, now algorithms are

applied to FX trades. Liquidity seeking algorithms that

have been developed in equities are certainly directly applicable

to other asset classes that are traded on exchanges or

exchange-like structures. Moreover, it allows them also to

find that liquidity or assess its relative value and then decide

whether they take it or not. In that regard, you’re seeing a

lot more sharing of tools and techniques and understanding.

We also able to link together some of the more esoteric

bits of what happens in other markets and how they affect

equities and vice versa. Therefore, I would say that there is

definitely convergence of understanding underway; but, at

the end of the day, there still has to be specialisation, which

will remain for quite some time.

CHANGING ECONOMICS in THE

BUY SIDE/SELL SIDE RELATIONSHIP

FRANCESCA CARNEVALE: Is there a new understanding

of the need to pay for consumption and resources in such

a complex and changing trading environment?

ROB KAROFSKY: Yes, absolutely and speaking for our

firm, more so than ever. As liquidity is scarce, so are some

sell side resources. I truly believe that we all make money

together in this industry and we all lose money together in

this industry, meaning that obviously there are divergences.

In general though we’re all going through a difficult time and

the sell side will have to do some hard facing of facts in its

efforts to try to figure out an effective business model and,

at the same time, how to scale their operations to provide

and service varying levels of volume and volatility which are

key drivers of revenues. Moreover, as we are about to deal

with massive regulatory change which could at some point

also cut off some key drivers of revenues for the sell side, I

wouldn’t be surprised if we get to a model where the sell side

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TRADING ROUNDTABLE

are demanding some sort of operating margin with their buy

side clients, which is something that we may have to deal

with at some point soon in the future. The days of subsidising

one business for another business are, given current circumstances,

going to be far and few between. We are very

well aware that there’s no free business anymore. We have

bills to pay and we need to make sure that we’re paying the

people. We are very focused on it right now and our list has

shrunk, which if everyone is working in this way, ultimately

has important consequences for the market. I think it is inevitable

that people at the top of the food chain will, overall,

take more business because of these changes.

That being said, we need to be relevant to people that we

believe add value to us and deliver resources that help us

make money, period. Miranda was talking about broker lists

and things like that. Yes, we are becoming very aware about

whom we’re doing business with and why we’re doing

business with them and how we are paying those people. It

is an important initiative that’s going on at our firm and I

would imagine right now that it is an important initiative

going on at every firm.

MIRANDA MIZEN: It is absolutely true that the buy side

needs to know who they’re paying and why they’re paying

them. We have already seen broker lists being curtailed, and

similarly brokers have to make decisions about the client

segments they want to service. This looks set to continue in

the current environment, and some of those consequences

will be positive. Do we need, for instance, so many dark

pools? Well, if we don’t and liquidity continues to form in only

some of them, then others might naturally fall by the wayside.

Natural competition might solve some issues of fragmentation

and cost. So many people are electronically connected.

Those connections cost money even if it is not in a pure

payment form. Even so, they still accrue maintenance costs.

Inevitably then, there is a lot of attention being paid to those

hidden costs of doing business, of just having these connections

and how you deploy your resources within the company,

which then dictates what you’ve got left for some of those

more innovative and discretionary and interesting projects,

other than just trying to meet the next regulatory deadline. So

much more is now visible in a way that it wasn’t five or six

years ago in terms of explicit and implicit costs, in terms of

bundling and unbundling, in terms of the way things are

allocated, who they’re allocated to, why they’re allocated.

CURT ENGLER: Obviously, there are implicit and explicit

costs. Tackling implicit costs will always be a battle. As for

explicit costs, clearly the sell side is under some considerable

pressures, given the backdrop of the market. That said it is

not sustainable to have 100% loss ratios or have the sell side

not earning a return. With that in mind, what’s in store for

the future? It could range anywhere from a cost plus type

model where if we have fixed tags that we know exactly the

cost implication if we’re adding or taking liquidity. That’s a

significant swing in the profitability of execution on the

explicit side. Then again there is the whole range of services

that the sell side provides. It is just determining, accurately,

what is that actually worth? If in practice it was easy to just

Miranda Mizen, head of equities research, TABB group. Photograph ©

FTSE Global Markets, supplied July 2012.

come up with a ledger of the costs involved and the revenue

needed to cover those costs, it would all be simple. Life unfortunately

isn’t that simple. Now there could be a whole

host of other unintended consequences from applying a

cost plus model, but to me it makes sense.

What’s happening in the trading world and in financial

services in general, in this post 2008 period, is really not all

that different from what’s happening in just about every

other industry in our economy; whether it is automobile

manufacturing or airline seats. Technology has been a highly

disruptive influence, margins have collapsed for a lot of

reasons and there is a fundamental restructuring going on

in the marketplace, and it is happening both on the buy side

and sell side. Buy side desks are much smaller and more

efficient than they’ve ever been and the sell side is working

aggressively to become more efficient as well. This is part of

the natural evolution of things and trading desks have to face

this issue and deal with it.

ROB KAROFSKY: The sell side equity business model has

always been inefficient and that’s why they talk about specialisation.

The sell side has layers and layers of specialisation.

If you look at touch points, it is electronic, it is

programme, it is cash, it is derivatives, it is research sales, it

is speciality sales; it is just on and on and on and on. And this

in a business that is 100% about picking up pennies and you

need to do everything to pick up that penny! As Jose

mentioned, this environment could provide the catalyst to

finally change the business model and help evolve it and

move it on to the next level. There’s always been a concern

and I’m guilty as well, of moving ahead of your clients, the

people that are paying you. It has always been a concern. We

may be at a point now where you have to take that risk of

changing your approach and business model in order to

preserve or drive profitability over the longer term. Change

is coming firms that are facing up to that change and

respond to it as Jose describes, will be the winners.

JOSE MARQUES: These changes are gut-wrenching

whenever they happen. As Rob says, there will be clear

winners and losers. But the story is the same in other industries.

They have had to make wholesale changes and they are

now benefitting from those changes. In the 1980s you could

hardly get me to rent an American car, let alone own one.

Now American cars are fantastic; cars coming out of Detroit

are now on par with anything being produced anywhere in

the world. Similarly in our industry, we are now forced to

look hard at what we do and why we do it. What you’ll ultimately

see is a much, much more efficient, better and more

transparent trading environment. Though it may be a few

more years for this play out fully, change is a reality. ■

J U LY / A U G U S T 2 0 1 2 • F T S E G L O B A L M A R K E T S

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