Steve Wood (Schroders): The role, especially in the last five years, has changed dramatically. Technology is a must-have within the trading desk environment, not only at the local level but on a global level as well. The halcyon days of the ‘80s and early ‘90s when you would arrive in the morning, give your order to a broker, have a nice long lunch, come back and book a trade out, have well and truly disappeared.
The amount of electronic trading we do is substantial so we need buy-side traders who are very well versed in trading in the current marketplace. They can’t be order placers, they have to actually be professional traders and this step up in quality has been imperative in the way we structure our desk. To put that in context, I actually hired one of the senior traders from a large sell-side investment bank broker to work on my desk because he has an in-depth knowledge of how multilateral trading facilities (MTFs) and exchanges work.
There’s also been a marked change in the way we view technology. If you can’t keep ahead with technology on the desk you’re going to quickly lose alpha to your peers, especially the high-frequency traders that tend to steal alpha by data mining trading patterns. So we are spending a lot of time designing algorithms that can beat the stat arb guys at their own game.
Funds Europe: Obviously technology makes some things easier to do but the environment has become more complex. Steve, you talked about the halcyon days. Is it an easier job to do now?
SW: No it’s a more difficult job. When I first joined we didn’t have an order management system, the traders would be sitting there at ten o’clock in the evening writing tickets after the close. Now if my traders are sitting there at quarter to five, it means something’s gone wrong. So it’s become easier from the perspective that the traders are there just to trade but the actual way you trade has become vastly more complicated and complex, especially the way we trade.
We don’t just trade on a silo basis. We have the ability to pass the order book all around the world so we can tap into pools of liquidity on a 24/7 basis. So you might have one stock which third of its total volume is traded in Asia, another third in London another third in the US. We can actually hit all those points of liquidity so what might be perceived as a day’s volume is only really a third of the day’s volume. So it’s accessing pools of liquidity on a global basis and that’s off-shore type liquidity as well through the crossing networks for example.
Funds Europe: Technology vendors often say that technology and automation does not necessarily mean a reduced headcount but that it allows traders to focus more on adding value. Is this true at your firms and what form does this value take?
Paul Squires, Axa IM: I’m not sure it’s quite as straightforward as to say it’s reduced the resource requirement. I would say it altered the requirement. We have a number of different fund managers, we have a number of different funds and we trade multiple asset classes. To some extent technology assists us but to some extent it also compromises us because our whole vision becomes somewhat aggregated. So certainly the job is more complex than it used to be and probably a number of us feel our remits are a lot wider than they used to be as heads of trading.
There have been so many changes in the industry but I feel the trading desk has absorbed that change rather than the fund managers. To some extent I feel my job is to keep the noise away from the fund managers and to keep the noise away from my traders so that they can have a fairly focused approach to their day job but it certainly means the head of trading job has changed.
SW: For us, we went from 55 traders down to 23. Over three years. And that’s adopting best-of-breed technology with the Charles River order management system and ITG’s Triton EMS multibroker platform. Now we’re somewhat volume sensitive so if our volumes doubled we probably wouldn’t need to take on more traders. Whereas if our fund managers doubled, I’d have to take on more traders because the face-to-face contact and service level is just as important as achieving quality execution in the market. So there’s a sort of double-edged blade there.
Funds Europe: Johan, since you come from a small organisation, how has technology helped you to compete with the larger managers?
Johan Erikson (DnB Nor): In terms of background, I started out on the sell side. First with retail clients, then first tier, then institutional clients, both domestic and foreign. And then I was asked by one of my clients if I wanted to come to the trading desk. The change from that point to today has been fantastic, and every year I’ve told myself I won’t go back to the sell side because the work has actually moved to the clients’ desks. Today clients have full control over the execution management risk on the desk. Everybody I hired came from the sell side and so it’s been quite an exciting challenge to transform the team into a system-driven ‘alpha’ desk. If I look at my desk compared to the larger managers, I think we are facing the same problems but perhaps there is an advantage in being a smaller organisation because we can adjust to changes quicker.
Funds Europe: It’s a difficult question but is there a single area of technology or single product that you would pick as the most important development on the dealing desk?
Mark Winter (Insight Investment): Seven years ago when I started developing a buy-side dealing desk at Insight, we didn’t even have an OMS, and we were very much paper ticket- based, and we had all the challenges that went along with that. And of course were denied all of the benefits – efficiency, compliance, audit trails – that we now take for granted with modern OMSs.
However, in my opinion the single biggest enhancement is all-round connectivity and the speed and the scalability it gives us as a desk. I’m sure we all remember ten years ago when a busy day on a dealing desk might be 70, 80 or 90 tickets. Last Friday we had two and a half thousand trades going through. Admittedly a lot of those were taken care of by making use of basket trading/programmes, but I kid you not, if I go back about 15-20 years , back to my days at Rothschilds, our approach to a programme trade would be getting somebody to type out a list of stocks, meeting somebody at 11:30 at a bar to go through it, and then hoping that they can come back to you later in the day, or more probably the next day, with an idea of a trading strategy for how you might approach that piece of business.
I remember somebody told me a story of how they’d done a similar thing but handed over a floppy disk to the broker, who then had a good lunch and left the disk in the back of a taxi, so there went the whole record of the programme trade. We’ve come a long way since then.
Connectivity has certainly delivered so many benefits to us in terms of enabling us to do our jobs smarter and better and with much lower latency, but not necessarily with less people. We’ve actually liberated the people we have on our desk to focus on the added-value part of the role rather than the grunt work of the administration.
As Paul said, we are all on a day-to-day basis in our jobs taking ‘one for the team’ fairly frequently, insulating our people to a certain extent, and keeping them free to focus on what we need them to do. I’m sure that a lot of the things on this agenda are completely over the heads of our internal customers. There are some, of course, who are exceptions who really do ‘get’ it, who embrace the market fragmentation of the last two years, for example. But in my view, even the most senior and outward-looking of my internal customers pay little more than lip service to the things that drive our thoughts on a daily basis.
It’s evolved into a far more all-encompassing type job where we’re facing off against, of course, our internal customers, but also the market and our compliance and risk people. We are the first port of call for compliance and risk when it comes to investigating anything about relationships with brokers, counterparties, how we interact with the market, order management systems, etc. It’s become a pivotal role, I think, and so different from our predecessors, maybe a generation before.
Funds Europe: Obviously MiFID has been a big development for you all but has it been a positive development?
SW: The concept was very good but personally I don’t think they took it structurally far enough. If you look at the US with the RegNMS over there, if that was the case over here you wouldn’t need smart order routers. That’s probably a bad thing because we’ve got smart order routing that others haven’t got so that’s probably a competitive edge, but as a market as a whole I don’t think they took stuff far enough.
The trade reporting regime has been a total mess. It’s been a case of two steps backwards for UK stocks and one step forward for European stocks, where there wasn’t any trade reporting before. But I think with the advent of printing agents which aren’t directly related to an MTF or an exchange is a concern. There’s been a multitude of incorrect printing, double printing, triple printing – not enough information on the prints that go through so you have cross trades or actually tag them so you can understand the information that’s been put in there. And if you talk to the data providers there’s actually people still printing on websites which can’t be picked up. So how much printing is going on outside the reportable regime in the visible areas is somewhat debatable as well.
Funds Europe: There has been a general dispersal of liquidity which I guess to a degree has happened naturally, but is it something that you all welcome?
SW: I think fragmentation is very much a red herring. I know the exchanges like to bleat on about it because obviously it’s eating into market share. But if you take BP and you looked at it pre-MiFID it was probably traded on twelve exchanges worldwide, three of which were liquid. So we have always had fragmentation but MiFID has pushed it into the spotlight.
Fragmentation impacts you as far as how good your smart order router and algorithmic trading tools are because that’s the tool that actually consolidates those pools of liquidity. There’s a big question mark over smart order routers. We’ve been looking at them very aggressively because I don’t think they do what they say on the tin half the time. Do they touch all the markets you want to trade in? Do they look for the market which is the cheapest for the broker first – and so on and so on. Do you actually want them accessing the prime market first for example?
Funds Europe: Does the way to tell whether one smart order router is smarter than another come down to transaction costs analysis (TCA)? Providers of TCA say that it wasn’t until the last couple of years that people were interested in it so there hasn’t been that much money put into developing it, but now there is more interest the development is going to pick up. Do you agree?
SW: With TCA the problem is rubbish in rubbish out, and it is very difficult to put good data in and to extract the data from brokers. I’ll get from our brokers each venue they trade on so if I’m buying 100,000 shares they actually come back and say we bought this amount on Chi-X, this amount in dark, this amount on the LSE.
John Barker (Liquidnet): Do they actually tell you the dark venue?
SW: We’re starting to drill down on that.
JB: That’s part of the problem. We have signed a number of agreements with the dark pools, investment houses and MTFs, but many of them refuse to allow us to let you know where you’re trading is actually occurring. It is certainly a discussion point for us as we build our Supernatural product.
SW: We’re pushing aggressively that we want that information.
JB: I cannot see why you should not be told where you’re actually trading, whether they are dark pools or the lit venues.
SW: I think that’s a key problem. At the end of the day we want to be able to run transaction costs on that smart order router by venue. Not only to see if the actual smart order router is doing what it says it can do but also if at the end of the day can we actually start to work with somebody to design a smart order router where we can see if there is a specific MTF or exchange which is going to suit that order type. It’s about getting down to that granular level of sophistication.
Paul Squires (Axa IM): We only have two algorithm providers that we use in specific situations and can get this granularity on those trades but it’s not a huge chunk of our business and the same as you Steve, we would love to know exactly where every trade we send electronically (via an algorithm or not) is transacted.
JB: It will still come back to the quality of the data. If there is continued fragmentation with prints not visible or not reflected centrally, then it will continue to be difficult to execute at the right prices.
Ian Firth (Aviva Investors): The sell-side is used to having a P&L because they run their own book but we don’t, therefore the only way we can look at our performance is by measuring and using TCA and anyone who measures TCA needs accurate data. Otherwise, you may be blindly thinking that you’ve done a good job. As much as we want to promote ourselves and keep our traders focused on what they’re doing, you can only do that if you’re given all the accurate information which is hugely challenging.
IF: If you had a blank piece of paper would you create the model as it is now or would you do it completely different? The fact is you have so many firms with a commercial edge to this that we are not going to be able to get from here to where we need to be in a quick easy step. Some of it is beyond our control.
JB: It’s absolutely fair to say it would not be modelled on the incumbent exchange and broker model of recent years. I do believe you would be documenting it closer to what we are seeing develop today and I feel that shows we are making progress. The interesting thing to note on the commission front is that at five basis points many brokers cease to be able to make money. Certainly if commissions are forced lower we are likely to see a number of firms failing to survive. Brokers have got to deliver added technology in a bid to continually deliver value-added services. But of course that costs money and we have to be careful we do not lose valuable brokers simply in the pursuit of lowering trading costs to the minimum levels.
Funds Europe: On the other side of the execution venue space are the incumbent exchanges. Have you seen enough innovation, developments and changes from the traditional venues to be encouraged?
SW: NYSE Euronext has. The LSE, now they’ve got a new CEO, are stepping up by bringing in Baikal which I would have thought is a preemptive strike in the lit market into Europe. I haven’t seen much movement from Deutsche Boerse. But innovation from the exchanges has not been as pronounced as the MTFs or even people like the crossing networks.
JB: What’s interesting is that some exchanges like NYSE Euronext are going for a global footprint, but the LSE is still very European. I think if the LSE wants to be one of the big global players along with NYSE, Nasdaq and possibly the Deutsche Börse, it has to step out of Europe and be comfortable doing that.
Funds Europe: Johan, what kind of execution venues are you using and what do you see in terms of the domestic exchanges?
JE: My problems started when Chi-X started quoting a year and a half ago and none of the local brokers had their technology in place. Even today we see local Scandinavian brokers that don’t access fragmented markets. And the ones that have connectivity installed, in most cases it’s very new to them which makes you wonder if they’re using it properly. This is something we have to work with.
But this is also something that results from operating in a smaller European country. Regulators don’t have the same resources and it takes a longer time to adapt to pan-European changes. For example, the use of commission sharing agreements (CSAs) is not approved by Scandinavian regulators but it seems to be fully adopted in the UK. So as someone outside of the UK, I am disadvantaged in my objective of seeking best execution.
MW: Has Burgundy [the MTF for the Nordic markets owned by 14 major Nordic banks] made a big difference?
JE: Not yet at all.
SW: Do you reckon it will?
JE: I think we see a similar story in several European countries outside of the UK. There isn’t a big understanding of the new market structures among smaller local brokers while a lot of the larger brokers want to keep things as they are. In Sweden and with Burgundy it is all becoming very blurred – Burgundy is owned by the main primary exchange members with the objective of reducing exchange fees. As an asset manager, the ideal scenario from a best-execution perspective would be that the primary exchange narrows its spreads, but I’m not sure if that is in the best interests of all market participants and the owners of Burgundy.
Ade Cordell (NYSE Liffe): I come from an exchange, albeit from the derivatives arm of NYSE Euronext. One thing I’d like to know is what should we, at NYSE Euronext be doing for you guys. What would you like exchanges to do?
SW: You guys are probably doing a lot more than other prime exchanges but a lot of other prime exchanges just don’t listen to us on the buy side. It’s that conversation and communication element of it that I think is very important. Then it’s about global reach.
JB: We are a member of the LSE, we’re very happy working with the LSE. However, one of the problems is that they have failed to deliver quickly enough to be competitive historically. That’s the thing about harnessing new technology. For example, Chi-X was first to market but it is still number one because it not only got there quickly, but it has stayed innovative and therefore is managing to stay ahead and competitive. In the end I think the problem with the exchanges is that they need to get away from the incumbent label and get up the speed to compete. I don’t think anyone is anti-exchange; it’s just in the end you’re going to go where you get the speed of execution in conjunction with reliability and liquidity.
MW: Let’s not forget some of the problems we’ve all encountered in the post MiFID environment, such as the fiasco that is trade reporting. If we’re ever going to get to this utopian dream world of consolidated tape, such as exists three thousand miles away, maybe it’s the prime exchanges that are the natural owners of the provision of such a thing.
Funds Europe: One of the other areas that I wanted to cover is the use of derivatives. Is everyone an active user of derivatives is there a preference for OTC?
SW: I think we’ve seen a push to listed derivatives. The appetite for OTC products has started to wane and there is more interest in central counterparties (CCPs). But it all depends on how you evaluate counterparty risk and in an OTC product your risk lays solely with that single counterparty. So I think in the near future there will be a push from the regulators to get this stuff on exchanges if they possibly can, as we are seeing in the US with credit default swaps (CDSs).
Funds Europe: Ade, how will these regulatory developments affect the various services that NYSE Liffe is offering in the derivatives space?
AC: The main concern at the moment is that the US looks as though it is going to have one set of rules – which is currently being discussed – and the EC will have another. That is the last thing the industry needs and it could lead to regulatory arbitrage from market participants. Will they suddenly start to move their business into – perhaps – more favourable jurisdictions depending on the type of business they want to do?
From our standpoint we have a service which we launched in 2005 (Bclear) specifically for equity derivatives, designed to bridge the gap between listed and OTC. Market participants use derivatives for different reasons, some complex and some straightforward and there’s a gap there that I think the listed community can help with. Our Bclear service has done very well, largely led by the buy-side, your firms actually but on the derivatives side. As mentioned earlier, a concern is that different rules are going to be implemented and also whether or not the buy-side voice is really being listened to when invited to the table both in the US and in Europe.
SW: I think the buy side’s getting a bit more teeth as far as the Investment Managers Association (IMA) over here and the Investment Community Institute (IC) in New York are concerned. When I go to the NYSE Institutional Traders Advisory Committee in New York, ICI is very vocal about issues and over here we get the FSA to talk to the IMA so that we can voice our opinion. So I think we’re starting to get on par with the London Investment Banking Association (LIBA) and people like that as far as lobbying the right regulatory bodies. But we can always improve.
Funds Europe: In terms of brokers, how many are you dealing with? Are there too many? Can they be consolidated? How do you maintain a relationship with all of them, particularly when so much of the trading is done electronically? Do you still instruct your dealers to pick up the phone?
PS: I still think there is a lot of value in telephone conversation. We talk about convenience around technology but I think information is a really valuable commodity and every phone call to a sales trader reveals a bit of extra information, which works both ways. This insight is also a significant part of the service we offer to our fund managers. The kind of market commentary, insight, perception, analysis, intuition, whatever you want to call it, is perhaps equally as important to our fund managers as the ultimate execution so I still believe very much in the value of picking up the phone and talking to sales traders.
We talked earlier about sales traders being a bit conflicted with their own dark pools but what I find quite alarming is that some of our main sales traders don’t even seem to have much visibility of the MTFs which are lit. To some extent I’m happy to say we outsource our reach of technology and to some extent if we’re picking up the phone to a sales trader or a big broker we expect him to say “there’s a little bit (of stock) out there (on a certain MTF)” or “one of our clients has been trading this recently” or “actually I think we should try this in our dark pool”. I want them to use their much more advanced infrastructure for our benefit and that isn’t really coming through. So I think we find ourselves still having to be much more discriminate about which brokers we go to for specific services.
We have a huge list of brokers on our approved list. That’s partly because we’ve got two legacy businesses that have been put together and we’ve only just unified those broker lists to make one with 155 brokers on it. Of course we don’t do a lot of business with all 155 brokers – it is very much concentrated – but I quite regularly have a dialogue with compliance in response to them saying: “Can’t you just cut it down to 35?” I say that it would be quite convenient but every now and again we have small-cap business for which the fund managers absolutely need to access that liquidity and technology isn’t going to reach a small regional broker who may uniquely have that specific flow. It doesn’t really work for them so I think again there is a sort of shift of decision making to the buy-side trader in how and where the execution takes place.
SW: I think that relationship with brokers face to face is stronger than it was five years ago because the role of sale traders changed. They are not order takers. They are actually solution providers that show us trade ideas or if we’re working a hundred thousand shares on an exchange or MTF they’re the people who try to source the other 4.9m for us and add value that way. So I think that relationships are growing stronger all the time but to do that there has to be a very good sales trader on the other end. I think a lot of the dead wood’s gone now during the recession but the good sales traders that are left are highly priced.
Funds Europe: So I guess that is an example of where electronic trading allows that relationship between yourself and the broker to be all about that added value.
SW: Yes it’s freed us up to focus on trading and it’s freed the sales traders up to actually focus on giving us a better service.
IF: I think one of the problems is that brokers try to offer you every service under the sun. Don’t try to be everything. Be good at what you are good at because I’d rather speak to you about what you’re good at and not because you’re white labelling somebody else’s products selling something that you don’t have any knowledge of and you have no ability to control.
We’ve got a long list of brokers. In today’s market you can’t afford to have just a list of 20 brokers. It would be nice if that’s where all your flow went and you could control it but there are other dynamics involved and it is all about having the right conversation with the right people. There will be those brokers that you talk to just two or three times a year but when you do, you can use them to your benefit.
Funds Europe: Johan, your set up seems particularly technology driven. How has your relationship with fund managers changed since you’ve developed and invested in more technology? Do they know exactly what you’re doing? Do they have a greater understanding of what you’re doing or are they two separate worlds?
JE: We have seen a big change in the behaviour of our fund managers. When we established our dealing desk, it was very important that we had a rule that the fund managers should never interfere in a trade, it’s at the full discretion of the desk. The best thing we did was be as transparent as possible so that the fund managers can see what we are doing but they can focus on their portfolio tasks.
We use transaction costs analysis (TCA) to measure the quality of execution for every trade. The next step for us is to have online TCA for everything we execute on the desk. Today we have a short delay of 15 minutes to get an update for every trade we do and for every algo we use and it’s made a difference, particularly in terms of our relationship with brokers because they know that we are measuring everything.
Our ambition is to work as internal sales traders and market interpreters and at the same time adapt to the overall changes we see in electronic trading. Fund managers also see that clients are asking more about our execution capabilities so we are becoming a natural part of the RFP process. Overall I know that we are appreciated for the work that we do.
Funds Europe: For the rest of you guys, do you find there is a difference between the old school fund managers and is there any empathy with the younger fund managers?
SW: It is not necessarily that cut and dry. Our desk is set in the middle of the fund managers so they sit round us. So we’re in constant contact and one of the things that technology has put in is that we can talk to them a lot more aggressively about value-added information. We have a lot more time to do that and feed them in ideas and react to what they are trying to achieve with that investment idea. Very much a team scenario compared to what it used to be 10-15 years ago, them and us. So the trade desk is very much part of the investment process rather than a middle office function as it could have been perceived some time ago. It’s a three legged stool – research managers come up with the ideas, fund managers construct their portfolios and we implement them in the open market. If any leg of that stool is shorter than the other, then you are going to fall off.
IF: We are increasingly seen as solution providers. The new guys are more technology savvy but when we do our MiFID presentations, there is still a glazed look that comes over many of them. You try to explain to them how much more complex trading is going to become and they say, can’t I still ring Fred up – he always gave me a price and will always give me a price. It’s not like that any more and it’s a lot more complicated. So I think they are happy to leave the trading process to us.
JB: It’s amazing how it’s changed now in the last five years.
SW: I think times have changed as I feel I’m spending more and more time presenting to clients. The client’s focus has actually become more acute as far as trading and the actual cost the trading can occur on the portfolio .
IF: Some clients will get it and some won’t. Some will want the details and some won’t. One good thing about MiFID is you can show that you do what you say you do. Our best execution policy is not just one thing. We don’t have a single process that we always follow because the market does not work in a linear way so we have to adapt it. I think that is where clients are more interested because they accept the fact that complexity is part of the process now.
Funds Europe: Like you said a lot has changed in the last five years but can we expect to see yet more changes in the next five years?
MW: There will continue to be an evolution. Firstly, Steve picked up on it – the interaction is greater than ever before now for people in our peer group to have a liaison with not just our internal customers, but with the ‘king makers’ for our industry, the Mercers, etc, of this world. Consultants are asking more and smarter questions these days. We are increasingly being involved at the RFP stage, and the marketing people are now frequent visitors to the dealing desk.
The other big development is around the progress we’ve made with our long-short Absolute Return Funds proposition, and how the development of these has focused the attention of the fund managers on transaction costs more than ever before, possibly because the remuneration package of the fund managers is more directly linked to the performance, perhaps? Every basis point counts and always has done, but hitherto that wasn’t quite at the forefront compared to where it is now.
Funds Europe: So the market developments seem to be geared to make your role more important within the firm. So from that perspective, long may the complexity continue?
IF: But I also think it’s important to have one foot in the past. I’ve nothing against the exuberance of youth but we’ve been through some of these things before and experience teaches you that not everything that glitters is gold. Change is not good for the sake of change, you’ve got to believe there’s an end game to this and sometimes you’ve got to be able to look back instead of forward and be aware what the pitfalls could be before you rush and change for the sake of it.
- Johan Erikson, head of global trading, DnB Nor
- Mark Winter, head of trading, Insight Investment
- Ian Firth, head of centralised dealing, Aviva Investors
- Steve Wood, executive director, Global Head of Trading, Schroders
- Paul Squires, head of trading, Axa IM
- John Barker, managing director, Liquidnet Europe
- Ade Cordell, director of OTC services, NYSE Liffe
- Nicholas Pratt, technology and operations editor, Funds Europe