Magazine Issues » May 2011

CROSS-ASSET TRADING: Don't let the distance bug you

AntsNicholas Pratt finds that restructuring dealing desks to aid cross-asset trading is helping some firms scrutinise brokers and risk-manage trades more effectively

The case for cross-asset trading is gaining momentum among buy-side dealers and is widely recognised as the foundation of the dealing desk of the future. Whereas in the past, dealers were placed near their respective portfolio managers and generally segmented
by asset classes, there are now other ways of communicating that do not require such close proximity.

Buy-side dealers can argue that there is more to be gained from having a closer connection to their fellow dealers rather than portfolio managers by means of a tightly integrated cross-asset dealing desk.

But it is only in the last few years that this has started to become a reality. Christoph Mast, managing director and head of trading at RCM, which is owned by Allianz Global Investors, says: “Our trading desk is about 15 years old and has mainly been looking after equities trading but also derivatives, fixed income and FX [foreign exhange]. In the past, we have only been doing a few cross-asset trades but we are doing more and more derivatives and FX transactions.”

One consequence of this change, says Mast, is a new generation of traders who are different from their predecessors. “We are also seeing a new generation of traders. They are no longer just order clerks but dealers with their own ideas and wider ambitions.”

Two major factors that are aiding this new reality of cross-asset trading include dealing desks that have started to implement architecture which can take advantage of the multi-asset expertise among dealers, and the growing amount of trading technology available for cross-asset strategies.
Despite the progress made in technology terms, some notable obstacles still remain for buy-side traders, not least the fact that many of their intermediaries are not set up to best serve a client with a cross-asset focus, particularly brokers. This was one of the issues that came up repeatedly in a panel session at the recent TradeTech event in London, which focused on buy-side trading strategies and systems.

The broker burden
It is arguably the brokers that face the biggest burden in changing their set-up to cater for the cross-asset trading demands of their clients. Mast says: “The brokers face the same difficulty as us. They have a lot of specialists but they are not always working together. So it would help us if they were to work closer together.”

It is an observation that is shared by Vincent Moojer, head of equities trading at Holland-based fund manager PGGM, who says that cross-asset trading has helped improve the ability of fund managers to assess their brokers’ effectiveness. This has highlighted weaknesses in brokers’ cross-asset trading capability. “One benefit for asset managers is that we can compare brokers across all asset classes and what we have found is that many of them do not know each other on an internal basis and have to introduce themselves to themselves.

“It would be helpful if we were able to have credit extended across asset classes or if we could take equity research from a broker and pay for it with fixed income flow. It is difficult but brokers must be organised differently if cross-asset trading is going to be possible for
asset managers.”

Helpfully, fund management dealers are finding they do not have to rely on their traditional brokers for execution thanks to the growth of electronic trading.

Extra scrutiny of brokers is also driven by cost pressure, because the need to control costs has led buy-side dealers to focus more on execution quality and to look at what they can do themselves to ensure it, as well as how they can more accurately evaluate the effectiveness of their brokers.

“We have developed a new evaluation matrix to assess commission runs for equities and derivatives and we are also enquiring more about transaction cost analysis [TCA],” says Mast. “This is still a tough area when related to OTC [over-the-counter] transactions but
there is more and more data available for derivatives and FX so we are hopeful, but also sceptical, that anything will happen too quickly in this area.”

The appetite for cross-asset trading among asset managers has affected sell-side firms. Martin Henning, head of trading at BNY Mellon Service KAG, says. “We had asset management clients that wanted to trade a whole range of instruments from equities to ETFs [exchange-traded funds] so we had to completely restructure our desk, hire new people and build a close relationship with all our brokers.”

Trading risks
Along with the extra insight into the sell side, cross-asset trading has also helped buy-side dealers to risk-manage trades, as highlighted by Moojer. “Most asset managers are separated by asset class but asset allocation strategies are normally part of a much wider picture.” 

“There is an increasing awareness among asset managers that you can make basis points on a fixed income trade and then throw it all away with the wrong FX trade. So there is an obvious value in having all your traders in one room to discuss any cross-asset trading issues.”

Measuring trades on a cross-asset basis is still a challenge, however, he adds. “The explicit measurements are still done on a separate asset class basis. But it is possible to look at the overall picture even if it is not possible to put a number on it and to see how the process can be more efficient. The knowledge of other markets and asset classes can still help to save costs and to help the trading desk achieve its aim of adding more value.”

There are also technical as well as organisational challenges to enabling efficient cross-asset trading, as various technology vendors are well aware, says Philippe Buhannic, chief executive and co-founder of New York-based TradingScreen Inc, an execution platform provider. “A lot of technology has been designed to focus on specific asset classes or specific exchanges and execution venues so it can be difficult to connect them.

“There are also big data issues when it comes to multi-asset trading. Traders are becoming huge consumers of pricing data and when this demand is extended to every price for every instrument in every market and all in an integrated form, then this creates an obvious logistical challenge,” Buhannic­ says.

And there are also cultural challenges. There is a dichotomy between buy and sell-side firms. Whereas the buy side tends to be very integrated, the sell side is typically a very separately organised industry. Consequently, it can be difficult for asset managers to find someone on the sell side who can talk across products because they are used to seeing systems in their own asset class and that is what they expect. 

“Organisations on the buy side are more sophisticated at acquiring multi-asset information,” says Stuart Grant, a business development manager at Sybase, a database management software provider. “Sell-side technology has not traditionally been made available to the buy side, but this is changing.

“The biggest challenge is how you can reduce the reliance on technology and managing the sheer volume of data – going from end-of-day data to tick data and making systems that are powerful enough to process all that information in near enough real-time. How do you tie your business rules into your technology without relying on an army of developers?”

Ultimately, these are all challenges that the buy side, their providers and their intermediaries will have to overcome to avail the obvious benefits which cross-asset trading offers. Not only does it help traders see the bigger picture in terms of asset allocation, but for achieving compliance – a more transparent environment for ensuring best execution and also more efficient use of capital reserves.

Compliance is likely to become an increasingly important factor in the decision of trading desks to adopt a cross-asset approach. The growing sophistication has led regulators to widen their scope beyond a heavy equities bias, as evidenced by the new rules for trading derivatives, and consequently compliance officers are adopting an approach that spans multiple asset classes. Therefore, it is hugely beneficial if the trading desk is set up in a way that integrates all the various asset classes being traded.

As Grant says: “Everything compliance-wise becomes simpler, faster and cheaper because all the information is in one place.”

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