Linda Giordano and Jeff Alexander, Principals, TABB Group further examine their efforts to standardise execution venue reporting, and look at how it can help both the buy-side and sell-side.
Since we last contributed to the GlobalTrading journal, we came to realise that a single broker was not the right place for us to continue with our programme to bring transparency to execution routing and venue analysis. As a result, we moved into the TABB Group organisation, helping create a TABB METRICS product called Clarity.
We believe that we are now better able to analyse data from brokers of all sizes. The July 2014 move to TABB has made us more effective, which has been much better, more interesting and more valuable to clients.
Currently, we’re taking all the routing data from brokers, whether things are filled or not, driving a big push for standardisation, including areas around FIX tag 851 and other related initiatives, such as the standardisation of time stamps. As the data comes in, we process it and issue reports for clients. However, we’re going to be moving to an industrial strength platform soon that could potentially lead to daily processing. This could be a little overkill, but it’s a move in the right direction.
Our data has shown clients what’s going on across multiple brokers. There’s always a delicate balance between cost and execution. For example, is a broker being too cost sensitive, too aggressive, or are the broker and investor aligned to provide truly best execution?
To accomplish this, we look at strategy in terms of what is the client’s intention and what order types are being used. We want to see broker and client alignment and how investment strategies are implemented, which is not easy because strategies are very different when a broker is providing or taking liquidity.
The first step is to get a very high level of review of where the broker is routing to and where they’re getting filled. We take a look at a sample and see that the broker is trying to route through agency pools. We have charts and tools that split the orders out into lit and dark, and we’ve actually classified them into more granular categories, including a broker’s own dark pool; agency pools; consortium pools; blotter scrapers; and lit, inverted and electronic market maker liquidity pools.
We have learned that when you begin to analyse the data, you discern definite trends. If a broker has a cost sensitive model, they will begin trading in the free or inverted markets first, which means they are taking from broker venues, consortium-type venues and electronic market maker type venues. These are free places to execute, so you can start seeing that this type of broker has a very cost sensitive philosophy in routing.
For the most part, these pools are not offering protection from information leakage. Nor are they offering size or anonymity. This is because they are prepaid. It’s for the broker’s economic benefit and that can be seen through our analysis.
The broker has to be as cost effective as possible but still ensure that they are protecting their client and that is where the line has become muddled: the buy-side wants to make sure that brokers are not doing things to their detriment.
Drive for transparency
It is important to say here, it is not always that the sell-side has to pay more for execution and the buy-side just gets better prints. Sometimes the buy-side gets a little too aggressive in cost cutting and the broker is forced into more cost-effective routing strategies. If the buy-side are constantly pushing their broker on costs – don’t forget you’ve got research to be paid for, too – the end result is that routing starts to look unbalanced. In some cases, if the buy-side wants more aggressive, costly routing, they have to look very hard at commission rates they’re paying and consider increasing them.
The intent is for the buy-side to have a more meaningful discussion with their brokers and work together. One problem is that everybody has their own definitions. Items like commission rates are defined differently on each broker report. There are also areas that are less well-known, such as time stamps being calculated differently on broker reports, meaning that even the items that people think are clear vary between broker to broker.
Examining the difference between a router-based time stamp and an actual time stamp, we found that the router-based time stamp happens when the broker gets a fill from the market and then stamps reflect the time they got the fill – rather than the time it filled on the exchange.
The difference can be significant, so if a buy-side firm gets a report from one broker based on their router-based time stamps, and another broker gives actual market time stamps, you are obviously not looking at the same thing.
The result of standardisation is that brokers can focus on key metrics and improving execution, eliminating the need to have a discussion around definitions. Buy-side firms know how the numbers are calculated because Clarity is completely transparent in terms of how everything is calculated.
The conversations around standardising FIX tag 851 and time stamps are first steps to allow people to standardise a lot of these other conversations and to drive cross comparability of data. Moving forward, we have to encourage the sell-side to open up and the buy-side so they’re all able to understand it and implement the solutions to manage a lot of the data.
Regulators have been looking at areas like these but it is unclear if they want to come up with a standard. If they were to drive a standard report, each would have the same matrix and each client would have a very simple and easy-to-digest report regarding their routing practices.
The standardised reports that the regulator has put into a trial so far are not particularly complicated but also not very illustrative. This could be an area where the regulators have seen industry solutions to the problem but there does not necessarily need to be a regulatory-enforced level of reporting. However, some areas obviously do have a much greater need for regulatory involvement, especially if commercial solutions are unable to meet the needs of the industry.
Trading needs to be driven by execution quality purposes, not by payment for the flow purposes and it’s something that some firms are not grasping. There are firms that exist solely because of payment for flow arrangements, but they’re not good enough from a quality perspective. This is an issue that shouldn’t be too difficult to put right.
The tradition in the United States has been that the market has come up with its own solutions. As we see it, this is not always the best way because market solutions at different times are biased. Whoever has the loudest voice and whoever has the most money is going to sway things.
Problem is, the buy-side has not been in the driver’s seat and that’s been to their detriment.