Bidroute - a logical way to improve program trading Friday, September 19, 2008
Many people outside of the City would be surprised to know how "Heath Robinson" much of the internal systems infrastructure actually is at most companies. Spreadsheets play an integral part in many key functions and email/faxes/phone are still used in some dealings between counterparties.
One notable area of spreadsheet blizzards and emails/faxes is program trading, which refers to the execution of large baskets of shares in many companies.
When placing program trade orders, investors are keen to minimise their "market impact", by which I mean trading in a manner which adversely moving prices against oneself because the market becomes aware the trades before execution is complete. Brokers aim to assist such investors via their dedicated Program Trading desks.
The desk can either execute these baskets on an "agency" or "principal" basis. With the former, the investors continues to face the same price risk in the market, receiving the price that is achieved, but aim to reduce market impact by utilising the brokers execution facilities/expertise.
As principal, a broker buys the basket from the client without knowing its specific contents other than general characteristics e.g. number of stocks, their sectors, their approximate value. They will then aim to profit from the execution by trading it at a better price in the market, but with the obvious risk that they may fail.
An equally significant deterrent though is that orchestrating program trades can be a time-consuming and complex manual process, especially when little exists by way of standard formats to exchange information - one is constantly coping with emails flying around and spreadsheets being constructed and amended by multiple parties.
A growing difficulty for fund managers is being able to satisfactorily demonstrate to the regulators that you sought to achieve best execution [not necessarily the same as best price] on behalf of your investment clients.
BidRoute seeks to address this headache in 3 ways
- By providing a single communication hub for routing program trades to multiple counterparties and describing them in a consistent manner, which makes orchestration easier and hence lessens the burden of accessing a wider market if desired
- Offering facilities to operate a competitive auction for the program trade between brokers, which should lead to a better price being obtained via a fair and transparent process
- The platform assists in administering the trade, pre and post execution and maintaining records to demonstrate quality of the execution/service received. This is important when seeking to demonstrate why routing decision were made and highlight why price was not the only determinant in awarding a program to a particular broker.
Understandably, some brokers have been less than keen to participate in a service that would expose them to transparent price competition, albeit on an anonymous bidding basis, preferring an opaque environment. However, they have been more interested in the administrative efficiencies the platform offers, especially when dealing with hundreds of such trades per day. Knowing that the auction component was optional has made take-up on the sell side much easier.
Despite this, the buy side have not been quick to grab this opportunity for reasons that presently elude me. After all,
- there is no direct cost to them in using it
- implementation and integration looks relatively trivial, with the service utilising FIX and hooking up to major order management systems
- administration, orchestration and record keeping are simplified
- a buy-side dealer can run a price auction if they wish
- execution and service quality can be recorded and measured