Fixed Income TCA. TCA and its use in fixed income reducing cost, bringing transparency and moving towards electronic trading in fixed income

Transcription

1 Fixed Income TCA TCA and its use in fixed income reducing cost, bringing transparency and moving towards electronic trading in fixed income

2 Why do Fixed Income TCA? MiFID II hasn t changed best execution requirements - per se, but regulators have expressed disappointment with what they see as substandard execution policies and review processes - So greater scrutiny is almost certain. Regulators are demanding greater post-trade transparency in non- Equity markets which should increase the supply and reliability of good pricing data on which TCA so crucially depends. Trading desks and trading strategies become more integrated, practitioners, and especially equity traders, who have already witnessed the impact of TCA on processes and cost. Want those same analytical tools to examining other asset classes. TCA can be a useful means to look at an investment product to measure its success, and work out when the cost to trade starts to erode the alpha of the trading idea

3 Organisational structure Objective Create a review board consisting of key personnel. Define TCA framework (Compliance, Broker review, cost optimization) Comply with regulatory and client demands of regular broker reviews and cost transparency. Process Define TCA benchmarks for each fund based on investment style and trade objectives. Monitor and review potential behavior change in trading style (Voice or Electronic) Consider Peer group comparison and Data co-operations. Collect data and define filters (Liquidity, Volatility, Bond class, Duration, Rating, Country..) Result Monitor and review firms order route to market (Voice and Electronic trading) Venue review measuring slippage and information leakage (fill size, fill rate, Toxicity) Broker review measuring in which capacity the broker acted (Liquidity, Mark-up, Spread, information leakage, Review operational opportunity cost (Operational delays, Timing, Momentum capture)

4 What to measure? Primary objectives in Fixed Income TCA

5 Explicit cost: Dealer mark-up & settlement cost Broker type: Principal or agency Liquidity provider, Riskless trade Dealer markup: Risk premium to hold or source liquidity Comission vs. Risk markup Risk premium vs. riskless Settlement cost: Clearing & settlement Clearing cost, Dilivery quality, Counterparty risk Things to consider: Inventory turnover at the sell-side (Often less than two weeks). Likely hood of broker loss on inventory. Electronic venue pricing - Should be free of risk premium and offer benchmark pricing. Average trade size & Spread

6 Implicit & Operational cost Trade initiation Working Final fill Operational cost Implicit cost Total cost Time delays prior to the order reach the broker or trading venue: E.g. system, organisational processes. Implementation shortfall: The price difference between your Arrival Price and the final fill. Alpha lost as a result of operational delays and Implementation shortfall.

7 Market impact Trade initiation Working Post fill Determine what your firm consider the trade initiation time: Trade decission time (PM) Trader recieve the order (Trading desk blotter) Broker recieve the order Arrival price definitions: Historic bid/offer price data provided by independent supliers Sell-side provided bid/offer history Volume Weighted Average Spread (VWAS) Mid-spread between bid/offer from various source Evaluate using reversion analysis Track the price movement at variable points after the last fill T+n Challenges with measuring market impact: Acessing holistic data to compare to execution price Lack of centralized reporting or Global Limit order book (GLOB) create difficulty in measuring how much your own trade moved the price in the market. Hard to measure on OTC or Illiquid trades due to lack of data.

8 Market Timing & Momentum T-n Start measuring at a date prior to trading decission date Typically Last traded price or prior day close is used. PM Trade If logged measure the PM Alpha generation based on the bid/offer at the time he/she decided to trade. If not logged have your overshight committee assume a log time. E.g. T open. Released to trader The time the order hit the trading blotter Released to broker The time the order is released to the broker or trading venue. Final fill The time the order is filled T+n Measure N days after the last fill to find momentum gained or lost

9 Widely used Benchmarks Explicit cost PM`s price directive at trade decission time Peer group comparission (Commission & Dealer mark-up) Implicit cost Best bid/offer at initiation and implementation Average price from peer group Sell-side provided bid/offer at initiation and historically Volume Weighted Average Spread (VWAS) Trading price of similar bonds Yield curve

10 Bringing transparency trough electronic trading Will Fixed Income mimic the equity markets?

11 Did we get transparancy in Equities?

12 How do we solve the issues? How do we solve the issues? Time, Destination, Geografi, Liquidity? OTC & IOI MTF order books Electronic trading Automated BCN Exchange order books US: TRACE appears to reduce investors cost significantly, supporting a transparent pricing regime Europe: Mifir will give TRACE like transparency in Europe Various excisting and future solution will increase transparency in the coming years (Bloomberg CBBT, Global Trading Analytics, Tradeweb, XTP and Neptune) All-to-all trading rather than purely dealer to client Require Venue post-trade reporting Global Limit Order Books (GLOB) Where liquidity allow it.

13 Electronic developments Why are we seeking electronic solutions? D2C: leaks information on buy-side orders, Increases market impact while the order is telegraphed via phone to the other participants., Increase risk of tilted quote. RFG: Reduce above risk, but it does not eliminate or hide your order from information leakage Dealer Inventory at the banks trading desk is 10% of what it was prior to the Financial crisis. Electronic solutions should: Allow buy-side-to-buy-side crossing: All-to-all is agreed to be a must, but purely buy- side-to-buy-side trading is also highly valued by several traders. Have Mandatory, automatic blotter scraping: Hoping that buy-side traders will contribute is too optimistic. They are busy and any lag in frequency of contributions to a platform will lower the success rate for matching orders, leading into a cycle of failure. Have An independent clearing and settlement agent Electronic developments Should aim to broaden reach by the buy-side desk Better identify inventory and liquidity at trading venues Can we standardise inventory? Can we standardise what the banks are holding and get that aggregate list formed and sent to the buy-side and display it in their EMS or OMS? Encrypted Dark pools Eliminating message boards One part limit-order book and one part mid-point execution dark pool, with designated market makers (DMMs) in the limit order book to drive the market. Most sort after platforms currently: Liquidnet, Algomi, Project Neptune, Bondcube. (but there are many others) Most Used platforms: Bloomberg, Tradeweb, MarketAxess

14 61% of buy-side trading desks will invest in Fixed income trading system over the next 12 months, spending less than 500k. Only 20% will invest in TCA solutions