Transaction-cost analysis (TCA) offers buyside

Transcription

1 Applying real-time trading analytics for achieving improved TCA in FX TCA is still nascent in the FX environment but as Dan Barnes discovers, it has the potential to leapfrog development stages found in equities. Transaction-cost analysis (TCA) offers buyside firms a better understanding of their execution quality. Typically it operates by taking key data points such as the price and time of trade execution for a fund and setting those against a benchmark of other funds trading data to create comparative performance charts. But these services, that have been pioneered in the equities market, face some fundamental challenges in FX not least because it is predominantly an over-the-counter (OTC) rather than venue based model of trading. FOCUS Fifteen years ago there was no need for TCA because everything was on the phone; your base price was 70-71, if the client told you he wanted to buy it you told him 75, so four pips were yours. You could achieve this by an activity-based costing approach or by a looking at the unit costs, says Ralf Behnstedt, managing partner of FX Architects. With the advent of electronic trading over the last couple of years, where you have multiple liquidity providers and liquidity aggregators set up, you are not just holding out your prices to your own clients you are holding them out via application programming interfaces (APIs) and they can trade with you, so TCA has become more important. Fragmentation Because foreign exchange is an over-the-counter market it is highly fragmented. Although there are exchange-like venues and electronic communication networks (ECNs), they are not interlinked like the equity markets are so there can be some variation in the prices found on them, creating a role for products that put multiple prices in the same screen, called aggregators. Aggregation technology grew up in the equity market along with TCA. We have seen a huge shift to electronic FX trading and that is leading to market fragmentation, says Rebecca Healey, a Londonbased senior analyst at research firm TABB Group. To establish your true level of performance you need to be able to incorporate historic and real-time data wherever possible to read transaction cost analysis (TCA) effectively. As a consequence people are starting to question where is best to trade. Historically buy-side firms have found that single-dealer platforms were the most effective way to deliver improved pricing. Some research we have seen studied showed liquidity provision from top five banks versus an aggregated liquidity feed from Reuters, EBS and Currenex. The best-bid-offer spreads were better 95%-99% of the time on the aggregate spreads. The reality is that the well-trodden path should no longer be the 78 january 2013 e-forex

2 >>> of time and energy to best execution analysis and execution-quality analysis for people to portray the best time of day to get the best price and to identify the right counterparties. There are some tools and techniques that trading firms can use to optimise their best execution goals, which are data driven like equities. It starts with having a broader view of one s performance in the market than the singular focus on the price you did the last trade at with the last counterparty. You can t do just voice broking anymore, you have to dive into electronic trading, adds Behnstedt. The problem is how to approach it. If internal transaction costs are higher than the external transaction costs then you are losing money. And so you need analytics which show you whether you are on the profit or loss side. There are a couple of solutions on the market but it is still early days because the concept of TCA has not been implemented at all organisations. It starts by giving you an analysis at which millisecond the rejection rate starts and or where the slippage for latency started. This could be done on a per liquidity provider basis, so if you are dealing with a bank for example and you have a slippage of 200 milliseconds because your client in Asia is doing everything out of London, your rejection rate might get to 100%. These kinds of analytics are in the first stages and will continue to evolve. Drivers for TCA Two trends have combined to drive interest in TCA. The first is the use of FX as an investible asset class by buy-side firms, the second is a response to the lawsuits that buy-side firms have levelled against custodian banks which were charged with executing the FX legs of equity and bond trades. The buy-side firms have alleged that they were overcharged for these trades. automatic choice. Participants need to understand where best to trade and when and TCA offers the ability to navigate the FX markets more effectively. Best execution Jon Fatica, global head of analytics at TradingScreen says, In FX, the concept of best execution is not as evolved as it is in equities, but we have devoted a lot A big driver [for TCA] was the headlines; for years the custodian banks globally have had these captive relationships with the asset owners and the stewards of the assets, the fund managers. The whole irony is that FX is the largest market in the world but has never had the same type of transparency as equities or therefore the tools to monitor and measure execution quality, says Peter Weiler, executive vice president, sales at TCA provider Abel Noser. The forex side was a natural extension of our equity business because with any global cash equity trading there will be a forex component to it, he continues. Greater scrutiny came from a lot of the litigation january 2013 e-forex 79

3 >>> that process and provide retail customers with almost algorithmic levels of capability. There s the cost of execution and the cost of trade in terms of block size and opportunity cost. We re seeing more focus on the cost of execution TCA analysis, and some quants are collecting historical data and starting to use that as reference material, at the moment just for near-posttrade analysis, so they can start to understand whether or not they have optimised the timing of their trades. New platforms In June 2012 eight new FX platforms launched (FastMatch FX, FTSE Curex, FX SpotStream, Jiffix Markets, Liquidity FX, MoltenMarkets, tpspotdeal and TraFXPure) signalling that perceived sentiment of the market is moving away from the traditional OTC model. Electronic platforms will not only help to reduce volatility in prices, but they will also potentially provide a valuable source of data for TCA systems. Ralf Behnstedt If internal transaction costs are higher than the external transaction costs then you are losing money. And so you need analytics which show you whether you are on the profit or loss side. It is not certain that the introduction of these ECNs will change the FX market sufficiently to make the data they produce useful for TCA, says Behnstedt. You will always have market participants which try that started here in the US. The big distinction was the difference between standing order instructions versus negotiated transaction. What was happening is that asset owners were captive to the execution desks of the custodial banks if FX was required for a trade. Some fund managers would take that course, others had enough resources to provide currency desks where they would go ahead and negotiate for themselves, shopping around to try and get better prices for their clients. People saw there were discrepancies in performance by comparing the performance of the underlying cash equities to what the asset owners were reporting after the forex conversion. Nevertheless the market is still young and TCA is not yet being adopted by a large number of firms says Stuart Grant, business development manager, SAP. We ve seen a slow pick up of FX TCA all in all, it s one of those where firms with the largest flow and widest connections have picked up on it and we ve also seen some interest from organisations taking flow from the retail market to blend that with institutional flow in order to improve the economics. They are also focusing on how they can use TCA to improve Rebecca Healey To establish your true level of performance you need to be able to incorporate historic and real-time data wherever possible to read transaction cost analysis (TCA) effectively. As a consequence people are starting to question where is best to trade. 80 january 2013 e-forex

4 >>> to leverage inefficiencies in the market. This will grow as electronic trading grows. We all know that some liquidity providers behave in such a way that if they know you have a certain kind of aggregator running, they may widen your spreads automatically. Clients of those LPs need to pay close attention to TCA as here they are dealing with an increased likelihood of incurring losses. By providing a timestamp on the data, the venues could provide more consistent information across multiple trades which would assist with the reliability of TCA provided on the back of it; data inaccuracy and lack of consistency is one of the greatest challenges for TCA providers. There is the opportunity to get time-stamped data from a lot of the new FX venues and some market participants are requiring it, observes Weiler. We get our data from a number of data sources, some are aggregators like Bloomberg, and we get the data from 25 sources, but there s still fragmentation in that and we don t enjoy the centralised data that we typically get in equities, for example with the US consolidated tape. That said, in the early days of equities simply having clients capture data was a challenge. Order management systems (OMS) were perhaps a result of firms realising there needed to be more efficiency in the investment process, he notes, as they became data capture mechanisms (DCMs) and over several years business rules were captured and defined making analysis a finer art. Today, many FX platforms are not as robust as they could be, says Weiler. Some use spreadsheets, some clients use an OMS to capture information. So from a variety of points of view there probably needs to be more work done on the client side capturing accurate information, whether it is timestamps or other sources of information. We are seeing quite a variety of data flow, and there needs to be more work done to capture information, custodians specifically need to time stamp their activity, as of late there is just one that does, but there are challenges and I think we see parallels with equities. However some commentators have observed that the new trading platforms may inhibit the development of TCA in the short term. The time stamp element is an important one here, says Grant at SAP. The emergence of these new FX 82 january 2013 e-forex

5 parallel with equities, is the equivalent of seeing level 2 liquidity. You can see it visually and we can capture that. You can not only have the gestalt of watching the execution in the market, but also you can capture the data behind it. SAP offers a reference architecture and a pilotbased environment for real time TCA which is asset independent. The technology which is facilitating that is in-memory systems; the event-stream processor (ESP)and SAP Hana, which are two high performance memory-based analytical environments. Any legacy technology will inhibit the development of TCA Jon Fatica venues is delaying TCA as these organisations are focusing on connectivity, building out the capabilities within their existing systems, to manage that. The time-stamp issue is one that we are starting to see a number of organisations focus on, to provide a consolidated view across currencies. That is valuable information that can be provided to their traders in terms of understanding where they can be executing or providing that automatically into their algos. We don t have a single shrink-wrapped solution, says Grant. The ESP engine is the real-time piece, it has the capability to do the analysis in real time in an FX environment. Hana gives you the ability to have near real-time access to high volume big data analytics. You bring the two together and use the ESP engine to do your decision making about where to execute a trade based on the TCA elements. You use Hana to start doing your historical analysis or broader TCA which can be referenced in real-time by the ESP engine. That can make more intelligent decisions. Rather than making it an order router you can bring in timing decisions and volume decisions based on historical profiling. The big picture Once the data has been collected it has to be represented appropriately for its use, either representing historical comparisons or immediate real-time trading decisions. Advances in the electronic trading technology being used in FX can provide a system of both capturing and representing this data. Fatica says, Clearly the development and use of execution management systems is a huge step forward, and that is where we are well positioned, having a broad-based multi-asset-class capability for execution. We can capture that, we don t have to have clients source that data. Any legacy technology will inhibit the development of TCA. The new EMS platforms do allow advanced TCA. Firstly they allow you to see multiple dealers at the same time, which in a Peter Weiler If you re trading a yen dollar and spots or forward you want to understand how your costs are versus everybody else. 84 january 2013 e-forex

6 Applying real-time trading analytics for achieving improved TCA in FX >>> SAP has partners like visualisation specialist Panopticon, which has a push capability for data analytics which the SAP systems can plug straight into. We re able to do all of the heavy lifting analytical work using underlying in-memory components, push the results out to the visualisation so you can have very rapid updates occurring on the screen, but with much more complex analytics going on under the covers, says Grant. Weiler notes that his firm sees a demand from both asset owners and fund managers, who want to understand what their costs are and how they stack up relative to their peers. The concept that a picture is worth a thousand words and applying visualisation to a managers style and seeing how it works in different environments, Europe vs the US for example, that helps people to think about how they can tweak things, he says. If you re trading a yen dollar and spots or forward you want to understand how your costs are versus everybody else. For any given month or quarter, at Abel Noser, we provide people with visual depictions of how they are interacting with the marketplace. We show them a Stuart Grant The time-stamp issue is one that we are starting to see a number of organisations focus on, to provide a consolidated view across currencies. january 2013 e-forex 85

7 >>> chart on an aggregate basis of all of their positions for an asset class. We ll look at things like the behaviour of a stock two days before a trade; then right at the trade date; when the order is entered in the market place; and five minutes later. We check if there is there any slippage, if there has been any information leakage, and so we start to get more and more detailed and decompose cost. Then we look at after the trade has been completed three days out and thirty days out which gets more into portfolio management. Kitted out There are some limits to the technology that is available for FX TCA at present. Weiler says that he is not aware of any tool kit on the FX side that is comprehensive and real-time. What happens is that vendors are gathering data on a quarterly basis and marrying the market data they get with the trade data and then coming up with online reports, he says. From what I see with our peers there are a number of steps that have to be taken first in terms of data improving, being more comprehensive, more robust data timestamps etc before there s a push for real-time information. Fatica also observes that there are some technical challenges to be overcome before every firm can use TCA systems as they stand today. The trick is to make sure that the latency on the execution platform is as low as possible; when you have another layer of software between a client and a dealer that is a bit more of a challenge. Clearly the equity marketplace leads the way in co-location, which minimises latency between the different parties, he observes. Real experts in the low-latency / high-frequency trading game may well be able to develop their own technology in house says Jim Kwiatkowski, Global Head of Sales at FXall. The HFT style hedge funds are enormous data consumers and in some ways they can create their own idea of best execution; because they collect so much data they can do their own data analysis, he says. Where we see demand from people wanting us to assist them is in the asset manager and corporate segments. Both want to achieve best execution but have different ideas of what best execution means. They may be looking over time at how their FX transactions desk is performing at executing FX trades for funding or hedging. For example, are they executing in the right pairs and at the correct time of day? Execution quality analysis can inform alternative trading strategies that help to lower costs. In certain situations, clients may choose to execute a synthetic trade in a liquid pair to get the best execution rather than trade the underlying pair. If you need to do Euro-CAD, maybe a Dollar- CAD and a Euro-Dollar trade would get you a better price? Asset managers are able to consider these factors when trading and use execution quality analysis (EQA) tools provided by FXall in order to do so. Corporates are a bit different, most are not trading firms by nature and only need to fund and hedge their business operations. However, they are public companies who answer to shareholders and so are required to demonstrate that they follow a process for obtaining best execution of their FX trades. They need data and anlysis to help them understand how they can best achieve this, says Kwiatkowski. Speed of change Keeping track of price changes in the high-speed markets has become impossible for the human trader to do, making systems that can make decisions, such as complex event processing platforms, increasingly valuable. Five years ago you got one or two updates a second for a currency pair; right now especially if you have volatile markets we have seen for 300 updates a second for G10 currency pairs, says Behnstedt. If you have that many changes you have to move towards CEP engines, meaning a lot of technology has to be moved from a rule-based development approach towards complex event-based items which gives you more power and 86 january 2013 e-forex

8 currencies. That is a very interesting aspect, because in equities, you can t really measure the alternative trading tactic because you only have one event and it s over. Effectively in FX you could measure concurrent events, large trades vs. small trades and see how that plays out in the market. No right answer A challenge for the firms that want to use TCA for benchmarking against peers is that there is no standard data set that is recognised. In the equities markets an industry initiative entitled Open TCA was launched by several sell-side firms, however one vendor, who asked to remain anonymous, expressed scepticism over the scheme. Jim Kwiatkowski In certain situations, clients may choose to execute a synthetic trade in a liquid pair to get the best execution rather than trade the underlying pair. flexibility to move big data sets through, and to process them efficiently. That is another change that is coming with TCA as old technology can t cope with the update rates. But if you move to CEP engines you have the possibility to dive into TCA. I know that some of the providers of liquidity aggregation, pricing, smart order routing such as smarttrade and Streambase they have these kind of things as well, and in some cases they have algorithms in place in order to minimise shortfalls in latency and processing which are useful. TradingScreen uses OneTick as its in-house CEP, but Fatica notes that using this for FX may be putting the cart before the horse at present. In fact, we have some processes running as we speak doing some analysis on the various currencies and relationships between quotes, he says. That has been in response to questions that have arisen from clients about how to provide perspective on their execution quality. There are a variety of issues: the difficulty of orders, a comparable concept in equities; people say that there is infinite liquidity in FX, but it doesn t come without a price. For example in equities, we have only one given quote at a time for a given size. In FX you have multiple quotes for different sizes and It hasn t really gotten off the ground in equities, it stalled, he said. The difficulty there is that with open TCA there was just some sell-side brokers teaming up and the vendors weren t invited to join. So I don t think that will get off the ground. These are very early days in the evolution of TCA for FX. There are huge parallels with what equities went through but many think that it is on an accelerated timetable in the foreign exchange market. It is already delivering valuable results. Initially when we embarked on this we saw that custodial trades were higher across the board and then when there was more scrutiny those costs came in line with more negotiated transactions, says Weiler. Then the powers that be decided they would continue the same practices; their legal defence appeared to be that it was a disclosure issue. When they did that the costs started climbing back up. Fatica believes the example of the equity market is just repeating itself in FX. The challenge is that there is no centralised market data collection process, but our platform can serve as that. We see executable quotes and the more dealers we have on the platform, the richer the data set and the density of the transactions is increased, So, the concern that a transaction with a time stamp will find a match in the collected market data at the same instance I think is now being addressed. We are finding we have a plethora of activity and we will be able to measure the various sizes, and how active those quotes are and how active the quotes change. So it s a rich data set, rich enough to drive some initial analysis and provide guidance on algos. 88 january 2013 e-forex