Buy Side Firms Are Paying Close Attention to Counterparty Risk
With the collapse of Bear Stearns, the buy side needs to monitor which broker-dealers to use as a counterparty.

The subprime mortgage crisis has led to fears about the solvency of top brokers, and, as a result, has raised concerns about the buy side's exposure to bulge-bracket technology risk. As the markets have become more electronic and low-touch, sell-side firms have become major developers of algorithmic trading strategies, acquired execution management systems (EMSs) and launched dark liquidity pools.

"In an indirect way, the EMSs either have been purchased by the bulge-bracket firms or have been gobbled up by the OMS [order management system] providers," says a buy-side trader who requested anonymity. "There are no independent EMSs out there."

Although all broker-dealers and some independent firms have created algorithms, the buy side still seems to rely mostly on bulge-bracket algorithms. "I guess you could say that's true," the buy-side trader comments. However, he contends, there are enough brokers providing technology that the buy side is not relying on any one particular firm. "You're not tied to three, four or five -- there are 10 varieties out there," he says. "Even though it's all supplied by the sell side, it's pretty well diversified."

This is even more true with alternative trading systems (ATSs) and dark pools. The fact that the more than 40 sell-side ATSs all are piped into one another, the buy-side trader argues, creates diversification. "Because they're all interconnected, you don't have to worry about going into one pool," he explains. For instance, if a buy-side trader puts an order into NYFIX, the Credit Suisse (AES) algorithm could enter NYFIX Millennium and cross with the order in NYFIX where it resides.

"There are enough providers of technology out there that if you have a concern with one firm, you can find a replacement," observes Tim Olsen, SVP and head trader at ICM Asset Management in Spokane, Wash., who notes that he doesn't use a lot of the bulge-bracket alternative trading platforms. He says he prefers the agency-only, independent platforms (i.e., Liquidnet and ITG Posit Now).