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While most traders cite finding liquidity as their chief challenge, the way liquidity is provisioned and located is very different depending on the market. Some markets are very intermediated, to the point where most volume is matched upstairs; some are transparent, and significant liquidity is exchange-matched. Some markets have greater connectivity and are FIX-compliant, and others use proprietary linkages. All of these factors influence how traders find the other side.
The most significant trend in global trading certainly is the push toward more self-directed trading. While the migration from traditional channels toward low-touch channels still is nascent - only 5 percent to 7 percent of buy-side flow currently is allocated to low-touch channels (i.e., DMA, algorithmic and crossing networks) - brokers have repositioned their models for global use, initiated global marketing efforts to automate the buy side's trading desks and pushed their clients toward low-touch channels.
While the order flow directed toward low-touch channels has been nominal, TABB Group believes that DMA and algorithmic migration will occur fairly quickly (within the next two to three years) as 44 percent of firms voiced a preference to increase the order flow placed through low-touch channels from the current 7 percent (see chart below).
The use of DMA is expected to more than double between 2005 and 2007, reaching 11 percent of order flow, at the expense of phone and FIX usage, which are expected to decrease by more than 15 percent over the same time period (see chart, page 42). Once traders are comfortable with DMA, they likely will progress to algorithms and other advanced execution tools.
Presently, more than 90 percent of all orders are routed via phone or FIX, which are viewed as traditional channels. So while markets in Asia, Europe and Canada have been introduced to advanced execution tools, their use still is considered to be a minor portion of their potential. But there is evidence for future change, as the projected growth of DMA, crossing and algorithms is projected to triple, while reducing the use of traditional channels to 79 percent of order flow by 2007.
What Does This All Mean?
Why do buy-side firms want more direct access? They are moving to advanced execution tools mostly for execution control and efficiency, and to reduce market impact. It is not that current intermediated brokerage does not suit the buy side; it is that buy-side firms would like choice. For certain orders, brokers have or know where to find liquidity, and that is fine. However, for orders with available and directly accessible liquidity, why not take more control, automate the execution, reduce impact and better align the execution with the order?
As this occurs, the migration toward low-touch trading will mean significant changes to the business. The focus will be placed squarely on connectivity. As markets grow more global, traders increasingly will turn to electronic trading mechanisms in their quest for best execution. The lack of connectivity among trading counterparties and systems now is a significant point of dissatisfaction among global investment managers. However, without effective connections from their OMSs to their brokers, DMA platforms, algorithmic trading systems and TCR tools, their ability to progress to a more-automated market will be severely inhibited.
This also will have an impact on exchanges and data providers. Exchanges will need to become more transparent, providing greater levels of connectivity, data and access as more brokers and buy-side firms will want higher-speed and cleaner data. If the U.S. is any model, it also will mean a reduction in trade size, an increase in data velocity and messaging rates, and an overall increase in transaction volumes. This will tax the entire industry as everyone involved will need more bandwidth, storage and processing power.
As the global markets turn toward more direct access, the other significant question mark is pricing. While we have not seen significant price discounting in the European, Asian and Canadian markets, as more brokers and vendors look to amortize their advanced execution technology over a wider geography, it will be interesting to see how long the brokers will hold off discounting their direct-access channels. Currently, it does not seem that commissions are playing a significant role in spurring adoption; however, the discount pricing model certainly is a card in brokers' implementation strategy deck.
