The global pressure for tighter financial regulation and greater transparency is driving a buy-side push for transaction cost analysis outside of equities. The trend is taking root as buy-side traders are increasingly challenged to defend their strategies on a number of fronts, ranging from regulators and clients that are demanding greater insight into the investment process to senior-level executives looking to ensure their firms’ safety and profitability.
TCA also is being seen in some quarters as a remedy for the strained relations between the buy and sell sides that have developed amid the rubble of the economic downturn of the past several years, according to Robert Kay, head of analytics at TradingScreen, an execution management system provider that expanded its TCA capabilities across all asset classes with its acquisition in February of GSCS Information Services. “What you have is a bit of an erosion of confidence on the part of people who don’t know the details of the trading process, … something of a loss of confidence between the buy side and the sell side,” he says.
“I don’t think that pressure is going to go away soon,” Kay continues. “To some extent it will even come from the sell side wanting to re-earn the trust by demonstrating how good of a job they’re doing.”
TradingScreen (New York), whose clients have traditionally used TCA for equities, has seen demand for its fixed-income and foreign exchange TCA offerings climb recently, although there is less demand for its derivatives offering, Kay reports. The company’s TCA services allow subscribers to conduct “peer comparisons” of rival firms’ executions, using data from companies willing to add their information to its platform, he explains. Firms looking to demonstrate to internal and external audiences that their data was prepared independently also may find TradingScreen’s TCA appealing, Kay adds.
Making Sense of Newly Available Data
Like most fixed-income TCA providers, TradingScreen is positioning itself to capitalize on the flood of new data that buy-side traders will need to analyze as regulators around the world ramp up reporting requirements for debt securities.
In a sweeping measure last March, the Financial Industry Regulatory Authority moved to expand the Trade Reporting and Compliance Engine (TRACE) to include debt issued by federal agencies, government corporations and government-sponsored enterprises. FINRA’s move pushed up the number of debt securities subject to TRACE reporting requirements by 50 percent.
The largest independent regulator of securities firms doing business in the U.S., FINRA now publishes end-of-day aggregate information, including the total volume and number of securities traded. The Securities and Exchange Commission is mulling similar measures.
“There’s been a significant focus from a regulatory perspective around the globe,” says Jason Lenzo, the head of equity and fixed income trading at Russell Investments, a dually registered investment adviser and broker-dealer. “Some of what’s happened for the last three years is going to strain relationships, … from dealer to dealer and dealer to client — which raises the question, ‘Are people no longer trusting their counterparties?’ ”
Lenzo says Russell opted to build its own TCA product combining its exclusive performance metrics with several analytics tools from third-party providers. He explains that Russell aims for a total package while many TCA providers tend to specialize in particular assets. The company’s traders, Lenzo notes, conduct TCA on a real-time basis across all asset classes as well as analysis over longer periods, which can highlight broader trends.
Since fixed-income trading outside of government bonds isn’t nearly as fast as it is in equities, most fixed-income TCA reporting traditionally has been done on a monthly or quarterly basis. But Russell’s strategy of using real-time analysis is likely to catch on following FINRA’s move in March to beef up TRACE reporting requirements for debt-backed securities, according to James Noser, president of TCA provider Ancerno.
Bringing Transparency to FX
There also is a growing push for TCA within the world of foreign exchange, as international equity trading desks increasingly take responsibility for executing their own FX deals. The FX market — the largest and most liquid securities trading market in the world — also has traditionally been one of the most difficult in which to trade because traders have no central exchange from which to buy FX data. Exchange rates are highly volatile, and traders must grapple with the lack of regulatory requirements and rising costs.
“The sell side is really trying to help the buy side recognize that there are significant transaction costs, or there can be, to FX trading, and this is something they should be looking at,” according to Laurie Berke, principal at financial market advisory and research firm TABB Group. “So I think it’s something that’s coming, and it’s growing,” she adds, referring to the trend of applying TCA to FX trading.
Investment Technology Group is looking to gain a foothold within the growing FX TCA industry with its new service, ITG TCA for FX, which the company developed with FXall. FXall is a multibank currency trading platform that provides users with simultaneous access to multiple bank rates.
According to ITG, ITG TCA for FX, which debuted in May, is designed to give traders a more accurate picture by capturing and reporting on part of the true quoted and traded flow so they don’t have to rely on dealers for color or on market data vendors that might not be giving indicative rates. The service gathers market data from FXall, conducts analysis and reporting on clients’ trades, and produces reports for clients.
“The limits in the FX market are a function of the fact that the majority of the trading is still dealer-to-client and is not transparent,” TABB’s Berke says. “So the limitations on an algorithm and/or a TCA product in FX are that the banks have been, for the most part, unwilling to share their data.”
ITG managing director Ian Domowitz says ITG’s TCA for FX was designed with an eye on preventing lawsuits like one currently pitting the pension fund giant California Public Employees’ Retirement System against Boston-based State Street. In 2009, the state of California filed a lawsuit against State Street, alleging that the investment manager overcharged CalPERS and the California State Teachers’ Retirement System more than $56 million for FX trades. The suit came on the heels of CalPERS reportedly being told by a consultant that it had been charged noncompetitive rates on FX trades for more than six years.
“It is a market that lacks transparency,” says Domowitz. “We firmly believe that the growth of the securities markets generally is benefited by transparency into people’s performance and knowledge of what’s going on.”