European Equity Trading 2014: Part 2 - Low Touch Domination Takes Off

European equity trading continues its dramatic metamorphosis. Ninety-six percent of participants anticipate a continuation or increase in their use of algorithms this year, compared to only 16% in 2005. The idea that algorithms are just for dumb order flow has been relegated to the history books. The ranks of industry leaders who have embraced technological change are swelling with an influx of the middle majority who appreciate that they too need to rely on greater technology, rigorous analysis and improved trading processes in order to survive.

While low-touch dominance in model-driven order flow is nothing new, it is the gradual encroachment in terms of the proportion of wallet being paid to low-touch channels across the buy side irrespective of fund type or geography that will have greater impact on the industry overall. In 2014 low-touch channels are anticipated to receive more than 40% of the wallet for the first time (see exhibit), and these changes are finally beginning to impact the status quo.

The bulge-bracket prowess in electronic trading is now being challenged. ITG reached fourth position as the top algorithmic provider by frequency of mention for the first time in 2013, with UBS, Morgan Stanley and Credit Suisse continuing to battle it out for top algorithmic provider. This will enable a new era of electronic trading to emerge – one that will require buy side firms to further educate themselves, for with increased automony comes greater responsibility.

Given the wider challenges the industry faces in terms of payment for non-execution services, Europe will undergo a revolution in the type, quanitity and manner of services consumed by users of low-touch automation. European macroeconomics will contribute to this shift in requirements; the gridlock the industry previously faced from the economic crisis and uncertainty over the MiFID II framework is easing. Savers concerned with the low-interest environment are taking tentative steps back toward developed Europe – appetite for alpha is back. While passive funds have thrived in the low-touch algorithmic world, trading small and mid-cap names is both expensive and time consuming. As standardized algorithms still deliver sub-optimal performance, this will force innovation in the mix of products and services as the buy side has to become less dependent on 20-year-old relationships and embrace greater automation and autonomy.

A resource-depleted buy side now has the choice – compete with the quants, partner or outsource. This was the first year when BlackRock’s “Aladdin” was mentioned in the OMS/EMS space – a project that was deemed by some to be unworkable initially is now proving to be a blueprint for a future buy side. This challenge to the status quo will be revolutionary, changing what the sell side needs to offer, what the buy side elects to pay for, and whether independent vendors will in fact become the conduit between the future buy and sell sides. A new era of “OMES” will emerge – Order Management & Execution Systems -- to ensure full front-to-back STP enables short-term alpha opportunities to be incorporated in the investment process.

One area where this transition is already evident is with TCA. No longer vanilla, this is now independently verified, real-time execution analysis from multiple sources. Broker TCA will remain unable to deliver a truly holistic view unless the buy side is prepared to lead them into their inner sanctum. Some are, and garnering improved results from alpha modelling and optimisation of order routing as a result; whereas others are choosing to partner with new vendors as the fiduciary responsibility to demonstrate true best execution takes hold.

As the results continue to influence the execution process, bulge-bracket success in algorithms linked solely to research capabilities may be in for a rude awakening. Likewise, liquidity aggregators may be viewed in a different light as participants become better informed as to the benefits of limiting information leakage versus a potential decline in the speed of execution.

As automation in the execution space permeates across the asset classes and into additional products and services, low touch will no longer reflect merely a dumbing down of equity execution but a wider quantitative adaptation of technology. While technological leaders will continue to remain at the forefront, it will be the shift to technology by the moderate majority that will deliver greatest radical change throughout the industry. Hold onto your seats; low-touch domination is set to take off.

European Equity Trading 2013/14, Part 2: Low-Touch Domination Takes Off
For this year’s buy-side trading study, TABB Group spoke with 58 head traders of equity management firms across Europe, the UK and the US. These firms comprise 49 long-only asset management firms and nine hedge funds, managing €14.6 trillion in assets under management (AUM). The interviews were conducted during Q4 2013. The research includes 45 exhibits and illustrates the changes in algorithm and dark pool usage by ADV, commissions paid and geography; how firms are responding to the impact of increased regulation; changes in TCA providers and usage; IT spend indicators for 2014; new products to be traded electronically; and changes in the OMS/EMS space.