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sources - in darkpools and crossing networks – has brought about competition, lower spreads and cheaper commission rates. However, buy-side traders are saying enough is enough, and they are beginning to call for a halt to the continued dispersion of liquidity in return for greater depth, “real” trading interest, and a shot at block flow.
Buy-side traders are looking to algorithms to help them effectively access multiple sources of liquidity. They are constantly testing the performance results of the various algorithm providers for different types of orders under differing market conditions. They are carefully monitoring their success rates in determining which dark pools to use, keeping a careful eye on the risks of information leakage and toxic order flow. In the struggle to complete large or illiquid orders, buy-side traders comb inbound indications of interest (IOIs) for legitimate counterparty flow from sell-side sales traders who aren’t fishing for an order. The level of frustration is high, as liquidity is hard to find and sell-side coverage no longer measures up to the buy-side trader’s needs or expectations.
Traders sitting on buy-side desks are not just responsible for finding liquidity at a reasonable price, but are now managing the delicate balance between conserving alpha through superior execution and obtaining the level of service and support that their portfolio managers and analysts require. As self-directed trading represents an ever-increasing percentage of their daily flow, and as commission rates across all execution styles shrink to historic lows, the new imperative is to effectively manage commissions to optimize the sell-side relationship. Buy-side traders are moving aggressively to consolidate commissions through the establishment of commission sharing agreements (CSAs) with a core number of brokers who can provide everything from technology to research to capital. As the universe of broker relationships contracts, and the percentage of total flow allocated to the core list increases, the business model for the second-tier brokers and niche research providers changes rapidly and likely inalterably.
In these market conditions, it is important to be important. The buy-side trader and his or her sell-side partners need to be of significant mutual economic benefit to one another. Traditional buy-side firms will need to compete with hedge funds and high-velocity trading firms for the first call on flow or an idea. Sell-side firms will have to find a way to maintain sufficient margins in their execution businesses to attract and keep talented client-facing professionals. Buy-side firms will continue to look to the sell-side for advice, alpha, insight and solutions. The sell-side will need to provide innovative tools, customized services, and unique value-added products to maintain their seat at the banquet table.
The TABB Group study on Institutional Equity Trading 2007:
Divining a Path to Liquidity
For this year’s buy-side trading study, TABB Group spoke with 65 head traders of US institutional equity management firms. The discussions covered the ways in which they are directing their order flow across multiple execution venues; trends in the growth of electronic trading and the impact on high-touch trading services; the use of sell-side program trading desks; expectations on trends in commission rates; the surprising significance of indications of interest (IOIs); the drivers behind using or avoiding dark pools and crossing networks; the challenge in finding performance in algorithms; and buy-side traders expectations about the impact of commission sharing agreements (CSAs) on their execution and research relationships with the Street. |