HITTING THE SPOT.

William Capuzzi talks industry trends and ConvergEx’s liquidity seeking algos.

There has been so much discussion about high frequency traders. What is your view?

It is the proverbial double-edged sword. On the one side, they have been part of the fabric in the US market for many years and are quickly evolving in Europe and Asia. Without them, spreads would widen and liquidity would become even scarcer. On the flipside, the velocity of the trades may introduce risk.  We are supporters of high frequency trading (HFT) so long as it can be properly managed.  In addition, regulators have a tough job defining HFT and what controls should be in place and many well intended rules often have unintended consequences.

How do you see the market evolving?

Europe has changed significantly on both the lit and dark side.  Five years ago, if you wanted to trade Vodafone, for example, you had to go to the London Stock Exchange, but now around 30% of volume is on multilateral trading facilities (MTFs) and there’s an ever-growing percentage of the market moving toward the electronic dark side.  In some ways it’s not surprising that it has evolved in the same way as the US which had exchanges and then alternative trading systems (ATSs).  The difference is that in the US it took about 20 years for the transformation to happen, but in Europe it was compressed into a relatively short space of time. Going forward, I think three types of liquidity will continue to dominate the European trading landscape – exchange, dark and MTF liquidity. We should, though, start to see disparate dark pools start to connect with each other due to MIFID II and other market forces as well as more transparency into this dark flow.

What do you see as some of the biggest stumbling blocks in Europe?

The lack of transparency and post-trade interoperability between clearinghouses has certainly been the most visible challenges facing both the buy and sell sides.  A consolidated tape would be a great improvement for both the buy and sell side because it would provide for greater transparency into lit prices.  In addition, regulation seems to be on the horizon in terms of truly understanding dark liquidity in Europe.  Although things are changing, the post-trade clearing and settlement environment in Europe is still much more inefficient and expensive than in the US. In many cases, the region still operates along vertical silos and although the concept of a European DTCC makes sense, it is complicated in terms of how to develop one.

How important is dark liquidity for the buyside?

Buyside firms have begun to look at different ways of accessing liquidity; especially as electronic dark liquidity has become much more relevant in Europe. They understand the many advantages of executing in the dark pools – minimal information leakage and market impact, potential price improvement and the potential to find natural liquidity for illiquid names. Industry reports peg European dark volume to be around 5% of the overall trading volume and many dark aggregation algorithms show an even higher percentage, so it is important that buyside firms do not miss this growing liquidity. However, transparency is key for these firms when they are executing in the dark and they need to know how orders are routed and where they are executed.

What do you see as your biggest challenges on the buyside?

Understanding and addressing the changing microstructure of the market is something we are constantly monitoring and adjusting tools and strategies to account for daily. We’ve dedicated significant resources to this effort.  This is different from transaction cost analysis in that it is not just how you perform on a post-trade basis, but also on the pre-trade and intra-trade sides.  As an example, before I trade and when I’m trading an order, what venues should I include in my search for liquidity, which dark pools should I trade in, what flow is potentially toxic  and what implicit and explicit costs should be considered.  We have developed a comprehensive suite of algos that provide a greater level of transparency and access to dark liquidity. Last year, we launched Spectrum which enables portfolio traders to execute across a diverse array of dark venues while allowing them to maintain their required cash and sector balances. It offers features that are included in many portfolio algos for lit markets, but are not always available in the dark such as three separate cash objective options based on a customer’s preferred level of cash constraint, enabling them to keep the appropriate level of cash on their books for a portfolio.

We also enhanced Darkest, our global liquidity-seeking algorithm, which allows users to simultaneously access the vast majority of the dark liquidity spread throughout Europe — all with a single order and with minimal information leakage.  This aggregation, across disparate dark pools, is extremely important as without this logic, it’s virtually impossible to wrap your arms around the liquidity available today.  We have agreements with the major broker crossing networks and dark MTFs and the algo directly connects to these pools. It constantly readjusts where orders are being sent in real time thus creating a one-stop-shop for access to dark European liquidity. We also show where orders were executed with real-time notifications and end-of-day reports.

How do you keep the edge in these markets?

We are in constant full speed ahead mode and are continually tweaking our algos from a performance standpoint. You cannot stand still because liquidity keeps shifting and there are different places to trade. Our goal is to win a greater share of the commission. We don’t have research or a commitment to principal trading, so it is all down to our trading ability and our technology to achieve best execution for our clients.

What other execution tools do you offer?

We have a suite of American depositary receipts (ADR) products which offers institutional clients the ability to convert underlying stocks listed in a number of foreign markets into ADRs, denominated in US dollars. ADR Direct® can execute conversion trades in 32 countries through any order or execution management system. The most recent additions include Indonesia, Korea, Malaysia, Thailand and Turkey.

We have Reverse ADRs^SM which extends local trading into US trading hours so there is continuous trading when there is news and activity during the Europe/US overlap. Customers who trade ADRs in the US receive a local currency conversion price in seconds and settle the trade in ordinary shares in the local currency, all according to the local settlement cycle.  There is also ADR Plus^SM which is an advanced percentage-of-volume algorithmic strategy that allows customers to source liquidity for their ADR trades in both the overseas and US markets. It provides customers with access to deeper pools of liquidity and the ability to achieve better price execution without having to manage the ADR conversion process.

Looking ahead, do you think market conditions will improve?

Post-election in the U.S., we are still in the pretty low part of the trough and a lot of money is still sitting on the sidelines. There are concerns over the fiscal cliff in the U.S., China’s economy and the eurozone debt crisis.  As a result of these factors I think portfolio managers will continue to hold their breath waiting for things to sort themselves out.  The collective hope out there is that 2013 brings renewed confidence in the markets both from a retail and institutional perspective.