Goldman Sachs is always seen as being at the top of its game. Brad Hunt discusses the major challenges in the marketplace and how GSET is responding.

Goldman Sachs was one of the first to build an electronic platform. What has been the development?

Yes, we were among the first of the major banks to develop electronic execution services. We began in the U.S. in 2000 and expanded to Europe in 2002. I joined Goldman Sachs in 2001 with the mandate of building out our electronic trading offering in Europe, which we launched the following year. It was clear to us that changes in the equities market landscape were afoot; it was only a matter of time before the trends in the U.S. resonated across Europe and Asia.

How has the group evolved?

The global electronic trading group now totals approximately 400 people, so is a very large business. Our offering has grown significantly and expanded to multiple asset classes such as equities, options, futures, synthetic products and foreign exchange. There is a lot of focus on multi-asset class trading, and we have spent a great deal of time and effort developing our offering to provide comprehensive trading solutions that leverage the trading expertise of the Goldman Sachs franchise, and address the needs of our clients. We also provide access to all major pools of liquidity in Asia, Europe and North America, as well as integrated algorithmic, portfolio and spread trading functionality, pre- and post-trade analytics, clearing and prime brokerage services.

And you just launched the latest version of REDIPlus. How does that differ?

We are constantly striving to better our offering in line with the changing needs of our clients. Our clients can connect to us via REDIPlus or a host of vendor systems. REDIPlus version 9.1 introduces enhancements to options and futures trading capabilities as well as portfolio trading. It also enables users to integrate certain functions of the Bloomberg service with REDIPlus. Options traders will be able to use a new Time-Weighted Average Price (TWAP) algorithm, which leverages the “Strike” order type to minimise market impact while accessing liquidity.

What would you identify as the major themes over the past year?

Other than dealing with the fallout from the Lehman default, this has been quite an eventful year on the trading front. Clearly, the macro-economic environment has thrust a great deal of stress on all market participants. In response, the buy and sellside continue to seek ways to automate their businesses. For example, we are seeing many more buyside clients seek ways to map the portfolio manager’s intent onto the order instruction, and systematically segment and trade the order.

On the market structure side of things, the major themes have been inter-venue competition among MTFs and exchanges, the fragmentation of liquidity among venues, and across lit and non-displayed liquidity pools. The exchange competition has really been facilitated by MiFID, and the lit/dark changes have been more correlated with the relative growth and importance of high frequency trading (HFT) on these venues, and a corresponding growth in the sophistication of algorithmic trading. Of course, clients have increased their demand for low impact, non-displayed liquidity as liquidity on order books has become more dispersed.

The other clear theme is the continued frustration experienced by many of our clients on post-trade transparency. On this point, we see a greater urgency to find a solution in order to ensure investors maintain confidence in the market structure, and to this end, we are engaged with the industry participants and regulators in trying to find a lasting solution. I wish 2009 had been a year where we saw efficiencies on the clearing front, however, that continues to be problematic, and as a result, Europe is still relatively expensive for end-investors. Our data shows that, in aggregate, 2009 saw total trading costs decline, but clearing costs increase as a result of trading and clearing fragmentation and declines in trade sizes. So, we are not there yet.

What about all the press about high frequency traders?

It is clear that HFT has had a substantial influence on equity trading and market structure, but it is a mixed picture, depending on your perspective.

HFT adds much needed liquidity and efficiency to the markets, and drives inter-venue competition, tighter spreads, and spurs innovation. But amidst this, HFT has changed the nature of trading, and inevitably pushes some boundaries. Post MiFID, we have seen average trade and tick sizes decline, order book depth decrease, and simultaneously, exchanges are devoting considerable investment to cater to this growing community of sophisticated electronic market-makers.

To us, we see many net benefits to the market overall, but it’s clear this style of trading is having an effect on the institutional market. Exchange order books are less relevant now to the institutional orders than previously was the case. But, it’s also clear that there are many commercially astute firms that are willing to fill the gaps – dark pools are really the best proxy for this – in the same way upstairs accessible liquidity always has been, but there will also be other models. We strongly believe the regulatory framework should allow competition in this area, rather than force a one-size-fits-all model on an investor base with diverse needs.

What about sponsored access?

As I said earlier, post MiFID we have seen many technology-based innovations so it’s understandable that some of the recent developments will generate some scrutiny. In the case of naked sponsored access – where a broker or clearing firm offers unfiltered access to an MTF or RM – we think regulators have a basis to ask how this benefits the marketplace as a whole, and how risks can be mitigated.

What do you think the next phase of MiFID will bring?

Whilst MiFID has brought much needed competition and consistency of rules across Europe, it is still relatively new legislation. It is clear there are some areas that have worked less well and need additional focus. The biggest issue, in our view, is sorting out the post-trade tape and lack of competitive forces in market data. Despite market share erosion, real-time market data prices have not come down. Our clients are also frustrated that OTC trades are not easily reconciled and included in pre-trade decision-making and post-trade analysis. This is a complex issue to solve, but we expect a lot of movement on this in 2010, and we are very engaged in that process.

There has also been a great deal of talk about dark pools, but the reality is that non-displayed liquidity has always existed and been relevant to the institutional trading community. We don’t think the institutional market will want their orders and trading intent to be forced onto a displayed venue, so we favour a model where investors have choice. In the short-term, we think the lit books will continue to become less relevant to institutional trading and non-displayed venues – either broker operated or MTFs – will grow with the demand for low-impact trading.

What about clearing and settlement?

Solving the clearing and settlement issues will continue to be a significant challenge, but would represent the biggest “win” for Europe, in terms of bringing badly-needed efficiency and cost reductions to end-investors. There was a view that there could be a market led solution, but the exchange-brokered code of conduct has not facilitated real competition, let alone consolidation, and it’s clear now the that an EC-led directive on clearing is on the cards for 2010.

What are the electronic trading group’s plans for next year?

The direction of this group will largely be guided by the changing needs of our client base and finding comprehensive solutions for their trading needs. In a way this business is very simple – it’s all about liquidity and accessing it more intelligently than anyone else, coupled with a high level of service and flexibility. We have benefitted from maintaining a high degree of R&D spend in algorithms, crossing, and smart-routing through the downturn, and are excited about rolling out some cutting edge innovations in 2010.

What’s clear in all this is that the market has become much more quantitative, so it helps having a deep bench of quantitative trading talent to draw from. You need to ensure that your smart order routers have a competitive edge and can trade an order aggressively and, most importantly, post a passive order at the right price and in the right venues. As dark trading grows, so too will the need to differentiate dark order placement strategies.

We think one of the biggest trends in 2010 will be a greater demand for customisation. We expect clients to become much more quantitative in the way they approach order segmentation and trading optimisation. Firms will need flexible and adaptable technology with a strong quantitative backbone for scenario testing, and which allows them to get closer to the client decision-making process, and most importantly of all, provides incentives for brokers to compete objectively on execution performance. We think this is one of our strengths, and we have been working on third generation algorithms that are much smarter and can dynamically adjust, adapt and react to the changing market environment.