Brave new world?
Huw Gronow assesses the impact to date of MiFID II and how Newton Investment Management is responding.
What do you think the impact of MiFID II has been to date?
MiFID II has not been a big bang type of event, which on reflection has not been surprising because we all knew what the requirements were and there was a lot of preparation. The key thing for us and other buyside firms was to improve and enhance the processes in order to meet the new higher standards. The regulation on best execution for example, requires firms to take the higher standard of “all sufficient steps” versus “all reasonable steps” to achieve the best possible results for clients. For many firms who have hitherto introduced a culture of best execution as a process, this should not represent major change.
As for the actual impact on trading, it is still too early to say. Due to the delaying of the implementation of the dark pool caps, the transition was perhaps smoother than it might have been. Arguably the delay has made the transition less of a cliff edge than it may otherwise have been as brokers will likely have made the changes to their routing logic anticipating the DVCs (double volume caps) being implemented on time. In these early stages though, some predictable outcomes have occurred: the dark MTFs have lost significant sub-large in scale (LIS) market share, and block trading seems to be on the increase as we see adaptive behaviour from institutions.
Where do you think the flow will migrate to?
It will depend on what mechanisms and routing logic brokers will use and how they will adapt in this new environment. At the moment there has not been any significant migration to lit exchanges and MTFs, while non-displayed large in scale, systematic internalisers (SIs) and periodic auctions have attracted flow. It is still to be seen whether that will continue to be the case. There is no doubt though that the regulators will be closely looking at trading flows.
As for the research side of unbundling, there were an increasing number of asset managers, including Newton IM, who decided to pay for the research themselves versus passing it down to clients.
What was the reason behind this?
Newton IM covers external research, rather than asking clients to pay. We have a strong global research capability tasked with producing stock ideas for exclusive use in its client portfolios. It represents a fundamental pillar of our wider investment process. However, the firm also draws on some external research and analysis to inform and support this process, and to incorporate relevant and healthy challenge to its perspectives.
In terms of unbundling itself, I think the more widespread it becomes, the links between research and trading commissions will decouple. I expect we will see open competition for execution given the freedom of choice as well as evidence that the high standards of best execution under MiFID II were applied.
There has been a shift from TCA (transaction cost analysis) to BXA (best execution analysis) – what have been the drivers and how do they differ. What tools and analytics do buyside firms need?
The discipline of TCA has evolved considerably over the past ten years and now we are seeing it being applied across more asset classes aside from equities. However, it is only one part of the process and you have to apply the principles of best execution across the entire pre- and post-trade lifecycle. This has meant that the dealing desk has been promoted from just being a clerical adjunct to an integrated part of the process. There is now continual feedback between the traders and portfolio managers so that they can add actionable insights to the investment process. This has meant that the relationship is more of a partnership which is why we moved our trading desks and investment desks closer together. It has improved communications between the two groups.
Also, under MiFID II, the priority is to create a process that consistently delivers the best outcomes for clients. The regulation creates an opportunity for buyside dealing desks to add value to the investment decision-making process through using execution data. It allows you to display and decompose the costs with the portfolio manager and then create a feedback loop throughout the process, evolving a culture of continuous learning and process improvement. Each buyside will choose and apply technology and analytical solutions that best applies to their own clearly defined processes; but it is clear that as the volume of data increases exponentially, the capabilities to interrogate, interpret and produce actionable insights will fall on the execution function.
How successful do you think firms will be to apply TCA to other asset classes such as fixed income?
I think in time the principles of TCA will be extended because there will be more data available to calibrate for fixed income trades. It will take time but we are already beginning to see this happen in FX. One of the keys will be the metrics and not the benchmarks used to measure TCA. There will not be a one size fits all solution, but they will have to take into account different trading styles as well as the volatility of trading.
How do you see the execution landscape changing in the wake of MiFID II and how is that changing the relationship between buy and sellside?
The fragmentation that we have seen since MiFID I has not led to lower trading costs for institutional investors from the data that we have seen; one of the reasons is that by definition you are spreading your risk across a larger number of venues. I expect to see further fragmentation under MiFID II and the continued move from high touch to low touch as well as to large in scale venues.
This shift has also changed the relationship with the broker. A generation ago, it was based on people holding the information, while today it has shifted to a more technology-based relationship. Buyside traders have also become much more sophisticated and analytical. They have adopted a DIY approach and are doing much more in the way of self-directed trading. In equities, this has meant interacting with exchanges and different venues across markets as well as being more selective and trading in large in scale blocks. The key is to look at the investment strategy and to determine how urgent the trade is. If it is less urgent, for example, you can be more patient and trade in block venues. The introduction of conditional order types has also offered some flexibility in the process.
Has Newton IM met the challenges of MiFID II and market conditions?
Newton IM has devoted significant resources to implementing MiFID II on time and has put in place the necessary systems, controls and checks to help ensure compliance on an ongoing basis. Overall, though we have ensured that the team contributes more to the investment process in terms of insights from trading experience as well as assessing the impact of positions and inventory aggregation on portfolio construction. We have adopted real time analytics and tools which inform dealers on the technical decisions that they can take through the trading cycle.
What do you see as some of the biggest challenge going forward?
Volatility. The challenge is to be nimble and to be able to quickly adapt the trading style and execution and to ensure that all channels of communication are open with the portfolio manager. There is also the perpetual buyside challenge of searching for liquidity. This is why it is important to have a close relationship with the broker who can help you navigate the different venues in the market ecosystem and for dealers to understand that environment and the impact of their interactions within it.
Huw Gronow joined Newton Investment Management (IM) as Head of Dealing in October 2016. He was formerly Head of Equity Trading at Principal Global investors for 12 years. Prior to that, Gronow worked for BlackRock International and TT International as an equity trader. He holds an MA in Natural Sciences from the University of Cambridge, as well as the Chartered Member status of the CISI (Chartered MCSI).©BestExecution 2018
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