BUYSIDE DEALERS PLAY THE MiFID HAND.

The combination of unbundling, MiFID and the ensuing new trading platforms and techniques has meant that the buyside dealer has had to rethink their role. Best Execution talks to Clare Vincent-Silk, principal, operations at consultancy Investit about her new report – The future of the buyside dealer – on how fund management companies are tackling the issues.

What prompted Investit to undertake the research?

It came from our Intelligence Services (a subscription service that allows members to access the latest reports and thinking on investment management topics) in response to members’ request for the information. There have been a huge number of changes over the past few years and as a result, quite a range of attitudes towards the dealing function. MiFID (The Markets in Financial Instruments Directive) has focused the attention but the Myners report and the publication of CP 176 (the Financial Service Authority’s consultation paper on bundled commissions, soft commissions and transparency) also made the buyside look at dealing in terms of how much money they were spending on research and execution. We wanted to get a picture of how firms were responding. Altogether, we held face to face interviews with 47 different firms, 20 of which were fund management groups, ranging in size from £15 bn to £1 trillion assets under management. About 16 were software vendors, three multi-lateral trading facilities (MTFs), three brokers, with the remainder being an investment consultant, outsourcing dealing providers and the Financial Services Authority (FSA).

What were the main areas that you covered?

We looked at a range of issues from the drivers to the use of MTFs, algorithms and direct market access to transaction cost analysis and the skills needed for today’s dealing desks. One of the general drivers is the desire to improve the efficiency of dealing due to the advances of technology. An interesting finding was that while MiFID is definitely a factor, the drop in broker capital commitment is also prompting the buyside to look at cheaper ways to trade large order sizes. Capital is not readily available due to the credit crunch and the industry expects this to continue.

According to our results, currently, 19% of our respondents used broker capital commitment, 12%, algorithms, 7% MTFs and 1% DMA. When asked what their behaviour would be over the next three years, 81% of firms said there would be an increase in the use of MTFs, 47% thought that there would be a decrease in the use of capital commitment while 78% saw an increase in the use of algos. Views were split 50/50 on the likely increase or decrease in the use of DMA. The reason for this response is that the use of DMA and algos are similar and people prefer using algos over DMA.

Was trade reporting a major concern as there is a great deal of talk about the lack of a consolidated tape?

Before MiFID, trade reporting had to go to the central exchange and was then forwarded back through data feeds via a Bloomberg or Reuters. This was especially true in the UK which had superior standards in transparency. Today, it can be a confusing picture especially with the increase in MTFs and dark pools. It is difficult to see pre trade price information and the buyside may be working in an environment where they do not have the confidence about the price. Although Reuters and Bloomberg say they have a consolidated tape, fund managers now have to pay more for the service. The European Commission is conducting a post MiFID implementation review which is due to be completed in 2010. It is hoped that trade reporting will be one of the areas it addresses.

How are firms upgrading their technology?

One of the big surprises of the findings was the rise in the buyside’s implementation of execution management systems (EMSs), We found that 40% of respondents had installed EMSs, in 2008, up from 14% in 2006, while only 20% were not considering moving to an EMS, compared with 54% in 2006. There are several reasons behind this trend. One is that fund managers are looking for more sophisticated execution techniques to improve dealing efficiency. They want better connectivity and an easier system to use for algos, pre-trade transaction cost analysis and other tools. Also, some firms had older order management systems (OMS) that did not have features such as FIX connectivity and it was cheaper to upgrade to an EMS than update their OMS. I also think EMS is seen as a sales tool which demonstrates that firm has the latest technology and is seeking greater efficiency. Finally, the EMS is a good way to monitor brokers. Even if a firm is not going to be actively using some of the more alternative trading methods, an EMS allows fund managers to keep an eye on their brokers, enabling them to ask more intelligent questions about their execution capabilities.

Are you also seeing an increase in the use of transaction cost analysis?

Yes, our report showed that 44% of firms give TCA reports to clients on request. This may only be one or two clients requesting, but it reflects growing interest in dealing efficiencies by clients. They are becoming much more knowledgeable about TCA and are asking more questions.

What are the views on commission sharing agreements?

The regulations were supposed to promote unbundling and the splitting of commissions between execution and research. However, our findings showed that some fund managers are still directing flow to their brokers as a reward for their trading ideas. This leads then to the question of what is the value of the flow and to what extent do commission sharing arrangements truly work. We found a wide difference in the number of CSAs being used.

From your study, what do you think the buyside believes to be one of its greatest challenges?

Ensuring that they have the right skill sets. As dealing has become more sophisticated, about 50% said that technology was a required skill set as dealing has become more sophisticated, while 17% were after sellside knowledge. They wanted people who had a greater familiarity with algos, DMA and new trading techniques. About 39% wanted more asset class knowledge, especially derivatives as well as exchange traded and over the counter derivatives as well as foreign exchange, moneymarkets and to a lesser extent fixed income. Roughly 17% wanted wider market experience such as quantitative dealing methods and more experience dealing in international markets.