Trade Cost Analysis – A few steps back to take it a long way forward.

Tim Healy, Global Marketing and Communications Manager, FIX Trading Community.

Trade Cost Analysis (TCA) can mean very different things to different people. Historically, TCA has been a very subjective study. Different methodologies in the market have meant that TCA has become somewhat shrouded in an air of mystery.

The definition of TCA on one well-known internet encyclopaedia site is that it is a method of determining the effectiveness of financial investment portfolio transactions. Simple, clear and to the point. Theoretically yes, but the reality is somewhat different.

In this modern era of regulation and a push for transparency across the board, there have been growing voices for TCA to have a universally recognised set of benchmarks and data points that everyone understands and that everyone can use. This isn’t just for the buyside of course. The sellside and vendors have a vested interest in making sure that the data that they are providing, and being provided with, is standard across all aspects of the market. Only then can the true value of the trading services of the sellside be measured against each other. No small task.

The FIX Trading Community has worked on a large number of initiatives over the years and always with the ideal of addressing the needs of our members. The working groups that spring up as a result of these initiatives are run by volunteers from the industry who give up time from their day-to-day work to contribute to the working groups in any way they can.

The FIX TCA Working Group was formed two years ago. Co-chaired by representatives from the buyside and sellside, it has identified that there are real needs in the market to create a glossary of industry acceptable TCA terms and to define a standardised set of best practices. The reasoning behind this is to remove that air of mystery and uncertainty that can pervade the world of TCA. Transparency, as in many aspects of the market these days, is key for the buyside and for their clients.

The initial scope of this working group has been to develop industry-wide terminology and methodology for equities, from pre-trade to post-trade analytics. Within this initial scope, there are some fundamental questions that the group has posed and then attempted to answer.

1)      What is the cost of trading?

2)      What do we want to measure?

3)      How do we measure the cost of trading?

From the perspective of the buyside and the sellside, these questions have a number of different answers. For the buyside, there are generally three traditional views of TCA: portfolio manager (PM), trader and management. Whilst the PM and trader will have somewhat similar requirements, the trader’s need for implicit cost measurement, which includes the execution cost, is key to his role within the organisation and for the measurement of brokers. Aside from this, TCA professionals are starting to make their mark in buyside firms where individuals are employed and dedicated to provide TCA across their firm.

From the perspective of the sellside, brokers will typically provide services to the buyside that combine the needs of the PM, trader and management. This preserves, strengthens and deepens the long-term relationship between client and broker and is absolutely fundamental to a broker’s TCA offering. Additionally, brokers will analyse TCA data in great detail to continuously improve execution quality through the fine-tuning of existing and new automated strategies.

For the TCA Providers, those three questions could provide some diverse replies. TCA providers are for-profit enterprises and have an incentive to see TCA as an evolving topic. By promoting their offerings as unique or superior to their peers, they will attempt to gain market share. Both standardised and custom solutions present drawbacks and advantages. The challenge for both entails trying to represent vastly different buyside investment and trading strategies, either in a single methodology or in a customer-driven bespoke solution, meaning that the true cost of trading may be masked.

In an attempt to help these three groups tackle these three questions, the TCA Working Group identified that the number one issue was the inconsistent and often confusing use of terminology and methodology. That is not to say that the group is looking to tell the TCA providers that what they are currently doing is wrong or misleading. The group is trying to set down a list of general definitions and benchmark definitions for the industry to leverage.

General definitions are terms that are commonly found within TCA and represent the contribution of all the member firms of the Working Group. Benchmark definitions are derived from the order lifecycle. With this, the group is providing a neutral naming convention which acknowledges different perspectives from the buy and sellside on the same point in the order lifecycle.

The Working Group encourages the financial community to review the document* and to consider adopting the terminology and other best practice guidelines within their own organisations.