By Canute Dalmasse, Head of Execution Services Asia Pacific, Goldman Sachs
In May this year, the Asia Trader Forum [ATF] (buy-side trader’s consortium) released their framework and guidelines for an IOI Code of Conduct and Best Practices. In addition to that framework, George Molina previously noted in this publication that “the problem with IOIs has always been the lack of transparency because of the perceived interpretation that brokers sometimes were fishing with IOIs – that they weren’t real”. At Goldman Sachs we believe the focus for IOIs should be on quality not quantity, offering a genuine source of contra side liquidity for clients. There should be clarity and tradability of all IOIs sent, ultimately incentivising clients to respond with the confidence that they will find the liquidity they seek.
The release of industry best practices is an important development for the viability of IOIs in Asia and these guidelines should be wholly embraced by all market participants. Systematic use of qualifiers on all messages sent and specifically, using the ATF recommended methodology to identify when an IOI should be considered natural or non-natural is of utmost importance. In our view, the Sell-side should work collectively and invest in the infrastructure to implement the guidelines for market best practices over an IOI’s lifespan. By collectively embracing the new framework, IOIs will become an ever more important tool for helping institutional clients and their end investors source real liquidity, reducing market impact and trade costs.
Proposed reforms
- Scenarios: The ATF’s published ‘IOI Code of Conduct and Best Practices’ outlines four scenarios under which potential IOIs can be classified. The key distinction across these scenarios is whether an IOI should be flagged as natural or not. Industry practices have varied to date on what constitutes a natural IOI with differing interpretations on the types of flows that qualify. The new code makes a distinction between agency flows and facilitation unwinds of actual positions that can be flagged as natural, versus facilitation risk hedges and unrelated facilitation initiation flows that should not. By making these distinctions, the ATF Code of Conduct tries to draw clear lines as to what can acceptably be considered as natural going forward.
- Order Qualifiers: Enabled by advances in trading technology, the ability to seek and match against appropriate liquidity flows has become a common feature used by the buy-side. It is for this reason that the guidelines also specify data points to be set on individual IOIs that assist in the trading decision process. In addition to natural / non-natural tagging, IOIs should display price limits, order size and type and trading instructions (e.g. Limit, Working with More Behind) using industry standard tag values. The goal of qualifiers is to help clients more effectively interact with natural liquidity.
- Best Market Practices: Underpinning the ability for buy-side firms to trust that IOIs are accurately described and are being properly worked are a series of 15 best market practices. These practices can be broadly grouped together as workflow and control features with care for client information.
Execution controls
Interaction with IOIs should be managed via access controls and have appropriate flow segregation with clients grouped on a tiered basis. Access to the IOI ecosystem should be two-way, for instance, viewing of IOIs by a counterparty that is not also allowing their own orders to be advertised via IOIs should not be permitted. To maximise transparency brokers should also offer clients the option to reflect their own IOIs back to them. We believe these controls are best implemented through flow automation, allowing audits against active orders from which the IOIs are generated and removing the risk of human error. Additional functionality or policy should ensure that an “in touch with” categorisation is only used where a client’s continued interest to trade has been confirmed, and not by default.
Operational features
Execution workflows may need to be modified to support the new best practices; however there are valid concerns underlying the buy-side’s need for more robust functionality. For example, a commonly cited issue is that an IOI becomes stale. In order to ensure accurate and up-to-date information, refresh times on IOIs should be less than 15 minutes. Use of qualifiers should be systematic and standardised to aid in consumption. If a broker cannot populate designated FIX tags, their systems should reflect the same qualifiers in a comment field.
Care of client information
The very nature of IOIs is a passing of information and as such brokers should exercise appropriate care and control. Systems should enforce minimum and maximum IOI sizes with respect to a given stock’s ADV and further tailor quantity as appropriate to each client or client tier. In addition, brokers should consider the time value of information and thus the importance to each client tier.
Why this matters to the sell-side
- Clients: With the release of the Code of Conduct and Best Practices memorandum our clients have spoken on what they expect from the sell-side. The sell-side now has clear guidelines in the absence of a standardised regulatory framework. Many sell-side firms are already currently operating under parts or all of the new best practices, making harmonised implementation within reach.
- Change: With change comes opportunity. As confidence levels grow on the buy-side there is potential for increased usage of IOIs as a liquidity sourcing tool. Brokers that improve their execution capabilities by adopting these measures will be well positioned to capitalise on these changes.
- Value-add: It is well known that the buy-side continues to consider their brokerage relationships against the backdrop of an ever evolving regulatory landscape. Brokers that can adapt to market standards and operate on a best-practice basis will have a value-add above those that do not.
Industry support and adoption
- Sell-side support: In order to realise the full benefits of increasing IOIs as a buy-side liquidity channel the sell-side community should also come together to adopt these new standards. The members of Asia Trader Forum have worked hard to map the best practices. Sell-side industry groups should now work to ensure their members understand this framework with the goal of a sensible implementation in a reasonable timeframe.
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