The more things change, the more they stay the same.
Especially when it comes to trade transparency and what the buy side wants. Institutional traders, increasingly focused on best ex for their costumers and keeping their own compliance department happy, continue to seek as much transparency into the trading process as they can. And compared to five years ago when they open were seeking transparency into the opaque world of dark pools, still want to see the what, when, where and why for their orders and trades.
And while much has been done by the brokers and the regulators, who have taken the opaque trading process and made it more translucent, is it transparent? Has the buy side gotten what it wants? Moreover, can the brokers give them enough trade clarity?
“I think the pursuit for transparency is a quest. Finding the right balance to balance the needs of the variety of opinions that exist is an important consideration,” said Brad Bailey, Capital Markets Analyst at Celent. “For investors in illiquid securities, who their execution time frame, not in hours, or even days, but weeks it is crucial to ensure that transparency does not penalize investors in low liquidity, or market cap names. On the other hand, transparency in liquid securities is a boon to the creation of actionable data that allows deeper insight and analytics into trading.”
Spencer Mindlin, analyst at Aite Group, told Traders Magazine he looked at market transparency as something that is dependent on one’s point of view – namely either the buy-side trader or sell-side sales trader.
“I think the answer to that question depends on who’s being asked,” Mindlin began. “The buy-side will likely say ‘no’ and they want and need more transparency. Exchanges will market transparency as a competitive differentiator. And the sell-side is typically stuck in the middle.”
In the end, he said that market structure evolves in cycles driven by innovation and regulation. Therefore, each time market structure undergoes a significant change there’s likely to be renewed call for additional transparency.
So, where does that leave the market?
“It’s important for all involved to appreciate the pros and cons between voluntary and mandatory disclosure,” Mindlin continued. “Mandatory disclosure comes with significant costs in spite of the benefits it purports. The industry is grappling with a reality for compliance, and there is typically a wide gap between a regulatory compliance report and a report that is informative and useful for the end users. And voluntary disclosure is different and might earn a competitive edge with clients. In the end, regulators and competitive forces aren’t going anywhere soon.”
And what about the consolidated audit trail? Along with Finra’s current reporting system (which employs a time lag) currently in place, the CAT could also prove useful in providing market transparency – to regulators and exchanges immediately but also to traders at some future point in time. But the CAT has been slow in coming. So, can it help?
“I don’t think so. I think the calls for additional transparency and standardized disclosures about exchange order types in 2013 was more about revealing how the exchanges operate and their approach to order routing and client segmentation,” Mindlin said of the CAT. “CAT was generally a response to the global financial crisis. CAT is unlikely to deliver much of that transparency to exchange end-users.”
Mindlin explained that Thesys CAT (the developer of the CAT) is in a tough spot as it tries to corral the brokers while trying to build a solution works for everyone. And CAT has been wrought with delays. And the sell-side, according to many, hasn’t exactly been in a rush to bring the CAT to life and incur its share of the costs associated with it given today’s lower profit margins.
“Some participants are concerned about privacy and information leakage. Others are concerned about technology incompatibilities,” he continued. “But, it was inevitable that brokers would push back and advocate for their own interests. If you put six brokers in the room you’re likely to get 12 opinions.”
The following article first appeared in the September 2013 edition of Traders Magazine
More Disclosure Wanted
By Peter Chapman and John D’Antona Jr.
Buyside traders want the Securities and Exchange Commission to wrest information about the inner workings of exchanges and alternative trading systems from their operators.
That was the consensus of traders from 37 buyside desks who participated in a workshop put together by broker-dealer Bloomberg Tradebook. Based on the discussion, Bloomberg produced a list of 17 questions for exchange and ATS operators about their order handling practices.
In June, Bloomberg sent that list to the SEC, asking the regulator to require exchanges and ATSs to provide answers to the questions. Those answers should then be made available on the SEC's website in a standardized grid format. The purpose is to provide investors with a better understanding of market structure and the role each exchange or ATS plays in it.
THE QUESTIONS
The questions are grouped into three categories. First, traders want to know if an exchange or ATS has any affiliates that might be trading in the venue. The concern harkens back to the Pipeline Trading episode in which an affiliate of the dark pool operator secretly traded against buyside orders.
Second, traders want to know something about the order handling practices of the venue operator. Specifically, they want to know if the venue is sharing information with a third party. This concern harks back to the LeveL ATS affair in which the dark pool operator shared sensitive information with its routing partner, Citi's Lava Trading.
Finally, the traders seek some understanding of the venue's order matching methodology. Pointedly, they want to know if a venue offers certain players special advantages. This concern echoes recent criticism from the buyside that some exchange order types may give professional traders unfair advantages.
The buyside also believes it may be advisable for the SEC to review exchange order types periodically and if it finds there is not much usage in a particular order type, it should consider eliminating it.
At the workshop, the traders "expressed a real need for more transparency around how their equity orders are handled and how orders interact with the marketplace-on exchanges or ATSs and in dark pools," Tradebook president and chief executive officer Ray Tierney said. "And at Bloomberg Tradebook, we fundamentally believe that transparency drives trust in the marketplace."
In his letter to the SEC, Tierney said the buyside believes "the Commission should strive to provide additional transparency and a more standardized disclosure process."
BUYSIDE DEMANDS
At least one buyside trader with whom Traders Magazine spoke agreed. Cheryl Cargie, head trader at Ariel Investments, said: "We definitely want more clarity on these important market structure issues from both the exchanges and ATSs."
Whether just one of the above questions gets adequately answered or all three are, increased transparency in the marketplace can only help the buyside trade better, she said.
“I want to know how these venues price an order, who gets first dibs on it and who is in there looking at the order," Cargie said. "These are questions that need to be answered. We, the buyside, want this."
David DeVito, head trader at Madison Investments, said that he was especially interested in the exchanges and venues having a standardized disclosure process.
"When it comes to transparency, we operate under the 'trust but verify' model," DeVito said. "A standardized disclosure process would certainly help. Comparing and contrasting existing disclosures and then challenging any differences among providers is cumbersome and time-consuming. There are a few providers who offer their own standardized 'checklist' for wider dissemination; but again, this lack of standardization becomes cumbersome for all parties."
The exchanges are taking steps to provide more information to the trading community. Earlier this year, they gave Rosenblatt Securities access to their order type data to help the broker with its study of exchange order types.
Also, Nasdaq has been a leader in providing information on order types on its website. Tierney pointed out in his letter to the SEC that Nasdaq "is the best example of the type of transparency that the other national exchanges should follow." On its website, Nasdaq defines its order types and provides examples of how they operate. Still, according to Tierney, some of the buyside want to see more complex examples that take into account, for example, how the order types and the matching engine handle "display with reserve orders." All and all, the buyside "commended Nasdaq for releasing statistics on the usage of the different order types," Tierney said.
At least one exchange operator said it is providing information about its systems to the public.
"We believe in sharing information and being completely transparent," said Randy Williams, a spokesperson for BATS Holdings. "We spend a significant amount of time with the buyside and believe it is important that all market participants understand how the market works."
Williams added that BATS provides detailed information about any changes or updates to its systems to its customers, as well as to the industry, through detailed rule filings and comment letters submitted to the SEC.
Buyside traders do query their brokers for information from time to time, according to Bloomberg, but they don't query exchanges because they aren't members. Also, they may not be customers of all of the alternative trading systems so they can't judge them all.
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