By Joe Wald, CEO, Clearpool Group
The leitmotif of equity trading over the past ten years has been one of control. More specifically, those in control of trading at the expense of other market participants.
Reg NMS, designed to remedy inequities of the specialist and Nasdaq dealer duopoly, produced a fragmented marketplace that gave way to diminished transparency in the trading and execution process led by the kingpins of control.
The post-Reg NMS market structure has now matured, and what we’re left with is a complex ecosystem that has bred conflicts of interests, bias and information leakage in ways that did not previously exist. An important way out of this minefield is through a shifting of control that comes from vastly enhanced transparency.
Transparency is a drumbeat Clearpool began loudly sounding last year, and for the simple reason that the integrity of the market and many trading businesses are compromised without it.
Clearpool routinely hears from our core constituency, sell-side firms outside the bulge bracket, about their frustration in delivering to buy-side clients a highly distinctive algorithmic trading platform. These sell-side firms are skilled at crossing stock and getting blocks, though the need to offer their clients a differentiated algorithmic offering has intensified as the market becomes more electronic and fragmented.
The problem faced by these sell-side businesses is a dearth of options when it comes to giving their clients what they want: improved transparency and control via algorithms that trade according to their specific, discrete requirements.
Joe Wald, Clearpool
Build-your-own software is an avenue for firms with the domain expertise to pull it off. Platform vendor solutions are perhaps only realistic for firms with the resources to hire a full electronic trading team, network engineers, compliance experts, support staff and service professionals. Then you have to bring on board quants and developers to write the algorithms, as well as oversee exchange memberships.
Broker white-labeled platforms for the sell side, introduced years ago, seemed to provide an answer to those firms unable to build their own algorithmic infrastructure. That is, until the buy side began deconstructing execution and venue performance only to discover that this approach was not delivering the most efficient way to get orders done. Rather than evolving, along with a changing market microstructure, broker providers of white label offerings to the sell-side stopped innovating. What remained is a melting ice cube.
The significant drawback of white label algorithms to sell-side firms is that they operate as opaque, one-size-fits-all black boxes where a rigidity in the execution protocol imposed by the bulge bracket belies conflicts of interest, particularly preferences surrounding maker-taker rebates, internal dark pools and internal market making. Someone other than the end-client is controlling where orders are sent, and for reasons that do not get disclosed. It’s a protocol that is literally programmed into the infrastructure of these white label algorithms: how an order enters the marketplace, where it gets sent and when, and what it does after execution – all without any say by the sell-side client or their buy-side customers.
Legacy broker white-label providers have figured out how to monetize their stale offerings while keeping them stuck in first gear. This intentional 'mouse trap' keeps the sell side at a distinct, competitive disadvantage with spill over to their buy-side customers of these white-label algorithms who experience poor execution performance.
It has taken the buy side time to measure and quantify what it’s really costing them to use these outdated technologies and the answers are glaring and unsatisfactory. They know they’re leaving too much on the table. The buy side is telling the sell side they will not trade with them until they come back with a better solution that doesn’t expose their order flow to the marketplace, resulting in inferior executions.
Clearpool’s next-generation technology, for what we’ve coined The New Frontier in Trading, is enabling these sell-side firms to answer the demands of their clients. Our sell-side customers and their buy-side clients want a more cost-effective private label solution that delivers better control over venue selection, execution and routing protocols. This degree of innovation and control will also lead to, and advance the cause for, improved transparency.
At Clearpool, we’re also promoting the need for standardized transparency or institutional 606. SEC Rule 606 requires broker-dealers to make available quarterly reports that present an overview of their routing practices for equity and option securities. An industry standard would raise the bar for transparency, since having a minimum requirement would create a foundation for real innovation to take place. The mandate for a baseline, regulatory requirement would also be a healthy outcome as it would become a must have rather than a want to have. Regulators are pushing for this, though the exchanges and bulge-bracket firms are resisting. Why? White-label algorithmic offerings from these firms, if they were required to provide a standard of transparency, would validate what the buy side has come to understand. The buy side, however, won’t be able to alter these legacy offerings because the technology that underpins them is outdated. The only way to change them is to do a complete rebuild, and there’s no will or intent on the part of the bulge bracket to do so.
More transparency, as well as the tools to study results and make changes to your trading, lead to a stronger market which is better for everyone. There are no losers in a more efficient market other than middlemen who are not the end beneficiaries anyway.
Control in trading has long been a negative, very costly experience for the buy side and their sell-side relationships that want to compete more vigorously and perform without unfair barriers. With greater control, the sell side can compete on a more level playing field. The buy side is demanding a first-class offering with real control, customization and transparency and that solution doesn’t exist unless you’re only willing to trade with the bulge bracket directly.
This problem of a bifurcated algorithmic and execution offering, where you have the haves and the have-nots, is something Clearpool has addressed technologically to give these sell-side firms and their buy-side clients access to liquidity, control, full customization and transparency, and the ability to have a better quality execution. Now, these businesses have a chance to transform control from a negative to a positive, as they take ownership of what rightfully belongs to them: full transparency that comes with having autonomy.
