MiFID II and unbundling represent a fundamental re-alignment of the European investment market that will force the buy-side to redefine the way it does business, according to Mike Bellaro, head of equity trading at Deutsche Asset Management.
“This [MiFID II] combined with unbundling could be the most significant amount of change we have ever seen,” he told the Buy-side Perspectives. “It’s equivalent to the Big Bang. Most have been focused on how to value research but profound change should be expected on the execution front.”
Where once the buy-side could rely on help from the sell-side, this is less the case today as increased regulatory pressures and capital constraints limit the ability of banks to intervene and provide services to the buy-side trading desk. At the same time, the buy-side is itself being directly affected by a combination of sophisticated technological advancements and cost pressures.
These changes can be seen as a disadvantage for the buy-side – but they can also be viewed as an opportunity. For Bellaro, the shifting situation means above all the empowerment of the buy-side, as asset managers take control over their own tools of execution. The challenge, however, is to take advantage of the opportunities on offer without dramatically increasing the buy-side’s fixed costs.
“My goal is to create a scalable platform,” he said. “If I triple my firm’s AUM, I should be able to do it without increasing the headcount. Automation is the key. We are in our next evolution which will allow us to automate more smarter.”
Bellaro is leading an ambitious drive to automate the trading desk as far as possible. Last year, 85% of Deutsche Asset Management’s flow was executed electronically – much of it through customised broker algorithms with no human intervention. “We are one of the most aggressive users of algo trading in Europe,” he said. “At the same time we are one of the most aggressive and leaders on block trading. We have had record volumes with record post trade performance driven by alpha from using strategic liquidity.”
Part of the ethos behind this push towards automation is the conviction that human traders should be reserved for the kind of trades where they can really make a difference. Deutsche Asset Management is building a buy-side block trading desk with dedicated traders looking after outsize positions. The idea is that traders should focus on the largest blocks possible, while other flow can be automated.
“We all have electronic trading in our DNA, we can all slice and dice, but block trading is a lost art,” added Bellaro. “Put the most complicated trades in front of a human. That’s where they add the most value.”
Deutsche Asset Management’s plans go beyond execution, however. The next step is to automate the broker selection process. This is done on past performance statistics, market share per instrument and other relevant data-driven factors. The idea is that when a trade instruction comes in from the PM, the automation software presents the trading desk with three potential brokers to choose from.
Data is a key part of that informed process. The trading desk has statistics on block trading with each broker going back five years. According to Bellaro, Deutsche Asset Management runs the only buy-side trading desk that has access to such information. The data is doubly important, he says, because a lot of blocks don’t exist on the OMS – so working with the sell-side in an informed way is crucial.
Beyond that, automation can be pushed further still – to have the software inform the trader about which algorithmic strategy would work best given the type of order. This would be based on analysis of previous best results. The idea is to help the trader to make an informed decision about which strategy to use – however the final decision would still rest with a human, at least for the more important trades.
“Maybe in today’s world of cost constrants on the buy side and sell side utilzing technology is the solution,” said Bellaro. “We want to automate as much as we can and as intelligently as we can. Do I really need a sales trader to negotiate that sales trade for me? Can we automate some of that process?”
One of the more controversial implications of the automation process is the potential automation of the sales trader role altogether. In the long-run, as more and more of the chain is automated, the possibility emerges to create some kind of ‘super-algorithm’ that sits on top of the entire process and takes into account all of the relevant information across the industry, using Big Data techniques to read the signals and warn of expected changes. Such a system would need to take into account real-time movements, as well as other feeds such as social media.
While no such system yet exists, Bellaro is in favour of pushing the technology as far as it can go in search of alpha and efficiency. “That would be fantastic. That’s the future,” he said.
Aside from technology and data, Bellaro also has some radical ideas when it comes to interacting with the sell-side. Deutsche Asset Management has cut its broker list from 17 at the start of 2014, to just six. In addition to these, there are two ‘wild card’ brokers that the trading desk uses for their speciality region solutions.
Part of the driver for narrowing down the list was the realisation that many of the products on offer were simply duplicates. For example, there is arguably not much point in having 17 different VWAP algorithms available, when there is little difference between any particular version and the next. The other factor is regulation. For example, in Hong Kong new due diligence standards have been introduced around algorithms; likewise in France there is an obligation to inform the authorities about algorithms and a five-year data storage obligation on top. This makes it difficult for the buy-side to justify maintaining a large selection of essentially similar duplicated tools.
But perhaps most radical of all is the decision to open up Deutsche Asset Management’s order flows to the sell-side, enabling them to see the firm’s flows directly. This is arguably a drastic step. But Bellaro justifies it with the argument that if a buy-side firm cannot trust a broker, then that broker should not be on the broker list anyway.
“We opened our electronic flow in order for our sell side coverage to see our flow,” he said. “We wanted to be able to interact with available strategic liquidity at a broker if it existed. As a result some of our largest block trades have taken place as a result of this iniatitive. We can still be stealthy on our electronic orders if needed but we find less need to do so currently.”
Aside from such open collaboration with the sell-side, there are also opportunities to be had by partnering and collaborating with other players in the industry, both on the buy-side and the sell-side. One example of this is the Plato Partnership, a consortium of buy- and sell-side firms that aims to create a block trading utility. Deutsche Asset Management is one of the founding members.
“The industry needs this kind of partnership,” said Bellaro. “The problem we have is that broker best execution information is sent in multiple different formats and each broker is different, so you can’t easily compare like for like. Then there’s data storage – there’s no repository to keep it.”
“To be successful you need all the above but also resource and tech support. We have to continue to reinvent ourselves to be successful. As the winds of change are comning its important to see what the change is coming. Read the tea leaves and put a structure in place that will give you that advantage.”