Electronic & Algo Tading Report

_Algo-Cover-2010-outlines.indd 1 9/9/10 6:07 PM

“In my world,
‘global’ means a broker that’s as comfortable
in Boston as in Beijing and Barcelona.”

UBS is an equities trading partner for your world.

As a top equities trader in the US and around the world,* UBS provides a consistently first-rate experience
whether you’re trading domestically or abroad. And with on-the-ground specialists and advanced tools
customized for over 130 local markets, we can serve you in whatever way you choose —through a single point
person or a team of experts.

We understand the world. Your world.

For more information, please contact us at www.ubs.com/yourworld

*Source: AutEx 2008. In the U.S., securities underwriting, trading and brokerage activities and M&A advisor activities are provided by UBS Securities LLC, a registered broker-dealer that is a wholly owned subsidiary
of UBS AG, a member of The New York Stock Exchange and other principal exchanges, and a member of SIPC. © UBS 2010. All rights reserved.

UBS ad.indd 1 9/9/10 2:23 PM

Elec&Algo Report_2010.qxp 9/10/10 9:59 AM Page 3

ELECTRONIC & ALGO TRADING REPORT WALL STREET LETTER SEPTEMBER 2010

EDITOR’S NOTE
www.emii.com Thank you for picking up a copy of Institutional Investor News’
second annual Electronic & Algo Trading Report. The report,
EDITORIAL PUBLISHING
STEVE MURRAY ALLISON ADAMS written by the editorial staff of Wall Street Letter, aims to bring you
Editor Group Publisher the latest on this year’s hot topics as well as those key areas that are
TOM LAMONT GAURI GOYAL
General Editor Business Director (212) 224-3504
just as important but not getting as much play.
VERONICA BELITSKI ISMAELA BEST
Executive Editor (212) 224-3297 Senior Marketing Manager (212) 224-3609 Two years removed from Sept. 15, 2008, the financial markets have
JEANENE TIMBERLAKE LAURA PAGLIARO withstood much berating from Congress, scrutiny from financial regulators and skepticism
Managing Editor (212) 224-3638 Marketing Manager (212) 224-3896
from the investing public. The world of electronic trading has also been through the
MEREDITH LEPORE VINCENT YESENOSKY
Senior Reporter (212) 224-3318 Head of US Fulfillment wringer, with executives facing questions from the Securities and Exchange Commission
CORRIE DRIEBUSCH DAVID SILVA and the Commodity Futures Trading Commission on issues such as high-frequency
Reporter (212) 224-3268 Senior Fulfillment Manager
trading, predatory algorithms, flash trading, co-location, trade reporting and tracking, dark
PRODUCTION REPRINTS pools, sponsored access, and more.
DANY PEÑA DEWEY PALMIERI
Director Reprints & Premission Manager
(212) 224-3675
This hasn’t slowed the industry at all. Case in point: algorithms are being used now more
COVER DESIGN dpalmieri@iinvestor.net than ever, even as regulators question their use by high-frequency traders.
SAMANTHA RALPH
CORPORATE
Advertising & Marketing Coordinator The buyside has always played a key part of the trading process but hasn’t always been the
GARY MUELLER
ADVERTISING Chairman & CEO squeakiest of wheels. Now, however, traders are starting to speak up as regulatory concerns
ADRIENNE BILLS STEVE KURTZ pervade more of the buy-side firms’ business. We tapped several head traders to get their
Associate Publisher (212) 224-3214 Chief Operating Officer
perspectives on what concerns the buyside in a roundtable (page 16) that covers a host of
PAT BERTUCCI
Associate Publisher (212) 224-3890 these issues.

Customer Service: PO Box 5016, Brentwood, TN 37024-5016 Of course, we couldn’t address the industry’s concerns without taking a look at the over-
Tel: 1-800-715-9195 • Fax: 1-615-377-0525 • UK: 44 20 7779 8704
Hong Kong: 852 2842 6910• E-mail: customerservice@iinews.com the-counter derivatives market, which is facing an automated, electronic world for trading
Editorial Offices: 225 Park Avenue South, New York, NY 10003. and clearing that is just over the horizon. Regulators are still sussing out the best way to
Tel: 1-212-224-3297 • Email: vbelitski@iinews.com regulate the industry, but that doesn’t mean the industry’s sitting on its hands. We’ve got
Institutional Investor Hotline:
(212) 224-3570 and (1-800) 437-9997 or hotline@institutionalinvestor.com
the details on BNY Mellon Clearing’s plans to approach this market head on and talked at
A Publication of Institutional Investor, Inc.
length about how the firm thinks the clearing structure should be set up.
© Copyright 2010. Institutional Investor, Inc. All rights reserved. New York Publishing offices:
225 Park Avenue South, New York, NY 10003 • 212-224-3800 • www.iinews.com It was no small feat determining what should be addressed. That being said, we hope you
Copyright notice. No part of this publication may be copied, photocopied or duplicated in any enjoy this year’s report. Feel free to contact any of us with feedback, questions or concerns.
form or by any means without Institutional Investor’s prior written consent. Copying of this
publication is in violation of the Federal Copyright Law (17 USC 101 et seq.). Violators may be
subject to criminal penalties as well as liability for substantial monetary damages, including Regards,
statutory damages up to $100,000 per infringement, costs and attorney’s fees.

The information contained herein is accurate to the best of the publisher’s knowledge;
however, the publisher can accept no responsibility for the accuracy or completeness of such
information or for loss or damage caused by any use thereof.
Jeanene Timberlake
From the publishers of: Managing Editor
jtimberlake@iinews.com

TABLE OF CONTENTS
NEXT-GEN EQUITY CLEARING THE PATH: MULTI-ASSET CLASS ALGOS THE FUTURE OF ANTI- BUYSIDE WORRIES FOCUSED
ALGORITHMS TAKE HOLD PREPARING FOR THE NEW EYE BIGGER STAGE GAMING : WHERE ARE WE ON REGULATION REFORM
By Meredith Lepore OTC DERIVATIVES REGIME By Corrie Driebusch GOING? By Corrie Driebusch and
Buy-side firms are looking for By Jeanene Timberlake Multi-asset class trading By Jeanene Timberlake Meredith Lepore
more sophisticated trading BNY Mellon Clearing’s strategies were expected to Anti-gaming technology has Buy-side executives talk
tools, and the sellside is Sanjay Kannambadi talks flourish into a big business, become more sophisticated about the impact of
stepping up to provide the about how his firm is but the electronic version of as gaming strategies have regulation on their
answer. Sell-side trading handling the uncertainty in the strategy is still catching advanced. Dark pool businesses, plus their
execs talk about the future of the OTC derivatives market. on. Sell-side executives spoke operators and dark liquidity technology needs and what
algo trading. about the requests they’re aggregators discuss current they want most.
fielding in that arena. and future solutions to the

4 8 12 14 16
growing problem.

©Institutional Investor News 2010. Reproduction requires publisher’s prior permission. To receive email alerts or online access to Wall Street Letter, call (800) 715-9195.
3


SEPTEMBER 2010 WALL STREET LETTER ELECTRONIC & ALGO TRADING REPORT

Next-Gen Equity Algorithms Take Hold
By Meredith Lepore

As the buyside becomes more advanced in its use of sophisticated
trading tools, the sellside is speedily developing algos that are equipped
with superior logic and liquidity seeking abilities, statistical ranking
models and the ability to trade in international markets with limited
market impact. Market participants on both sides stress that coming
algos have to be prepared to execute successfully in more volatile
markets, adhere to real-time transparency and reporting demands and
work in countries with very diverse market infrastructures. According to
an analyst, spending on advanced algorithmic trading technology will
reach more than $1.3 billion in the next year.

ADVANCED LOGIC example of this would be Deutsche Bank’s new algo, Super X,
Algos will need to be equipped with the logic and liquidity seeking which uses a statistical ranking model that analyzes the execution
abilities to perform successfully in different kinds of multi-lateral characteristics of each venue. In searching for the best place to
trading facilities, which are seen as the trade an order, it takes the traders’ constraints and stock
main contributors to market information leakage into account. Kang said Citi’s algos are
fragmentation. “We are dealing with algos prepared to handle difficult volatility and can halt a trade if there
trading in 30 dark pools and up to eight is market movement outside of the
exchanges. As a provider, you have to deal expected range. Algos must also be able to
with a marketplace that has trading venues learn from past experience by factoring
Hitesh with different qualities,” said Hitesh Mittal, transaction cost analysis into their strategy.
Mittal head of liquidity management for ITG. Minimizing the time between detection
“Each venue behaves differently, so the algo does as well,” said of events, ranging from news events,
Young Kang, global head of algorithmic products at Citigroup. To market data or a quote request, and the Young
Kang
meet that goal, the programs will start to include more granular actual placement of an order is essential.
market data, such as a news feed from Dow Jones, said the “Algos are now fully dynamic systems, using complex
directors. mathematical models to drive both macro level decisions of
Collecting more data for algos so they are equipped with speed and urgency but also the micro level order placement. The
statistical ranking models in their logic is a step that many firms sophistication of these models will continue to adapt and evolve
are working on to help change trading behavior on the fly. An based on client demand and market structure change,” said

4

ICAP ad 9/9/10 2:34 PM Page 1

SPONSORED ARTICLE

HIGH FREQENCY
TRADING AND FX By Daniel Torrey, head of New Business-Americas, ICAP Electronic Broking

Foreign exchange (FX) is the equities market ‘flash crash’. In highly side by enabling hedge funds and
world’s most liquid market and volatile conditions, trading volume on Commodity Trading Advisors (CTAs) to
EBS exceeded $383 billion (single trade in the spot FX market through
presents significant opportunities
count), representing nearly 255,000 the pre-screened credit of an EBS
for traders searching for alpha in transactions. EBS provided orderly prime bank.
new asset classes. efficient, effective access to prices at Before entering the FX market,
OTC FX functions well as a self- all price points, even during the most high-frequency trading firms need to
regulated market, as illustrated by the volatile 10 minutes of the trading day understand the different FX trading
EUR/USD price action that occurred (see chart). venues available (e.g. independent
on the electronic EBS platform on EBS was the first interbank versus bank-owned), and must
May 6, 2010, the day of the US platform to permit access to the buy- address a number of technology and
integration issues.
EUR/USD price action on EBS - 6 May 2010 They will also need to
modify their exchange-
5/6/2010 EUR/USD
1.2710 Bid
based equities trading
1.2700 Offer
Interrupt strategies and algorithms
1.2690 Deal
1.2680 before they are ready for
1.2670 FX. A robust software
1.2660
1.2650 development and testing
1.2640 environment, and a
1.2630
1.2620
rigorous simulated trading
1.2610 environment are also
1.2600
critical.
1.2590
1.2580 Access to high quality,
1.2570 granular market data is
1.2560
1.2550 essential, and FX-specific
1.2540 risk management
1.2530
1.2520 systems must be
1.2510 introduced.
1.2500
1.2490
However, despite the
1.2480 challenges that entry to
18:05:00 18:10:00 18:15:00 18:20:00 18:25:00 18:30:00 18:35:00 18:40:00 18:45:00 18:50:00 18:55:00 19:00:00 high frequency FX trading
presents, rigorous
The day of the US equities ‘flash crash’ (May 6, 2010) traders using the EBS platform traded record
amounts of volume ($383 billion). Market participants executed trades [red diamonds] at all price points
preparation and planning
amidst significant price swings, with virtually no gapping, even in the most active minutes of trading. will result in fewer
frustrations on going live.

Daniel Torrey heads EBS New Business-Americas for ICAP Electronic Broking (IEB). Dan and his team’s primary focus is selling the
benefits of EBS and EBS Prime to hedge funds, CTAs, FCMs and proprietary trading firms who seek access to EBS’ unparalleled
wholesale market liquidity. email: daniel.torrey@us.icap.com



Owain Self, global head of algorithmic and reviewed for compliance purposes.
trading at UBS.
ALGOS IN INTERNATIONAL MARKETS
TRANSPARENCY Algos that can be deployed in international markets, especially
Next-generation algos will also need to emerging markets, are the next frontier. The sellside is working on
provide more transparency in these building algos that are as similar as can be to the algos the traders
volatile and highly regulated times. have become used to but that also account for international
Owain Self
Calculating risk exposure will be on the to- market nuances and risks. Traders are more willing to invest in
do list for the next generation and real-time algos can provide foreign markets if they are able to use the same methods they are
visibility into an algo’s potential exposure and determine a trade’s currently using for their portfolios, said Dan Pagano, v.p. of
risk impact. Risk assessment will be especially critical with cross- strategic alliances at Linedata.
asset trades that have multiple legs in a single order and are done ITG recently made its algo suite available in Israel, and both Citi
in real-time. If the trade is being exposed too much, the algo can and ITG will be launching algos in Brazil for the first time soon. UBS,
be adjusted before the order is executed. “Clients need to see Bank of America Merrill Lynch, Jefferies, Nomura and Deutsche
slippage of orders in real time and where the orders are being Bank have also started extending their algo suites for emerging
executed,” said Kang. Citi is planning a roll out of its new service, markets such as Japan, China, India, Greece, Australia, Canada,
Citi Trade Viewer, which will help clients achieve these goals. The Eastern Europe and Latin America. “It’s important to note that we
desktop trading application, to be launched this fall, enables are operating in an environment of rapid market structure change.
traders to see every detail of an order in real time using visual This is a global phenomenon, as regulators across the Americas,
analysis. Europe and Asia-Pacific are grappling with ways to evolve their rules
ITG has increased their consultations with clients in the last few and surveillance apace with the global markets and advanced
years so clients really understand how the algo functions and technology,” said Self. This requires the architecture of an
what is the best way to use it, Mittal said. Transparency will also algorithmic trading platform to be respectful of core regulatory
help with regulation: data used in trading can be collected, stored concerns, while always staying focused on serving investor clients.

Execute at the
Oasis

Liquidity found. Discover a new category of algorithms designed specifically to source
small- and mid-cap liquidity.
Oasis is a unique and focused smart order execution strategy that handles obstacles related to
thin and difficult to trade names.
Combined with Knight’s leading market share in stocks that trade less than two million shares
per day — now you’re executing at the Oasis.

Find out what Knight can do for you
To find out:
phone +44 (0) 20.7997.7818 | US +1.212.479.2335
email oasis@knight.com
www.knight.com
© September 2010 Knight Capital Group, Inc. All rights reserved. Knight Equity Markets LP and Knight Capital Markets LLC are off-exchange
liquidity providers. Oasis is offered through Knight Direct LLC. TradeWeb BlockData - Market Rankings are based on trade volume reported
by Broker Dealers (Knight Equity Markets, Knight Capital Markets and Knight Direct LLC). YTD through Mar 31, 2010. To learn more about
Knight Capital Group, Inc. (NYSE Euronext: KCG) go to www.knight.com

KnightCap.indd 1 9/9/10 10:33 AM



Q&A: BNY Mellon’s Sanjay Kannambadi

ClearingThe Path: Preparing For
A New OTC Derivatives Regime
conversations we are having with clients. We are participating at
industry forums like the ones held by the CFTC to hear and
A major driver of the recently
understand the latest thinking and direction and share our input
passed regulatory reform was
and opinions.
the recognition among market
participants and regulators that
a stricter regulatory framework
WSL: The CFTC noted that as part of that
is necessary to govern the over-
discussion it wanted to solve conflicts inherent in
the-counter derivatives market.
mandating clearing of OTC derivatives. What
The Securities and Exchange
conflicts do you see?
Commission and the
KANNAMBADI: We certainly support transparency and openness in
Sanjay Kannambadi Commodity Futures Trading
the marketplace on behalf of our clients. To the extent they make
Commission are both working
memberships in the clearinghouses restrictive, that will restrict the
on rules that will detail the structure. The industry,
marketplace and limit openness and fairness. That is something
meanwhile, is working with what is available and preparing
we are certain about and we have heard from our clients that they
their businesses for the framework to come. Among those
want us to clear their books of business.
firms is The Bank Of New York Mellon, which launched a
As it stands today, some of the clearinghouses have very high
futures commission merchant just this summer in order to
artificial bars [for membership] for a variety of their own reasons,
play a role in the whole process. Managing Editor Jeanene
which do not qualify BNY Mellon Clearing to be a direct clearing
Timberlake spoke with Sanjay Kannambadi, ceo of the
member, so they expect us to go through other clearing members,
new venture, BNY Mellon Clearing, about what exactly
and that doesn’t make any sense. We are the largest asset servicer
that role will be, what the concerns are from a regulatory
in the world with $22 trillion in assets under custody and
perspective, and where the complexities lay.
administration for plan sponsors and asset managers, and if we
are going to represent them, we need to be members of those
clearinghouses.
WSL: What concerns are you hearing from clients One problem we have heard discussed about an open construct
related to OTC clearing? is that management of risk is paramount and entities that do not
have the size and capacity like the large dealers to manage risk
KANNAMBADI: We’ve been talking to key clients over the last few may create issues. But at the end of the day, one of the key points
months, and from a [futures commission merchant’s] is that as long as margins are set and [collateral is] collected
perspective, many of the conversations we are having are based appropriately, that is the first level of defense. The clearing
on getting our perspective and clarification around what is members are not the only defense mechanism there. The clearing
happening with respect to the Dodd-Frank Act and the potential members do come into play, but that is not the first level of
rules to be written. defense; it’s the margin you are collecting. In a default or worst-
There is lots of information in the marketplace; some is case scenario, there is no reason why you cannot allocate or
conjecture, only part of it is fact based. So, there is a level of auction a portfolio to clearing members or other parties in the
clarification that all of us are seeking and those are the marketplace, such as the buyside, for example. When you talk

8



about allocating and auctioning [a portfolio], the more parties only entity that can hold margin is an FCM. How that will all work
there are, the better. Further, suggesting that the same parties out, we don’t know. Because the FCM already takes in margin
involved in risk management of these instruments during the today, we already have the infrastructure to take in margin and
market crisis should provide expertise in the new construct is a segregate it. So, depending on how rules are on the non-cleared
conflict by itself. side, we will perhaps have to play a role there.
Clearinghouse structures have been in place for a long time in
the futures markets. You can always argue futures are different, WSL: In the midst of all the discussion about the
but at the end of the day, the [Dodd-Frank Act] is trying to rules, is anyone working on the nuts and bolts of
normalize those factors to make those products more standardized how this system will function? And is this an issue
so they can be cleared. That is the spirit of the bill— transparency at all?
and central clearing—so there is some level of structure in the
marketplace for regulators and all the relevant parties. KANNAMBADI: Yes, we are working on the flows with the
clearinghouses. We have been working with [the International
WSL: You just launched the FCM business, BNY Derivatives Clearing Group] on that, for example. Presumably
Mellon Clearing, so what is the bank’s vision in terms there are going to be variations of flows amongst the different
of how the unit will fulfill the needs of your clients clearinghouses. Whether it will all be centralized through one
in the cleared and non-cleared business as some of single workflow or not is not known at this point, but down the
this activity starts to shake out? road, I would expect it to be standardized.
There are going to be complexities either way. It’s a work in
KANNAMBADI: BNY Mellon Clearing represents a logical extension progress and over a period of time the process will improve itself.
of our business model. We intend to meet the growing needs of The important thing I think people need to understand and
clients who trade futures and derivatives and are seeking a global recognize is that there is precedence for some of this, it’s not like
clearing partner with proven operational, financial and risk we’re starting from scratch. From our perspective it’s very clear: we
management expertise. Regarding the shakeout, central clearing need to make sure this process is simple for our clients.
and where the FCM fits seems to be clear, but [on the OTC side,]
everything is dependent on how the rules are written. WSL: Both the CFTC and the SEC are just starting to
Typically, in a central clearing environment, most look at new rules, so what are you doing now to
clearinghouses will require clearing members to provide clearing tread water, so to speak?
services. In the majority of cases, if you are clearing client business
you need to be an FCM. We will play that role. In addition, our KANNAMBADI: We are talking to all the key constituents in the
clients are recognizing that in a cleared environment the bulk of marketplace and trying to better understand their individual
the operations and risk is shifting from the dealer to the FCM. processes as it relates to the clearinghouses. We are doing that in
According to the bill, clients get to decide which clearinghouse to the U.S. and globally as the global model also develops. We are
use for clearing. Once the trade is executed and is accepted for staying in touch with all the key market players and organizations
clearing, the clearinghouse becomes the client’s counterparty with so we are up to speed on the latest developments ourselves and
the FCM as the key intermediary. So clients will need to establish we’re working with clients to give them our perspective on how we
those FCM relationships upfront. This is an important role that we think the bill and rules will play out.
as an FCM will play. We are getting ready for central clearing. We are IDCG clearing
On the uncleared side of the equation, there are some members, and we’re going through the test phase and will be
questions outstanding. For example, swaps are also included in clearing trades for clients by the end of September. So we are
[the bill]. One question that remains is if you are a swaps dealer going through the connectivity test and things like that.
and you’re dealing in non-cleared swaps, how is the margin We are also looking at other clearinghouses and mechanisms
process going to work and who decides that? I think it’s the being discussed in the marketplace, such as the [CME Group’s]
regulators, between CFTC and the [Federal Reserve Bank] that will interest rate swap marketplace. We are also talking to
make the decision on the margin percentage, but then who gets to [LCH.Clearnet] and all the other players. At the end of the day, we
hold the margin? [Swaps dealers] have to give the option to clients as an FCM will look to clear books of business wherever our clients
to segregate it or not. If a client decides they want their margin to want to clear. In the whole scheme of things the FCM is a neutral
be segregated, then the swap dealer needs to segregate it but the party, it’s all client-driven.

9

ALGO-PipelineArticle 9/9/10 2:37 PM Page 1

SPONSORED ARTICLE

FROM ACTIONABLE
TCA TO CUSTOM
STRATEGY DESIGN Carla Gomes, Ph.D., research analyst, Pipeline Financial Group, Inc. and
Henri Waelbroeck, Ph.D., director of research, Pipeline Financial Group, Inc.

Most trading desks have tried to introduce Transaction Cost prove to be very difficult when the
circumstances of the trade are not
Analysis (TCA) into their process, but for over a decade they have known. Pipeline’s most recent
developments intend to fill this gap
found it frustrating and ineffective. In general, trades are broken
and convert TCA into a new tool that
up into multiple placements and sent to a variety of brokers can be applied not only to post-trade
back-testing, but also to live trading
under different market conditions and with different limit prices. and custom strategy design.
Inevitably, the end shortfall performance results are biased and
A new actionable TCA framework can
any inference made from them is compromised. distinguish algo performance from the
use of limits or trading schedules
The pervasiveness of high frequency evaluate brokers, algorithms and Trading schedules and limit prices, if
trading and increased awareness of execution venues in order to select the used appropriately, can enhance alpha,
the costs of trading large institutional most efficient. It usually consists of but if used incorrectly, can exacerbate
orders have raised the stakes for implementation shortfall comparisons trading costs. In standard TCA,
traders, who now face an ever more between competitors, sometimes implementation shortfall costs are
fast-paced environment with a wider accounting for trading difficulty measured as totals. Hence, the
set of trading tools and venues to measured as a function of order size, separate impact on overall
choose from. Traders need to know liquidity and volatility. It is widely performance of the algorithm, the
whether they are being taken acknowledged that trading alpha, trading schedules and the selected
advantage of and which algorithms are market conditions, speed selection and limit prices cannot be identified.
the most effective. Without reliable limit prices also have a considerable Pipeline’s enhanced TCA determines
TCA, how are they to know? impact on the outcome of a trade. Yet, the significance of every component
these are seldom considered in of shortfall costs. It provides an
standard TCA. This limitation is far assessment of the trade-offs
TCA is meaningful only in relation to from trivial when a trading desk needs associated with each decision element
the context of a trade to determine the providers that deliver and it determines the most
The relevance of TCA to strategic the best execution, yet each one appropriate selections. For speed
trading decisions has grown with the receives a systematically different selection, market impact is weighed
pressure on trading desks to reduce order flow. Inferences on the quality of against alpha capture to decide
costs. In general, TCA is employed to execution, even from a single broker, whether an execution with urgency is

ALGO-PipelineArticle 9/9/10 2:37 PM Page 2

SPONSORED ARTICLE

worthwhile. For limit price selection, Pipeline’s Alpha Pro suite, a new impact and post-trade reversion, but
to check whether there are generation of customized trade also in terms of adverse selection vs.
opportunities for tactical price strategies, leverages this TCA opportunistic savings. The latter is
selection, execution price savings are framework to associate an optimal identified by the analysis of
weighted against opportunity costs strategy to each trade arrival participation rates under different
from incompletion due to the price Equipped with the detailed knowledge market conditions and tracking
limit. Also, algorithm performance can performance against the Participation
of the alpha loss profiles at the time
be evaluated in parallel in terms of Weighted Price (PWP). Additionally,
of the trade, Pipeline can facilitate
adverse selection and opportunistic the performance results provide
efficient trading by recommending or
savings. With this knowledge, traders guidance to the best approaches in
deploying best-fitting execution
can devise forward-looking solutions terms of speed and limit price
strategies that enhance alpha capture.
and be more effective making the management in accordance with the
Orders with weak alpha loss are
right decision at the time of the trade. specific objectives of each manager.
executed with tactical limits, which
These enhancements to standard TCA
are more effective if deployed
transform it from a post-trade
Portfolio managers have distinct automatically rather than manually.
reporting product into an actionable
order creation strategies leading to Orders with considerable alpha loss
trading tool that provides direction to
different short-term alpha patterns are executed with front-loaded
custom strategy design.
strategies with reduced timing costs.
Just as an institution can implement
several strategies from a wide range With customization of trading
of well-known styles of fund strategies, the opportunities for Summary
management, including growth, value, delivering the best execution do not • An evidence-based selection of best
market neutral, indexed, etc., a single end here. A close collaboration execution algorithms requires
portfolio manager may also use a between portfolio manager, trader and dependable TCA that accounts for
multitude of strategies with his own broker can further leverage this the trading environment. Pipeline
distinctive investment style and skill. comprehensive body of knowledge by attends to this need with an
Typically, orders originating from long- determining the specific benchmarks, enhanced TCA that identifies
term strategies may create the goals to be met and then refining separately all sources of trading cost
opportunities for tactical trading, the design of execution strategies and lays the groundwork for optimal
whereas orders more focused on accordingly. trading strategy design.
short-term returns usually require • Assessing potential alpha loss is at
more aggressive trading, early on or at the core of the daily trading decision
later stages of the trade. As a result, Pipeline’s post-trade analysis enables
process, but quite challenging when
the order flow sent to the trader is dynamic strategy performance
the sources of order flow are very
very diverse in terms of short-term evaluation and fine-tuning
diverse and not fully understood.
alpha loss profiles and that may Pipeline’s comprehensive TCA is not Post-trade quantitative analysis can
require very different execution limited to the validation of trading provide validation to the selection of
strategies. Although some orders are strategies; it also provides all the limit prices and trading schedules
sent with very specific instructions necessary information to identify with immediate insight into the alpha
and goals, there are still many cases opportunities for fine-tuning each characteristics of the order flow.
where the trader has considerable strategy. Gradually, some drivers may
• Pipeline’s Alpha Pro uses this
discretion. A quantitative post-trade lose importance whereas others may
knowledge to direct each
analysis such as Pipeline’s can help become more relevant and, as a
distinguishable trade profile into its
the trader do a better job by providing result, trade profiles may also change.
best-fitting scheduled trading
detailed information on the short-term Short-term alpha loss is one of the
strategy. Alpha Pro strategy design
alpha loss profiles that characterize components of implementation
is dynamic as it capitalizes on
each portfolio manager’s investment shortfall that is estimated to validate
recurring, forward-looking TCA.
style. Each alpha profile is associated trade classification and determine
with specific trade arrival settings of whether characteristics of the order
order creation time, order size, market flow have changed or remained the
capitalization etc., which comprise the same. Execution performance is
set of relevant predictors. evaluated not only in terms of market



Multi-Asset Algos Eye Bigger Stage
By Corrie Driebusch

The marriage between options and equities has flourished in the
multi-asset class algorithm arena, and now the industry is looking
forward to offerings that are next in line. Both buy-side trading
firms and sell-side algorithm providers expect some growth in
multi-class algorithms, specifically in foreign exchange and futures
in the next year or two.

Currently the most popular multi-asset class algorithms remain Harrell Smith, head of product strategy at Portware, said the
options- and equity-tied algorithms. “Options and equities are a slow pick-up in multi-asset algos beyond options has been an issue
natural marriage,” one hedge fund manager said. Goldman of lagging demand. Nevertheless, funds
Sachs, Barclays, Jefferies, ITG and Knight Capital Group all offer that trade globally are driving demand for
pairs trading strategies that tie options and equities. For instance, algorithms that can handle foreign
Knight’s two offerings are a delta-neutral, or delta-adjusted, exchange. Smith noted that in addition to
strategy and a volatility offering. The former allows a client, options, FX algos are also viewed largely
typically a convertible arbitrage hedge fund, to execute an option as “useable” for algorithmic trading.
at a particular delta while simultaneously executing a delta hedge Portware already has a suite. Hitesh Harrell
Smith
in the underlying equity. Volatility algorithms allow traders to Mittal, head of liquidity management at
purchase an option at a particular volatility regardless of price Investment Technology Group, said ITG has focused a lot of its
while purchasing the underlying security at the same time. energies on its algorithm that incorporates equities and foreign
Joe Wald, managing director at Knight, noted that these exchange for stocks listed on both the Toronto Stock Exchange
time-saving tools have proven incredibly important in an and either Nasdaq Stock Market, NYSE Amex or the New York
especially fragmented market. “You’re Stock Exchange. ITG is looking at whether to launch similar
trying to maximize alpha that is heavily algorithms between other marketplaces, such as Europe.
dependent on executing both legs of the Mittal also sees futures, a natural hedge for equities, as
strategy—if you’re wasting time or another potential asset class to be embraced by algorithms. “It
inefficient on getting the hedge on, makes perfect sense to me to do [a futures and equities trade] in
you’re really giving up alpha there,” he tandem versus one guy yelling over to another guy across the
explained. One New York-based hedge room,” Mittal explained. “It’s an obvious one the market should
Joe Wald
fund manager who trades both equities move very quickly to.” In May ITG rolled out equity index futures
and options agreed, saying the only multiple-asset class trading capabilities in its portfolio algorithm Dynamic
algorithm he uses is a delta-hedge strategy. “It’s not very sexy, Implementation Shortfall. Mittal said it wasn’t based on client
but it’s widely used,” he noted, adding that he is not looking for demand, rather a belief that this is the next step for the industry.
other algorithms at this time. “We see this growing in the future,” he said.

12

Wall Street Letter is the only paid news service that brings you up-to-the-minute coverage of what’s
happening in institutional trading, advances in electronic trading—including algo’s and dark pools—
high-frequency trading, exchanges and alternative platforms.

Whether you trade, or provide trade-related services at an investment manager, hedge fund, proprietary
Wall Street Letter provides the critical market intelligence on what
the latest developments in trading and operations mean to you—and why. Other publications may report
on new technology and processes; only Wall Street Letter consistently delivers the perspective from the

are responding to daily changes in how, where, and why they route, track, and clear their trades.

Fully searchable PDF archive of past issues going
trading strategy, regulatory issues and market back to 2001
structure issues

you don’t miss key headlines

24/7 live news updates via the website – News is
posted as it happens

www.wallstreetletter.com
1-800-715-9195 for immediate access.

WSL booster color.indd 1 9/9/10 6:17 PM



The Future Of Anti-Gaming:
Where Are We Going?
By Jeanene Timberlake

The concept of anti-gaming technology and the logic that is used Systems. “In the early days, people talked of penny jumping and
to build it is getting more attention these days in light of an front-running.” In the first instance, a specialist, knowing of a large
increasingly microscopic focus on trading and market structure. institutional limit order to buy, would buy the same stock for a
“Anti-gaming” is the keyword in nearly any conversation that price one penny above the institution’s bid, hoping to move the
discusses dark liquidity, high-frequency trading or buy-side algos. price up and create an opportunity to make money back on the
Several firms have been quietly perfecting the technology, which sale. In the latter, illegal instance, a broker receives a buy order
essentially intends to protect a buy-side order from being picked and before filling the order, places a buy order for the same stock
off at a higher price than market realized prices in order to make in a proprietary account; the broker then
money on a sale at the NBBO. places the customer order, hoping to push
The technology ranges in approach and application, but all the price up to later sell the stock that was
works toward the goal of limiting buyside interaction with purchased.
predatory sell-side flow. Firms are using post-trade methodologies, Gaming today is more sophisticated in
reviewing data on a delayed schedule, but also have added in real- light of the increased use of algorithms and
time techniques. Some variations being developed will feature the prevalence of dark pool trading. Mario Giannone

monitoring activity at the point of sale and the ability to monitor According to Mario Giannone, head of market surveillance and a
for gaming across the market as opposed to looking at activity software developer at Liquidnet, “peeking” is a problem common
taking place in a single shop. in pools where trades are negotiated between counterparties. In
Already, there are concerns that regulators may try to restrict that situation a buy-side and sell-side member match up, and after
gaming activity, though it’s unclear how rules would work. One the buy-side member indicates he is ready to trade, the sell-side
factor that would make regulation difficult is that gaming isn’t counterparty is no longer there. “They can see a match and they
illegal or unethical, it’s a natural part of trading that traders have know there is someone of size on the other side,” he said, adding
to master to a certain extent. “True gaming happens when firms that while once may be accidental, multiple “peeks” often are not.
are identifying supply and demand Gamers may also try to test a price by buying little bits of a
imbalances in the marketplace and then particular stock at a time to test an institutions limit price and
take market action to effect price based on determine the size. Eran Fishler, director of research at Pragma,
their assessment, but identifying said one clue is when an institution gets a fill in a dark pool at a
supply/demand imbalances and using that price which is higher than the prices realized in the market prior
to one’s advantage is the job of every to the fill and after the sale, the price immediately reverts back to
Doug trader,” according to Doug Rivelli, ceo of more favorable levels. The danger in both cases is that the sell-side
Rivelli
Pragma Securities. member may go out to the public market and move the price
before going back to the pool to complete the trade, if the buy-
NOT YOUR GRANDMA’S GAME side interest is still there.
Anti-gaming technology started gaining traction and credibility as
more trading moved electronic. Larger institutional orders are the PLAYING DEFENSE
typical targets, and the games are not new, according to Henri Since no one expects gamers to go away, the consensus for now seems
Waelbroeck, v.p. and director of research at Pipeline Trading to be that the only option is to block the gamers once detected. Firms

14



are doing this now by combining technology for intraday detection better [than the institution placing the trade]... What I would like to
with old-fashioned data mining with the goal of finding trading think is that presumption is fundamentally wrong. No trader
patterns, whether within specific dark pools or for specific clients. should resign himself or herself to the idea that others are better
Fishler said Pragma studies post-execution data for executions its informed than they are,” he added. That line of thinking is what
clients make in the 40 or more venues it provides access to on a daily, started Pipeline on the development path of its Algorithmic
weekly and monthly basis. “We want to study [the executions] and see Switching Engine, launched in 2007. It applies the analytical power
which destinations play host to gamers. So, we look at the return pre- high frequency traders use to help determine what will happen in
and post-fill at the destination,” he said, which is where the firm will a stock to predict a particular algorithm’s performance and
notice whether the price reverts consistently. combines that with the institutional trader’s own knowledge of the
Pragma monitors a variety of other factors as well to root out strategy being deployed. On top of that, Pipeline recently
anomalies. Dark pools with anomalies are blacklisted until Pragma introduced Alpha Pro, which combines a firm’s trading history with
can determine whether the anomalies are due to valid market real-time conditions to create a custom strategy for traders.
activity or gaming. The answer to that question determines Pragma’s approach will also look to use gamers’ strategy of
Pragma’s next step, which can be as severe as deciding not to trying to identify orders. The firm is developing an algorithm that
connect to a certain venue any more, although Fishler said in will attempt to detect gaming that is happening relative to the
some cases they can target gaming down to the counterparty level. trader using the algo as well as gaming that may be happening
Giannone said his firm also monitors historical data that is elsewhere in the market and plan trade executions around that.
gathered from 35 different programs that survey his firm’s “Whether I’m trading or not, the next generation will understand
systems. “We gather information and look for patterns among our what I am doing and what the market is doing,” said Fishler.
members,” he said, noting it takes place on a T+1 basis to monitor Figuring out where gaming is happening outside your own world is
for outliers that may occur among members. “If any members are always difficult because you never really know what is happening,
doing something much more frequently than the rest of the Rivelli added. This algorithm should go a long way to solving that
community [compared to a community benchmark]... we will issue, though he cautioned that these types of strategies should still
proactively investigate that,” he added. be used in concert with other detection techniques.
In both cases, these historical views are backed up by real-time Liquidnet’s Giannone said his firm is in the process of rolling
systems. Giannone noted members of his pool are encouraged to out an enhancement to real-time capabilities that will move
complain if they see any type of suspicious activity but the pool also detection to the front-end. He noted that right now, real-time
does its own monitoring. “We’re hoping to catch it before a member monitoring will alert the pool operator that suspicious activity has
complains, of course,” he said. “If we think it’s a bad trading occurred, tipping off staff to monitor particular activity and
protocol, we may even, intraday, block a member from matching flagging the trades for further investigation and possible
again. One reason would be to alleviate frustration, but another is disciplinary action. The new capabilities, being developed in-
to give time to investigate what happened,” he added, noting that house, will monitor for gaming scenarios that, if engaged, will be
enough evidence will earn a permanent suspension for the gamer. acted on automatically. “If someone is breaking protocol, the
Pragma’s real-time monitoring and anti-gaming help determine system automatically takes action without investigation,” he said.
what activity is happening as part of gaming and what might be a Members engaging in the negative activity would receive alerts
real strategy. If it is determined that the activity can be attributed to and the third alert would result in an instant block from trading.
a gamer, the firm will stop trading or put limit prices on the trade, a “We would still investigate, but in terms of being proactive, this is
move Fishler characterized as the “main tool” for prevention. the Holy Grail.”
There is some concern that regulation could be under
FROM DEFENSE TO PREVENTION consideration to limit gaming in the U.S. similar to that which
Providers don’t have the same concepts in mind when looking at exists in the U.K. requiring pools to provide prevention technology.
the future, but there is agreement that one of Operators of global pools would likely be more prepared in that
the best tools for the future is to use gamers’ case. Still, the prospect is considered unlikely in the U.S. in light of
own techniques to combat them. “Anti- the fact that gaming is still within the rules. “There’s an important
gaming technology has developed as differentiation between gaming based on an assessment of
defensive mechanisms,” said Pipeline’s supply/demand versus actually knowing [information] and front-
Waelbroeck. “The defensive approach makes running it. As long as a trader is taking market risk, it’s difficult to
Henri Waelbroeck the assumption that someone else knows regulate a trading strategy,” Rivelli said.

15



Buyside Worries Focused On
Regulation Reform
Regulatory issues have been a growing concern for industry participants of late, including those on the buyside, thanks to the
sheer volume of new regulatory activity expected in the next few years. Chief among those concerns are the far-reaching
implications of the recently passed Dodd-Frank Act, which touches nearly every aspect of the financial markets and permeates
nearly every asset class. The following participants spoke about those concerns and how they’re dealing with it now, as well as
their technology issues, how they’re handling volatility and what they want now in response to questions from reporters
Meredith Lepore and Corrie Driebusch.

FROM THE BUYSIDE is now playing catch-up to this new, quickly changing environment.
Right now, I don’t think there is one major concern, but many
BASIL WILLIAMS, ceo of Concordia Advisors. Williams oversees smaller issues that the industry is focused on. [For example], the
the daily investment and business operations of the firm. Prior to [National Market System] issue. The Securities and Exchange
being named ceo, he was president and head of fixed-income Commission is proposing a new Rule 613 that would require
trading. Williams began his career at Merrill Lynch. national securities exchanges and national securities associations
(self-regulatory organizations) to act jointly in developing a NMS
JONATHAN KANTERMAN, managing director at Stillwater plan to develop, implement, and maintain a consolidated order
Capital Partners. Kanterman has more than 16 years of investment tracking system, or consolidated audit trail, with respect to the
management experience and has worked at firms such as trading of NMS securities.
Valenzuela Capital Partners and Woodford Gayed Management. [There is also] the “large trader rule,” which would require high-
frequency and other large-volume traders to code their trade tickets
JUDITH MOSES, portfolio manager at Evercore Wealth with a unique identifier.
Management. Moses has more than 19 years of experience in the For the circuit-breaker issues, we need to help stop flash crashes
investment management industry. Prior to joining Evercore, she was and [find] ways to speed recovery if they do occur, bust erroneous
v.p. at U.S. Trust, Bank of America Wealth Management and trades when crashes happen, etc.
before that she was with the Charter Financial Group. Algorithm flow catching up to phone orders is another issue. The
fact that the volume of shares that buy-side traders send to sales desks
KEVIN CRONIN, director of global equity trading at Invesco. and to the equities markets using algorithms will soon be the same.
Cronin has spent more than a decade at the helm of global trading for Probably the biggest issues are the unknown results of The Dodd-
investment firms. He has testified on multiple occasions in front of Frank (Wall Street Reform and Consumer Protection) Act, which
the Securities and Exchange Commission on a variety of subjects. grants the SEC an entire array of new powers. The unknown usually
results in the most apprehension.
STEVE SACHS, director of trading at Diamond Hill Investments.
He previously held the same position at SGI/Rydex. CRONIN: It’s not easily contained to one issue—it’s really the whole
picture. After the flash crash, you have a number of people trying to
rush to judgment on what went wrong and who’s responsible. As I
WSL: What is the biggest regulatory concern facing look at the world I can’t help but think the biggest risk for all of us is
the industry? to overregulate an environment that’s not today very well-known.
KANTERMAN: I think this is one of the most historic times for the For example, look at high-frequency trading. A lot of us have
industry, with new levels of technology driving growth, efficiency concerns about high-frequency trading. But there are a number of
and productivity, coupled with the resulting need for proper different participants in the marketplace that would be considered
regulation. As is traditionally the case, regulatory oversight lags and high-frequency traders and their place in the market is very good. It

16


needs to be well-understood and not a rush to judgment to focus is almost post-mortem of how orders are managed.
appease some faction of the market that says something has to be
done. Many of the things that led us to May 6 are not as easily fixed SACHS: First and foremost are the tools we need to better serve our
by putting circuit breakers or disallowing market orders. shareholders. A big driver of [technology changes] is also responding
to market structure—how we’re forced to trade these days versus
MOSES: While the recently passed Frank-Dodd Bill will certainly have days in the past. The fact is there are 40-plus execution venues out
a far reaching and, at this point, indeterminable impact on the there where a stock may or may not trade.
financial services industry, of immediate concern to those of us in Given that, and given the short-term noise in
wealth management is the uncertain tax regime. It is a challenge to the market, and given the illusion of liquidity
make investment decisions when one doesn’t out there, most of what we’ve done is getting
know what the capital gains or dividend tax better tools to find the liquidity we need to
rates will be next year. Will Congress allow make transactions. We can trade 4-5 billion
President George W. Bush’s tax cuts to expire, shares of volumes in the markets in a given
Steve Sachs
in which case our clients will be looking at a day but I don’t think [the markets] are any
possible dividend tax rate of 39.6%? I have more liquid than they were years ago. If anything they’re less liquid;
heard numerous possibilities being discussed, the depth of book has disappeared. What we need is a tool set to
Judith Moses
including dividend and capital gains rates of connect anywhere and everywhere and to be able to monitor how
20%, 25% or 28%, an extension of the Bush tax cuts for one year, our tools are doing in those marketplaces, what sort of gaming is
taking place.
keeping the tax cuts for those earning less than $250K, etc. There is
the same uncertainty with regard to estate taxes.
MOSES: Technology is an integral part of our business and advances
in technology have made it possible for us to easily invest in all
WILLIAMS: For certain operators in the hedge fund arena, SEC
asset classes, equities, fixed income, currencies, options, futures,
registration is a burden. A less certain question is bank capital
etc. Technology has lowered transaction costs and improved price
requirements and the lending activity of alternative asset managers.
discovery and liquidity to name a few benefits. But we have also
What will requirements mean to banks and bank clients?
seen some of the negatives of technology as evidenced by the flash
crash in May.
SACHS: I think we’re at a point where the pendulum has swung way
Now that the majority of equity [trading] is done electronically,
too far and we need a complete overhaul of our financial system. off the exchanges, there are not designated market makers whose
For the last five years since [Regulation] NMS we have moved to a responsibility is to provide an orderly market in stocks. One can see
market structure that no longer serves the fundamental investor. how a disorderly situation could occur if participants in electronic
The market is full of tactical trading strategies. My biggest concern is exchanges who typically provide liquidity, but are not required to,
a lot of one-off solutions, from the uptick rule to circuit breakers. step back from trading and liquidity disappears. Our responsibility
We need to take a step back and take a look at the whole market. to our clients is to use technology to help us construct and manage
The SEC is beginning to do that with the concept release, but now well-diversified portfolios while minimizing transaction costs. In
what happens? Will there be follow through? addition, we must protect and manage the risk that advances in
technology pose to our clients’ portfolios.
WSL: What type of technology issues are you focused
on right now? KANTERMAN: I think the biggest issues right now stem from the
CRONIN: We don’t fashion ourselves as high-frequency. Our time uncertainty. Companies don’t want to spend on new technology
horizon is not six seconds. We’re not trying to solve for pico- or and services until they have more clarity on the regulatory and
nanosecond. But on the other hand, because the market has compliance issues in the pipeline. Most of the industry is in a
become comprised of so many of these picosecond and holding pattern until they know exactly what will be needed. Then
nanosecond participants, we have to understand well how this arms there will be a wave of spending on new technology and upgrades
race is going to play out. We have to understand how our orders are to match the new landscape. These types of dramatic changes and
being handled. [For instance, what happens] if we send an order to advancements happen every 10-15 years.
one place [that] subsequently sends it to another place that
subsequently sends it to another? Who can see those orders and WSL: What’s your take on recent market volatility and
what potential information leakage can be from that? [We need to how it is affecting your business?
know] how technology works with respect to transaction cost in WILLIAMS: It has been good for our business. We are looking to
particular, and also in terms of what dark pools we can go to. The trade relative value, so when there are high levels of volatility, there

17

Electronic & Algo Tading Report

Electronic & Algo Tading Report

Recomendados

Recomendados

Mais conteúdo relacionado

Destaque

Destaque (17)

Semelhante a Electronic & Algo Tading Report

Semelhante a Electronic & Algo Tading Report (20)

Mais de Lisa Krow

Mais de Lisa Krow (20)

Último

Último (20)

Electronic & Algo Tading Report