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- 1. Liquidity Management: Driving Advanced Execution Past Algorithms Presented by Larry Tabb Founder & CEO TABB Group SIFMA – Technology Management Conference New York June 19-21, 2007
- 2. Agenda What is liquidity management? Why do we need it? How does it work? Why bother? What are the challenges? Conclusions 2
- 3. Liquidity management The math and technology around the appropriate handling of Customer orders, Liquidity provisioning, and The management of firm-wide risk and capital 3
- 4. Hunh? A broker helps others manage risk By selling risk exposure or mitigation Brokers do this on an Agency basis Getting products directly from others and marking them up, or Principle basis Selling products out of inventory that has been pre-stocked The pricing of this risk is determined by The Market Risk exposure Counterparty, Credit, Market, Liquidity, and operational Current, projected, and optimal 4
- 5. Liquidity management is the management of order flow, capital, and risk How do we manage customer agency order flow? What is our counterparty risk? How do I provide risk exposure/mitigation to our client? Is there liquidity in the market? How do I get it? Do we need to provide capital? How do we price it? How does this impact the desk and the firm? What is the desk’s risk? What do we want it to be? How do we get there? What is the firm’s risk? What do we want it to be? How do we get there? 5
- 6. Why do we need it? 6
- 7. Finding liquidity in an electronic world can be frustrating Traditionally, trading decisions were made by a trader Today, more flow is electronic Equity order size has decreased to about 350 shares per trade There are more market centers than ever that are “more accessible” The tease factor is high Brokers are making their liquidity electronically accessible but… Connecting is a challenge Liquidity is dark Commissions are falling and firms are looking closely at cost 7
- 8. Bundled/High touch order flow continues to decline as more flow directed to e*channels Shares by execution venue (share weighted) 2 Year CAGR 47% Sales Desk -12% 36% Program 9% 5% Desk 10% Direct To 14% 13% Exchange 18% 21% Algorithms 7% 24% Crossing 9% 15% Network 12% 2006 Source: TABB Group “Institutional Equity Trading 2006 2008 8
- 9. While exchanges talk of consolidation, fragmentation is a more appropriate discussion Firms With More Than 2 Investments in Alternative Venues LeveL CBSX BATS BIDS Boat Turq BOX Phlx NSX CSX BSE ISX Credit Suisse – 9 Citigroup – 9 Merrill Lynch – 7 Morgan Stanley – 6 UBS – 5 Bear Stearns – 4 Deutsche Bank – 4 Goldman Sachs – 4 Lehman Brothers – 4 Interactive Brokers – 3 JP Morgan Chase – 4 Knight Capital – 3 Bank of America – 2 Citadel – 2 E*Trade – 2 Fidelity – 2 Van Der Moolen – 2 Total Investments 10 6 6 4 4 4 8 7 12 5 13 7 9
- 10. Dark pools & crossing nets are fragmenting as at least 37+ are in or near production in US Nasdaq End of Day Cross Open Intraday Arca Opening Cross NYSE MatchPoint ISE MidPoint Match ITG Posit Match Posit Now Block Alert Merrill Instinet VWAP Cross Intraday End of Day Continuous NYFIX Millennium Natural Liquidnet Liquidnet H20 Pipeline Pipeline Merrill MLXN AXP (Algo Cross) Goldman Sigma X Morgan Stanley Trajectory Crossing Pool Credit Suisse Cross Finder UBS PIN BIDS CitiGroup Liquifi Citadel Ex Svs Citigroup, Citadel LCX Goldman Sachs, LeveL Lehman Liquidity Ping Lehman Brothers, ATD Merrill Lynch, Citigroup, Knight Knight Match Morgan Stanley, Lehman Brothers, State Street Lattice UBS, Credit Suisse, Merrill Lynch, Fidelity CrossStream Bear, BofA, Deutsche, Credit Suisse , ConvergEx ConvergEx Cross JPMorgan, Knight Fidelity Brokerage Bloomberg BlockHunter Pulse BlockCross 10 Source: TABB Group, Companies, Fidelity Capital Markets
- 11. The choice of liquidity pools is challenging at best Crossing Networks Exchanges ECNs Negotiation Broker - DarkPools NASDAQ BATS ATD BIDS NYSE Citadel DirectEdge Liquidnet ARCA Call Markets Citi Liquifi AMEX LavaFlow Instinet CrossFinder BSE Nasdaq KnightMatch TrackECN Chicago MatchPoint LavaATS NSX TradeBook POSITCross MS Pool PHLX Continuous – Blind SigmaX BlockAlert UBS PIN Dark Orders H20 Transition Platforms Derivative LeveL Lattice Exchanges NASDAQ CBSX Millennium Hybrid ARCA ISE POSITNow ConvergEx BATS Pipeline 11
- 12. With more venues and dark pools the trading process has become more complex New Buy-Side Order Flow Process Portfolio Buy-Side Yes Manager Orders Buy-side only Trader Xing Network Can I Find Buy / Sell-side Natural? Negotiation Yes Can I No Networks Specific No Add Yes Broker Dark Algo Value? Dark Liquidity Time/Price Small Footprint Algorithm Algos No Yes Displayed No To liquidity Algos Market Aggregation Out of Options Broker Capital 12
- 13. On the fixed income side no one even talks the same language - a host of models exist Retail Bond Distributon Platforms Brokerage Accounts eg. BondDesk & ValueBond Brokers Brokers Individual Investors Mutual funds Bid/Offer Real-time markets & SMAs Eg, Brokertec, EuroMTS & eSpeed Institutional RFQ Platforms Brokers Brokers Eg. TradeWeb, MarketAxess, & Reuters Inter-dealer Brokers Single Dealer System Eg, ML, GS, BARX… Brokers FIX for FI Protocol Brokers Institutional Eg. Lehman & Charles River Investors Underwriting Systems Brokers Brokers Eg, Bloomberg & Ipreo Corporations Treasury & Corp Finance 13
- 14. How does this work 14
- 15. First aspect – managing agency customer order flow – in most firms this is done Institution Broker Feed Handler Feed Handler Portfolio Mgt Exchanges Exchanges Algorithmic Exchanges Exchanges System Algorithmic Exchanges Flow Flow Event Stream ECNs Exchanges Order Mgt Exchanges Exchanges Processor System Time Series Database Execution Mgt Dark Pools System Order Credit Risk Generator Negotiation Negotiation Order Call Markets Call Markets Staging Continuous Exchanges Exchanges Order Exchanges Exchanges DMA Router Agency Internal Block Dark Pool 15
- 16. The next is managing capital, this is much harder Market Counter-party Data Risk Desk Positions Marginal Desk Risk Position Needing Consolidated Capital Marginal Desk Positions Enterprise Positions Risk Marginal Desk Risk Valuation Engine 16
- 17. All together you have a comprehensive way to manage order flow and capital Liquidity Management Pricing / Valuation Market Data Proprietary Trading Exchange Principal Capital Business Automated Market Making ECN Internal External Matching Capital Trades Dark Pool / Engine Crossing Network DMA/Order Sales Desk Routing Agency Business Algorithms Customer Order Flow 17
- 18. Why bother 18
- 19. Industry is increasingly global & more complex as foreign markets have outperformed the US China India Korea DAX Japan HK CAC FTSE S&P 19
- 20. Traditional funds are beginning to push the envelope as they launch alternative products Institutional managers launching hedge Institutional managers planning funds (2006) on launching hedge funds by ‘08 Yes Large 54% 17% Medium 40% Small 35% No 83% Source: TABB Group “Institutional Equity Trading In America 2006” 20
- 21. Derivatives business expanding at record levels with no end in sight US Derivatives Contracts Traded (in millions) 2,537 1 Year 32.3% Growth Rates 11 Year CAGR 26.6% 1,917 21.1% 25.4% 1,514 20.5% 1,207 7yr CAGR 18.4% 1,002 888 790 555 380 449 308 317 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: Options Clearing Corporation, Futures Industry Association 21
- 22. Quest for alpha is greater today than ever before Greater competition for returns Development of leveraged funds (120/20s) More creative ways to manage exposures Significant push to manage across asset classes Hedge funds driving coverage teams Risk and technology platforms need to follow suit Coverage teams need greater coordination and education 22
- 23. Increased leverage of firm’s capital generate greater returns, but at increased risk levels Major brokers’ ’06 revenue stream segmented by commissions and trading profits 66% 59% 60% 53% 50% 35% 35% 27% 25% 24% 15% 14% 15% 12% 8% Merrill Lynch Lehman Goldman Credit Suisse Morgan Brothers Sachs Stanley Commissions Trading Profits Other 23
- 24. Commission pressure has forced firms to focus on electronic channels Average per share costs (pennies) % Decrease ’05 to ‘06 Sales 4.00¢ -4.0% Desk 3.85¢ Program 2.20 ¢ -21.0% Desk 1.74¢ Crossing 1.80 ¢ 1.62 ¢ -10.0% Network Direct to 1.70¢ -28.0% Exchange 1.22 ¢ 1.90¢ Algorithms -38.0% 1.17¢ 2005 2006 Source: TABB Group “Institutional Equity Trading 2006 24
- 25. What are the challenges and opportunities? 25
- 26. Existing siloed infrastructure makes it challenging to manage risk in real-time Brokerages have typically organized by product Trading, sales and support Operations and reporting structures IT architectures Front-end and client-facing technologies However, things are changing Management is becoming more cross product Products becoming more global Trading becoming more horizontally integrated Sales and support becoming more horizontal 26
- 27. Data and enterprise risk management challenges make real-time analysis difficult Data management Lack of clean and reliable data make valuation challenging Especially in illiquid, complex, and challenging derivatives positions This is where clean data is most needed Risk Management The complexity of running enterprise risk valuations or complex portfolio valuations using Monte Carlo simulations is very calculation-dependent Challenging for even (especially) the largest firms to do this in real-time 27
- 28. Liquidity management allows for more efficient use of capital Agency flow will be more efficiently and effectively routed The more automated the routing and execution the lower the cost Leaving only the most difficult orders to be manually handled Orders that need or would be advantaged by principal would be more effectively Highlighted, priced, and managed Risk on the desk, floor and business will be more effectively managed as limits, positions, and hedges could be more effectively managed, changed, and monitored 28
- 29. Conclusions Electronic trading has not hit its peak Equity side is mostly agency The OTC side is mostly principle The challenge is marrying these two models Liquidity Management will help firms strategically Manage order flow Analyze and transfer risk Price capital Hedge positions While firms are starting down this path, the road is long and will be met by data, organizational, and technology roadblocks 29
- 30. Liquidity Management: Driving Advanced Execution Past Algorithms Presented by Larry Tabb Founder & CEO TABB Group SIFMA – Technology Management Conference New York June 19-21, 2007