An industry briefi ng prepared for Fidessa by A-Team Group
A New Frontier for Electronic Trading in Europe
Access
Algorithmic trading is entering the
mainstream. Financial institutions
are ready to deploy integrated
platforms for connecting to a
broad diversity of execution
venues, locating liquidity across
markets, and executing on that
liquidity quickly and effi ciently.
The more innovative fi rms have
been quick to realise that early
adoption of high-performance
trading platforms that incorporate
smart order routing technologies
will allow them to swiftly
consolidate their market position.
But deploying a platform that
meets these requirements is not
a trivial task. This Briefi ng offers
guidance on the key factors that
should be considered by fi nancial
institutions planning to build
their own trading platform or
evaluating the myriad of vendor
systems on offer.
The combined impact of MiFID and the emergence of new markets and dark pools has created an increasingly fragmented equity marketplace in Europe that is radically changing the face of electronic trading.
The day of the smart order router is here, and the use of algorithmic trading has entered the European securities trading mainstream. A trading fi rm’s technology response to the changing market structure needs to be signifi cant: today, electronic trading is about super-fast intelligent automation of the order routing process, towards the venues where optimal trading opportunities exist.
In a competitive “market of markets” liquidity will move increasingly seamlessly between execution venues. By taking a proactive approach to best execution for clients – rather than merely complying with regulatory requirements – many fi nancial institutions believe they can gain competitive advantage.
This is an experimental time: many traditionally reserved fi rms are turning to algorithmic trading systems for the fi rst time. It is no longer possible for a trader to trade European equity instruments eff ectively without smart order routing tools. Firms deploying smart order routing algorithms are attempting to create the right framework for the automation of trading decisions across multiple markets. As market participants build new internal trading infrastructures or assess the strength of vendor off erings, they must address the same set of considerations to leverage the opportunities posed by the new regime.
• Effi cient integration of core functions is key: any trading platform in the new environment needs to integrate
several key functions, including order management, market data, market connectivity, smart order routing, trade management, position-keeping and audit trail. Underlying all of this is the need to ensure good static data management, particularly with respect to fungibility between instruments.
• Despite the complex decision making process, speed of execution must not be compromised, and all elements of the trading infrastructure must be optimised to ensure lowest possible latency.
• Any trading platform must provide a consistent, consolidated view of fragmented markets, displaying orders and market data for fungible securities on accessible and appropriate execution venues. The deal-capture and position-keeping function must similarly provide consolidated trade records with specifi c venue of execution information.
• The trading platform’s smart order routing component must off er multi-market and multi-asset execution that optimises trading across the growing number of markedly diff erent execution venues. The smart order router must also be able to perform specifi c functions designed to meet the needs of the user’s investment criteria, and
needs to be able to deal with venues’ conventions around minimum order sizes, dealing capacity and other
rules of participation.
• It’s essential to establish the business and technical strategy and approach to connecting to new venues. Clearing and settlement of alternative market trades also adds a signifi cant technical and processing complexity and ultimately cost.
• The trading system needs to handle not only the instrument fungibility issue but also the hierarchical relationship
between execution venues. The smart order routing system needs to be able to determine what the primary
market is for any given instrument, allowing positions and trades to be viewed at a single primary instrument level. These important issues are among those explored in this paper and they require the attention of any trading fi rm that wants to trade in the new European market structure.
Implementing a Solution to Trade the Virtual
Pan-European Stock Market
Implementing a platform that takes advantage of multi-market opportunities – while at the same time meeting regulatory requirements – is a big challenge for trading fi rms. Whether building a trading infrastructure in-house or assessing the relative strengths of the various vendor off erings in the marketplace, trading technologists and the business leaders they support need to address the same basic set of considerations to leverage the opportunities posed by the new regime – and to avoid its pitfalls.
Are the Core Trading Functions Tightly Integrated?
The effi cient integration of core functions is key. When trading the fragmented stock market you don’t want to be using a fragmented technology solution. Many technology vendors propose the use of diff erent core trading technologies loosely grouped together to solve the problem - this is generally not optimal. If too many of the functions involved in electronic trading across multiple markets operate independently this adds latency, contributes to missing trading opportunities and increases the risk of operational ineffi ciencies and errors.
Any trading platform in fragmented European markets needs to integrate several key functions, including: order management; market data; market connectivity; smart order routing; trade management; position-keeping; and audit trail. Underlying all of this is the need to ensure good static data management, particularly with respect to fungibility between instruments - users must be confi dent that the multi-listed instruments they believe are interchangeable as an asset, truly are.
Is Your Defi nition of Instrument Fungibility Clear and Consistent?
The defi nition of fungibility between instruments is the cornerstone of any strategy or trading system designed to deal with multiple execution venues.
Trading systems need to know what market instruments they consider to be the same for the purpose of satisfying an order for shares. Clearly, there are key diff erences between securities that at fi rst appearance seem to be like for like. Fungibility is ultimately “in the eye of the beholder” and systems need to provide enough fl exibility to allow individual judgments and preferences as to what instruments are considered fungible.
How Do You Handle Multi-Market Execution?
The platform’s smart order routing component must off er multi-market execution that optimises trading across the growing number of execution venues. The smart order router must be able to aggressively sweep across user-specifi ed, relevant execution venues in order to identify liquidity at the requisite price levels. It must search out and execute against hidden and iceberg orders, and route client orders to appropriate venues in accordance with the user’s investment criteria. It must also be able to deal with any volume that is not immediately executable and optimize the passive placement of any remaining volume. Firms will need to adopt the tools required to apply a variety of smart order routing execution strategies with full fl exibility to adapt the algorithms to meet the fi rm’s execution goals in diff erent circumstances.
• Europe’s fragmenting
marketplace is forcing
market participants to
adopt fast,
super-effi cient trading systems to
seek out liquidity.
• Financial institutions believe
they can gain competitive
advantage by taking a
proactive approach to
the changes in market
structure.
• Firms deploying smart
order routing algorithms
are attempting to create
the right framework for
the automation of trading
decisions across multiple
markets.
Can the Platform Construct a Consolidated Market View?
Any trading platform must provide a consolidated market view, displaying orders and market data for fungible securities on accessible and appropriate execution venues. Importantly, this “intelligent” data display must be a highly functional trading tool allowing traders to interact on multiple markets effi ciently as if they were interacting on a single pan-European stock exchange. Similarly, multi-market trade tickers and multi-market trade prints must be available in a consolidated view easily accessible to the trader to assess current and historical market activity. The organisation and ease of access to sensible data consolidation requires careful software design and implementation.
The deal-capture and position-keeping function must similarly provide consolidated trade records with specifi c venue of execution information. Trades in a particular instrument must not be viewed as fundamentally diff erent if the deals are executed across diff erent market venues. Traders will also want to be able to see their stock positions consolidated as a single position per instrument.
Does the Trade Audit Trail Meet Regulatory Requirements?
The trading platform must provide a complete audit trail of all trading activity and events including all automated algorithmic decisions. This is required to provide proof of compliance with the fi rm’s execution policies and the performance of the execution venues.
It is essential that the audit trail shows the individual order handling and trading events in the life of a specifi c customer order, in line with a comprehensive view of multiple market prices and conditions at the time of each event.
Flexibility Is Key to Adapting to Future Market Changes
Before an order can be traded automatically across a multi-venue environment, a trading system must fi rst locate market opportunities. Understanding where liquidity is and the diff erences when interacting with diff erent venue types is imperative. As diff erent market models evolve it is crucial that any approach can be adapted to refl ect market changes and the evolution of market structures. Fierce competition between markets should result in market innovation and lower-cost trading. This is one of the main goals of MiFID. The European market structure is evolving fast and market participants need to adapt fast.
Are All Potential Liquidity Sources – Dark and Light –
Taken Into Account?
There are a variety of so called “dark pools” defi ning the new complex trading landscape of Europe.
In recent times, the market has seen a reorganisation and formalisation of the long-existing practice of fi rms’ crossing client orders internally. Some internal markets are now somewhat transparent (fi rms termed Systematic Internalisers under MiFID), while other internal markets take the form of organised dark liquidity, also known as internal broker “dark pools”. These new dark pools create another dimension of trading venue. As such, any liquidity-seeking mechanism must be aware of potential liquidity across a number of very diff erent venue types.
• When trading the
fragmented stock market
you don’t want to be using
a fragmented technology
solution.
• A clear and consistent
defi nition of instrument
fungibility is the cornerstone
of any multi-venue trading
platform.
• The smart order routing
algorithm must handle the
nuances of each execution
venue while directing orders
according to the user’s
investment criteria.
Internalisation in Europe has traditionally represented in excess of 30% of total European trade execution. As such, internalisation does not represent a new source of liquidity. The proliferation of so-called broker dark liquidity pools has been regarded as making liquidity and price discovery more complex. This is not necessarily the case - internal dark pools have never been better organised or more accessible to the customers of the fi rm. The issue is how to access these pools if not already a customer of the fi rm hosting the internal market: these pools do not advertise trading opportunities through price distribution and a trading relationship with the host broker is required to access them.
Alternatively, Systematic Internalisers under MiFID are obliged to report their available ‘prices’ to the public domain if the order size available is below standard market size and the stock is liquid. This will reveal more, but not nearly enough, of what is available for execution inside the large fi rms. There is now an opportunity – through the use of advanced smart order routing – to make these key liquidity pools more interactive and available to a broader set of market participants who want to trade.
Of course, this is not the only type of dark pool; the much touted Multilateral Trading Facility (MTF) dark pools and new hybrid exchange models are currently either pre-launch or still in their infancy. Those live have yet to report signifi cant transactional volumes. But with growth in use, and unique business models, some of these dark pools will establish themselves as important alternative execution venues, and how a fi rm interacts with these markets will become vital.
In short, it’s essential to appreciate that any eff ective liquidity discovery mechanism’s methodology for identifying opportunities across markets needs to recognise
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• As different market models
evolve, it’s crucial that a
trading platform can adapt
to refl ect future changes
in business models and
market structures.
• Emerging dark pools, both
private and public, must
be considered as potential
sources of liquidity.
• Smart order routers must
be able to understand the
different types of matching
platforms and their rules
and conventions.
the diff erence between these diff erent types of matching platform and business models. Smart order routers and execution algorithms need to interrogate the most appropriate dark pools in the right way to seek out opportunities that beat visible liquidity on other markets.
A Strategic Approach to Market Connectivity
In the context of new market structure evolution in Europe, it is of paramount importance to establish the business and technical strategy and approach to connecting to new venues. The decision to establish a direct connection to the latest hot venue is not a trivial one. It involves substantial eff ort, resource and investment to build and maintain good quality market gateways, and fi rms will want to ensure this investment is worth it. Clearing and settlement of alternative market trades also adds a signifi cant technical and processing complexity and ultimately cost.
Using indirect gateways has positive and negative implications. Member fi rm brokers can off er fast direct market access (DMA) and the use of smart DMA services. This may be an attractive market route for smaller fi rms, taking much of the complexity out of the trade processing of alternative market execution.
On the downside, this approach will reduce the fi rm’s involvement in the trade execution process and increase dependency on other, potentially competitive parties. The use of third-party brokers will also add unwanted latency to the trade execution process. This can encourage their buy side customers to establish a direct relationship with the executing broker or market member. For the broker, the loss of control over execution strategy and process will be apparent when utilising the services of another party when executing, as opposed to using member gateways and their own smart order routers and execution logic.
The approach taken will be diff erent for diff erent market participants. Those who do not depend on execution quality may fi nd the use of third-party brokers attractive. The fi rms that want to show and sell their competency in the trading and execution process will need to invest in the technology and supporting processes. It is likely that the strategy of a mix of direct and indirect market routes will be attractive for all but the top tier of executing brokers with pan-European execution and clearing capacity.
For firms opting to connect directly to new venues, it’s essential to create the flexibility to build high-quality and robust exchange gateways quickly. Multi-market connectivity can be a complicated and expensive business and it’s essential to adopt the right strategy and technology to ensure future-proofing - with the ability to maintain and enhance market gateways as they upgrade and enhance their platforms and business offerings going forward.
Using SORs and Execution Algorithms
Once connections to market data and appropriate execution venues are established, attention can turn to the cornerstone application of operating in a multi-venue marketplace: the smart order routing (SOR) mechanism.
Seeking out liquidity and determining the overall market’s best prices – while challenging – can be perceived as an eminently achieveable aspect of smart order routing. Effi cient software processing and today’s computer processors are capable
of consuming vast quantities of data to provide an overall picture of price and opportunity across multiple markets.
Knowing and understanding what trading opportunities exist across multiple markets, and comparing those opportunities in real time and acting upon them, are all quite diff erent challenges. Algorithms are needed to understand and interpret what is happening and deal with the nuances of diff erent venues’ trading models and rules. Without them, it’s diffi cult for a manual trading process to prioritise access to diff erent venues in an optimal way.
Among the issues that need to be handled are: the venue’s conventions around minimum order sizes, the notifi cation of dealing capacity and other rules of participation. Similarly, institutions that use specifi c types of orders must ensure that their smart order routing systems are capable of handling these order types in the appropriate manner. For example, a fi ll-or-kill order will fail if one element of a multi-leg order isn’t completed. A smart order routing algorithm must take into account this risk and deal with it appropriately. The algorithm must also ensure that by splitting an order between venues it doesn’t create an odd-lot that can’t be traded because the venue in question doesn’t support trading of odd-lots. The SOR strategy must ensure that when order placement is passive and opportunities become available on an alternative venue, there is a mechanism to reduce the possibility of missed trading opportunities.
Firms will need to have a clear view of how the smart order routing process works in the myriad of specifi c cases.
Traders and sales people need to be able to see what happened easily in order to deconstruct what the algorithm just decided to do with their order. This is very important. Lack
• It’s essential to adopt a
business and technical
strategy for connecting
to the growing number of
execution venues.
• Market participants must
weigh the pros and cons
of using indirect gateways,
with their control and
latency issues.
• Understanding what trading
opportunities exist across
multiple markets and
comparing and acting upon
them in real time, are all
quite different challenges.
An example of order depth for a single equity instrument across multiple European markets in a single consolidated view
2008 Fidessa ©
of human visibility and supervision of the process could present signifi cant risks to the trading business . For this reason, a clear audit trail must be available immediately to the user of SOR. The algorithm is likely to be made up of multiple distinct tasks or phases: for example, a phase to aggressively sweep transparent markets; another distinct task that looks for opportunities in dark pools dynamically and intelligently; and fi nally a follow-up strategy for dealing with remaining unexecutable volume. It should also have the ability to uncover and trade on hidden liquidity opportunities. This might entail a fast and effi cient aggressive sweep of appropriate and available markets, followed by a pause before a second sweep to catch markets refreshing with hidden liquidity, like icebergs.
Where is the Primary Market?
The trading system needs to handle not only the instrument fungibility issue as discussed previously but also the hierarchical relationship between execution venues. The SOR system needs to be able to determine what the primary market is for any given instrument. This allows for positions and trades to be viewed at a single primary instrument level. Primary market identifi cation is also essential in order to value positions with a sensible end of day mark-to-market price. It also allows the system to take into account MiFID-related metrics, such as average daily turnover on the primary market, currently used to determine when an order or trade is large in scale and therefore how it should be processed and handled by a fi rm. It will also assist in the smart order router for market preferencing and passive order placement. Algorithms need benchmarks and a benchmark market is still an unavoidable requirement. The ability to look at multiple markets as one, using a fl at instrument model, and having the ability to look at market instruments in a hierarchical model when appropriate becomes an essential feature of European multi-market trading systems.
Latency as a Differentiator Between Venues
The issue of system latency in the automated multi-market trading process is hugely important. Over time, execution venue system latency may emerge as a diff erentiating factor in choosing where to send an order, at least until all credible and appropriate venues reach the lower physical limits of latency. End-to-end latency is an important consideration in any trading system and it’s about to become even more critical. The initial aggressive phases of the smart order algorithm need to be executed at the highest possible speeds. The speed of the decision-making algorithm itself – and the resultant performance of the software and hardware infrastructure in response to these algorithms more generally – will throw latency into a very bright spotlight. Elements of the trading infrastructure that hinder the performance of a very fast algorithm will need to be removed, replaced or tuned for speed. Speed used to be an issue in all trading systems; it is fast becoming the issue.
Are Your Benchmark Algorithms Fit for Multi-Venue?
With the use of standard benchmark algorithmic trading models, such as VWAP (Volume Weighted Average Price) and POV (Percentage of Volume), widely accepted and used by the trading community, it’s crucial that trading strategies are clearly defi ned in line with a multi-venue market structure. It is important for a buy-side client to understand, for example, whether a broker’s VWAP or POV model takes into account a single market or multiple markets. Indeed, the question of what multi-market VWAP is and how many versions of it will
• The SOR algorithm must
be designed to avoid
unintended and undesirable
consequences, such as
creating odd-lots where
odd-lots cannot be traded.
• It’s essential for traders to
be able to deconstruct and
analyse precisely how an
algorithm has handled an
order, particularly during the
adoption of new algorithms.
• The trading system must
be able to handle the
hierarchical relationship
between execution venues,
allowing identifi cation of any
instrument’s primary market.
exist is still unanswered. If VWAP as a benchmark is to survive, the industry will need to align on multi-market standards for this type of data to be able to compare like with like. Single-market VWAP is likely to become obsolete in a thriving multi-Single-market environment. Similarly, POV algorithms require adaptation to multi-market volumes. With other advanced trading methods, such as program trading and pairs trading, contingent orders need to also adapt to a multi-market structure and this will require considerable technology adaptation.
All order-level algorithmic techniques need to be closely coupled with execution-style smart order routing algorithms. This is a signifi cant change that requires fi rms with algorithmic ability to adapt their models considerably.
The trading system will also need to pre-consolidate multiple market prices or trade information inputs before this data is fed into an algorithmic trading engine. This is because quantitative traders need to focus on their trading strategy from a programming perspective and it’s important not to overburden the strategy algorithm with price and trade data consolidation duties.
• The ability to look at market
instruments in a hierarchical
model when appropriate
remains an essential feature
of European multi-market
trading systems.
• Execution venue system
latency may emerge as
a differentiating factor in
choosing where to send an
order.
• If VWAP as a benchmark is
to survive, the industry will
need to align on multi-market
standards for this type of
data to be able to compare
like with like
.The trading system fl ows from customer to market in the new multi-market structure
A Blueprint for Intelligent Liquidity Access
Customer ConnectivityDirect Market Access (DMA), Direct Strategy Access (DSA), Client Orders
Program Trading Client Baskets
Care Order Management Institutional OMS
List & Wave Trading Waves, Trading Lists &
List Level Algos
Benchmark Algorithms Multi-Market VWAP and POV
Execution Algorithms & Smart Order Routing Multi-Market Aggressive & Passive Trading
Liquidity Access Regulated Markets, MTFs, Dark Pools
Internal Markets, Crossing Networks
Market Data
Analytics
Compliance & Risk
2008 Fidessa ©
• Firms need full trading
lifecycle audit data in
order to regularly assess
performance against best
execution policies.
• The trading system must
be able to monitor each
execution venue’s status at
any given time.
• The system needs a single
underlying data model for
handling any instrument
type that may be added in
the future.
It is helpful to look at algorithms in at least two distinct categories with distinct functions. Benchmark, or order-level, algorithms like POV and VWAP are concerned with when and how much quantity to execute, while execution-level algorithms, like smart order routers, are concerned with where and how to execute the order.
Orders generated from a benchmark or order-level algorithmic model can then be directed into the smart order router – which, as stated, handles any fungibility considerations and all aspects of multi-market execution, without burdening an order-level algorithm with, in this case, low-latency execution issues.
Creating a Full Audit Trail for Best Execution
It is essential in today’s regulatory environment to implement a record-keeping system that enables users to retrace what has happened in the order handling and trading process. Regulations require the ability to reconstruct the entire trading lifecycle with every point of the process logged. Firms need to regularly assess the performance of best execution policies. Regulators are interested in the trading activity of the fi rm. Increasingly, clients will want to understand what happened and why or may even challenge that the fi rm’s execution policy was not followed in a particular case. The trading platform needs to provide in-depth activity and event logs to a well organised record-keeping system, so that it is possible to show which venues were considered for a trade in a given security, which venues were not considered and why, and which other factors led to the automated trading decision.
At any point in time, markets and the technical routes to markets may be in a diff erent status and that will aff ect the automated decision on where to execute. An eff ective smart order routing system will reject opportunities that aren’t appropriate, given the user’s execution policies or strategy, and the audit trail needs to explain why and what prices and volumes were available at the time of trade.
Trading activity requires a full event log, including lining up the order handling and trading events with market prices and volume for all instruments that are considered fungible, across all venues that are being considered for the lifespan of the order. This is not a trivial data record and storage exercise.
Gearing Up for a Multi-Asset Future
The ability to handle multiple asset classes from a single technology platform, or indeed single trader screen, may not be a top priority for many in today’s marketplace. It is almost certain, however, to become a more widespread requirement for at least some types of institution. As such, it’s important that any trading infrastructure has a single underlying data model for handling a broad range of instrument types.
Today, the industry is addressing multi-markets for European cash equities in the post-MiFID landscape. It is plausible that other asset classes such as exchange-traded derivatives will in the future require the same set of technology adaptations discussed in this paper. Hence, whatever technical solution is deployed for multi-market trading of equities must be similarly transferable to other asset classes as appropriate.
This approach essentially ensures future-proofi ng of the trading platform, extending the shelf life and ultimately return on investment in a high-performance trading
infrastructure. Only by taking an open approach to future capabilities can fi rms be sure that their trading systems will be capable of handling emerging, unpredicted requirements.
Fidessa – It’s Easy When You Know How
Fidessa believes the trend toward liquidity fragmentation will gather pace as a number of new ventures launch new regulated markets, MTFs and newly formalised dark pools. As advanced ways of accessing and trading on the new venues mature, Fidessa believes that its integrated Fidessa platform is best placed to leverage the rapidly changing markets. The Fidessa “Intelligent Liquidity Access” (ILA) strategy has multiple development streams that will evolve the Fidessa product set in line with the market as it develops in response to the new regulatory environment. ILA is closely coupled with the Fidessa Compliance Suite and the Fidessa Advanced Trading Tools strategy, whereby Program Trading, List Management, Wave Trading, Pairs Trading and Algorithmic Trading (Fidessa BlueBox) will be able to seamlessly integrate and leverage new functions such as Fidessa Smart Order Routing, which is the core technology of ILA. Underpinning the entire strategy is Fidessa’s continued investment in performance and latency optimisation. Fidessa believes the changes in the market require a signifi cant commitment from market participants in order to access new venues and employ the technology required to interact with them eff ectively. Fidessa shares that commitment and acknowledges that the marketplace is only at the beginning of what will prove to be a revolution in European equity trading.
Fidessa Intelligent Liquidity Access
As part of Fidessa’s global Intelligent Liquidity Access strategy, and leveraging the experience and success of Fidessa
Montage, a market leading smart order routing solution in the US, Fidessa now off ers a smart order routing solution for Europe. Fidessa’s Smart Order Router delivers a multi-venue execution service fully integrated with Fidessa’s leading multi-asset order management system. Coupled with market access to new and existing European venues, including Chi-X, Turquoise and Equiduct, Fidessa’s SOR enables fi rms to optimise execution across Agency, Prop, Program, DMA and Algo trading fl ows. Key Benefi ts:
• Low-latency Smart Order Routing service
• Fidessa’s high performance market access technology
• Multi-market execution optimising trading across liquidity venues
• Consolidated tradable multi-market views displaying accessible execution venues • Multi-market trade tickers and Time and Sales
• Full audit capability enabling proof of compliance with execution policies • Seamless integration with the Fidessa Compliance Suite
