Buy-side videos

Buy-side trading desks deliver best execution on behalf of investors. Asset managers must determine how to provide best execution to their clients and have a regulatory obligation to do so. Read more.

Buy-side trading desks

The size of the trades which institutional investors have to place in the market can affect the price of the securities they trade. In addition, any information leakage ahead of the order being placed can allow other market participants to get ahead of the order and trade against it, either buying the securities that will be needed by the asset manager, or pushing down the price of securities that the asset manager intends to sell, to buy them at a discount.

In Europe, best execution rules are provided under the Markets in Financial Instruments Directive II (MiFID II) which came into effect on 3 January 2018. The 2007 European Directive (MiFID I) also had a concept of best execution, which was enhanced by its successor directive.

In the US, Reg NMS determines the rules for routing orders to provide the best price for execution.

Best execution is defined differently according to the instrument traded and the asset class. Instruments that are very liquid and have transparent pricing are better able to be traded according to the best available price. That is harder to find in less transparent markets and if assets trade less frequently, then simply filling an order can be the best outcome, regardless of price.

Additionally, market activity levels can significantly affect execution quality – if prices are volatile, it makes the timing of orders harder to manage. If volumes are low finding liquidity is more challenging.

Market data is not available uniformly across markets. It is often stated that fixed income markets are less liquid than equities, however there is a complete curve of instruments in the fixed income space, some of which exhibit very similar liquidity characteristics to equities e.g. US Treasuries. Trades in very liquid fixed income instruments, particularly in smaller size, will likely be executed in a low-touch electronic fashion. Examining the market impact of such trades and documenting best execution is a relatively straightforward and well understood task.

The more challenging area is in those instruments that are not so liquid and without continuous pricing.

In the US, trades are publicly reported for both equities and bonds – excluding US Treasury instruments – to consolidated post-trade tapes. While there are conditions upon the publication of trades, so as not to create risk for trading firms, this largely helps to create price transparency in US markets.

In Europe, the development of consolidated tapes has been mooted since prior to 2007 however, to date, the European Union has not fully developed a working model for one.

The use of transaction cost analysis (TCS) tools to help buy-side desks understand how their trading is performing is well developed in foreign exchange (FX) and equity markets, but bond markets use this far less in part due to the lack of available data.

Fixed income markets also see less use of execution management systems (EMSs) which can help to systematise and even automate trading to some extent, allowing easier trades to be processed based on a fixed set of criteria such as the volume weighted average price (VWAP).

Voice trading is still a major part of over-the-counter (OTC) markets such as fixed income and FX, while it is far less prevalent in equities.

For many investment managers, particularly long-only firms which seek to support investment based on longer term returns from assets in their portfolios, minimising the cost of trading as a part of the investment process is key. Some even allow their portfolio managers to trade directly into the market. For others, for example many hedge funds, trading can provide alpha by allowing them to take advantage of short term price imbalances, and arbitrage opportunities.

To improve the efficiency of their trading, buy-side desks use their order management systems (OMSs), execution management systems, smart order routers (SORs) and TCA to systematise the trading process, allowing their counterparties such as broker-dealers, investment banks, electronic liquidity providers (ELPs) and high-frequency traders (HFTs) to match their needs more efficiently than ever before.