Trader TV Bonds: Defining ‘best execution’

How do investors know if their traders are doing a good job?

A white paper has been published by the Investment Association (IA), to explain exactly that. Carl James, global head of fixed income trading at Pictet Asset Management, and head of the IA’s fixed income trading committee, and Ross Barrett, senior policy advisor at the IA, to discuss why investors need clarity on this issue, while Mike Thorpe, managing director at Tradeweb Europe explains if and when bond trading execution can be quantified and benchmarked.

Dan Barnes Welcome to Trader TV Fixed Income – your insight into the trading climate for professional bond investors. I’m Dan Barnes. How do investors know if their traders are doing a good job? A white paper has been published by the Investment Association to explain exactly that. In November’s show, we’re talking with Carl James, global head of fixed income trading at Pictet Asset Management and head of the IA’s Fixed Income Trading Committee, and Ross Barrett, senior policy adviser at the IA, to discuss why investors need clarity on this issue. We’re also speaking with Mike Thorpe, managing director of TradeWeb Europe, about measuring and quantifying best execution. Carl, Ross, welcome to Trader TV.

Ross Barrett Thanks, Dan.

Carl James Thank you.

Dan Barnes So when does best execution need to be addressed in the fixed income market?

Carl James Well, MiFID I really looked at the idea of creating a framework for best execution, but focused mainly on equities. That has now evolved quite a lot in the equity space where they’ve understood how to look at best execution, particularly through the use of trade cost analysis, so TCA. MiFID II focused on non-equity products, so fixed income, and it creates a higher hurdle for evidencing best execution. So, the idea of traders or buy-side traders having some sort of framework to look within has been provided by the regulator. However, we felt that it was right that the experts, the actual people that do the trading themselves, are able to put forward a more nuanced approach to the evaluation or analysis of execution.

Dan Barnes And Ross, what’s the purpose of the report?

Ross Barrett This paper isn’t about dictating to people, this is how you must do your best execution, because the IA is not in a position to do that and we shouldn’t be doing that. What it is, is saying these are the various factors, this is how they interact in different situations, and this is how you should consider them depending on what it is you’re trying to design. You’re trying to design an outcome for a particular trade at a particular time.

Dan Barnes And are there any risks in the interpretation of best execution reporting?

Carl James Yes, is the short answer. As an industry, we have a duty to our clients to be able to demonstrate what is it that we’re actually doing and be able to demonstrate how we’re evidencing, how we’ve done as good a job as possible within the parameters set. And I think what we want to be able to make sure of is that it’s not just a number, a single outcome. Generally with the more liquid instruments, there’s a lot more data. And what you’re able to do is plot those data points against what you’ve been doing, so it’s very much outcome-based.

Ross Barrett What we’re trying to do with this paper is explain when you need to take different kinds of approaches, how the different factors interact with each other, why trading made certain decisions. And also, with a fixed income trade, it can be executed over a much longer period of time, so what the PM is asking the trader to do, can change over time, during the course of the order. So understanding the story of how the trade actually unfolded, the layers that you’re talking about, is really important. If you are the compliance or the end client or senior management, you want to want to understand what has actually happened during this trade.

Carl James I mean, if you think about trade cost analysis, I first came across trade cost analysis in 1995. Very simplistic. We can look at the equity world and what they’ve done in TCA and learn from that, pick the right things from that that are relevant to fixed income markets, potentially where there’s more data you can pull that out. So you can say, ‘actually, we will pick some of that methodology and put that into some of the more liquid parts, generally the rates area.’ But also, we’re benefiting from an additional understanding of how to use data, and it is different. It’s not one’s better or worse, it’s just different, it’s a different asset class.

Dan Barnes Are there any changes that you’d like to see in the market which would support best execution development? I mean, there’s been talk of a consolidated tape in fixed income fx?

Carl James Yeah. So, the IA’s position is that we’d like to see a consolidated tape. There is a possibility within the new regulation, MiFID II, that there can be one. That hasn’t happened yet, so we’d like to see that being picked up by the regulator, but minus Brexit, let’s leave that aside. But we’d like to see that being picked up by the regulator and provided by them and that extra information would feed back into the market. We think it would enhance liquidity, enhance transparency. It would enhance the understanding that the end client has of what’s going on.

Dan Barnes Ross, where is the complexity in what traders are trying to achieve?

Ross Barrett That’s a really good question, because we talk to a lot of the heads of trading across our membership. And we’ve got a very consistent story, actually, about how complex some of the trading can actually be. And, you know, just coming back to this theme about not just having one number as the solution to everything, in terms of looking at how well you traded. So it’s like if you decide to buy a car, if you’re sole factor is, how much does it cost? That doesn’t necessarily get you to the right solution, and taking it back to bond trading is saying, ‘well, what data did I have? How is the market moving? How quickly was the market moving? What instructions was I given by the PM? How quickly did he want me to execute? What kinds of bonds am I trying to get into or get out of? And what cost are we willing to accept?’ So, understanding all of that without trying to make it smoke-and-mirrors and saying, ‘look, there is a genuine reason for this.’ That’s what we’re trying to unpick.

Carl James Trading is complex and generally doing any trade in any market. I mean, using the car market, it’s complex. There’s lots of choices out there. The good news is we’ve got some data. What we’ve got to do is, is push and understand where we have that data, utilize it appropriately and where we don’t have data, look for other ways of evidencing that best execution. This paper was written to say – rather than say, ‘here is a prescriptive methodology, ABC’ – it is, ‘here are some of the things you should be considering.’ And what it does is, it opens up the debate. And what’s nice about this is that the committee were all involved in writing this paper, and it was about making sure that we were adding our experience and expertize over the years to say, ‘well, this is where we think execution can demonstrate some real added value.’

Dan Barnes Ross, Carl, thank you very much.

Both Thank you.

Dan Barnes Now we’re going to speak with Mike Thorpe, managing director at TradeWeb Europe, about the potential for measuring and quantifying best execution to better support transparency. Mike, welcome to Trader TV.

Mike Thorpe Thank you very much for inviting me.

Dan Barnes It seems that there is a tension among traders between using transaction cost analysis, which is often thought of as an equity term, and best execution analysis. Do you think that best execution should always be quantifiable?

Mike Thorpe In fixed income in particular, there’s only a set of data that covers part of the fixed income spectrum to make transaction cost analysis make sense. But I think that’s a growing, partly through the continued expansion of electronic trading itself and partly through the reporting requirements that are fed through. Most of our clients would also recognize that they need to be able to define their best execution process, and that they need to be able to measure the steps through that process.

Dan Barnes So what do you think traders can do to better support best execution and reporting?

Mike Thorpe Well, I guess coming from a trading platform, you wouldn’t be surprised that one of the conclusions for us is definitely that where it’s possible, trading electronically is going to help in that process. It’s certainly possible in the post, MiFID-environment now  to process trades that have been traded by voice, and to pass those through a trading venue and even as a final step, the most important thing is, that they record an accurate timestamp and get them benchmarked against a suitable reference price.

Dan Barnes Do you think the data in the market at the moment, is it reliable enough to support the process as well?

Mike Thorpe If you’ve got a trusted source and a reliable provider of data, then I think you can cover a significant amount of ground. You should be using an active platform for sourcing that data. And obviously, the more electronic activity grows, and it has been growing even before MiFID II, for instance, European investment grade credit has now moved past the 50% mark in terms of amount of activity traded electronically.

Carl James Whereabouts do you see the most reliable data in terms of fixed income instruments at the moment?

Mike Thorpe There’s no doubt I think everybody would agree that in the rates world, say, in the government bond market, the data is most reliable. I think now in investment grade credit, there’s a growing amount of electronic activity, as I indicated, and I think, increasingly, there’s a wider and wider universe that can be relied upon of data and therefore measurable outcomes.

Dan Barnes How are traders engaging with you when they talk to you about this? What sort of challenges do they bring to you?

Mike Thorpe More and more of them have data analysts sitting alongside the trading teams. So, they are calling upon us for more and more data, their own data, as well as perhaps reference data, platfor- wide data. It’s incumbent upon us to be able to deliver more and more information, even if it’s for the same trading activity, just to satisfy their increased demands and requirements to analyze it.

Dan Barnes Is it deep enough and wide enough as a data set?

Mike Thorpe As I said, the growth in electronic trading is generating more data and more pertinent data. There’s more streaming data fed pre-trade by dealers. To take something like the European investment grade market, that’s moved to now more than 50% electronic since MiFID II. So, that’s generating on our platform and elsewhere more and more interesting data and reference points.

Dan Barnes That’s great. Mike, thanks very much.

Mike Thorpe Thank you very much.

Dan Barnes I’d like to thank Carl James of Pictet Asset Management, Ross Barrett of the Investment Association, and Mike Thorpe from TradeWeb, for their insights into best execution for bond trading, and of course you were watching. To catch our monthly reports on other markets or to subscribe to our newsletter go to TraderTV.NET.

Published on November 9, 2018

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