Best Execution/TCA (Trade Cost Analysis)

As data proliferates, best execution practices and Trade Cost Analysis (TCA) present both challenges and opportunities to fixed income traders. Increased regulatory pressures, a drive towards greater operational efficiency, and requirements for "best execution" are leading buy-side firms to reassess both their data requirements and their technology infrastructure. And as the amount of information available to traders increases, players throughout the industry are being asked to re-evaluate the quality, efficiency, and sustainability of their trading systems.

Setting New Standards

Introduction of the EU’s revised Markets in Financial Instruments Directive and accompanying Regulation (“MiFID II”) in January 2018 marked the beginning of a new era of regulatory awareness in the fixed income trading sector. MiFID II was designed to build on its predecessor regime (MiFID I) by establishing a more transparent financial system, restoring investor confidence, and improving the way that capital markets function “to the benefit of the real economy”.

Under MiFID II the buy side faces increased scrutiny over why they continue to work with their chosen brokers - and the regime imposes an obligation on organizations to put monitoring in place, so that they can guarantee the best possible results for their end clients. In this environment, the concept of best execution extends beyond a remit to achieve optimal pricing, to dictate that firms should optimize execution in terms of costs, speed, and the likelihood of execution and settlement.

Since the launch of MiFID II in Europe, global regulators and cross-border trading institutions have been under mounting pressure to bring their markets into line with new regulations. The July 2018 risk alert issued by the SEC Office of Compliance Inspections and Examinations (OCIE) increased the pressure, putting fresh emphasis on the need for compliance.

Organizations looking to show that they are taking sufficient steps in complying with best execution requirements must now hold themselves to a higher standard. They must make definitive moves to establish the best trading protocol to meet their liquidity needs, keeping a close eye on their investments in new technology. Hiring practices and service acquisition must be implemented with an awareness of the capabilities required on the buy side to actually achieve best execution for clients.

Obstacles To Best Execution

Generally speaking, exchange floor price quotes, over-confidence in market knowledge, and rigid mind-sets are all challenges for players in the fixed income world striving for best execution. In the face of industry standardization, traders must adopt a multi-faceted approach which gets the dealing team more involved in all aspects of the desk and technology workflows, while bringing the organization's investment, dealing, and execution strategies closer together.

From an operational standpoint, this requires an improved attitude and approach to data handling, and a willingness to embrace new technologies.

Trade Cost Analysis In Brief

One of these technologies is Trade Cost Analysis (TCA) - a process cited by some as an enabler in evolving best execution processes beyond RFQ, with liquidity transparency.

TCA (or Transaction Cost Analysis, as it's commonly referred to) lets traders analyze the cost of a decision to trade over a specified time period, with respect to various benchmarks. Each executed trade in the period of analysis is marked against a series of performance benchmarks, and the results are displayed in multiple interactive tables.

Trade Cost Analysis methodology enables analysts to drill down in a variety of categories, including trade date, order side, exchange, trade price, and underlying, to discover how each trade performed when compared to the benchmark.

Applications In The Asia Pacific Region

In Asia - a region of disparate rules, fiscal priorities, benchmarks, and differing levels of electronic-trading adoption - TCA is being applied to help cut costs, retain clients, and streamline workflows, beyond its relevance in matters of compliance.

Asia’s World City of Hong Kong has readily embraced best execution, with strong, transparent TCA now a vital priority for market participants operating within the city’s compliance framework. Similarly, the Monetary Authority of Singapore (MAS) was quick to roll out its own best execution requirements at the start of 2018, with robust TCA sitting at the heart of its bid for seamless regulatory compliance.

In Malaysia, though best execution requirements are yet to be enshrined in legislation, the importance of TCA has recently been in focus, due to the rapid expansion and digital transformation of local markets. By contrast, with the conventional benchmark in Japan being the volume-weighted average price (VWAP), which has very little market deviation and very tight quotes, a lack of regulatory pressure has kept adoption of TCA limited.

Elsewhere, the reliance of Trade Cost Analysis on abundant supplies of verifiable data has limited its scope in emerging or less technologically sophisticated markets, such as Indonesia. However, as development and international engagement with Indonesia continue, regulation and competition will heighten the need for integrated TCA as a tool for participants in the Indonesian market.

TCA In An Evolving Space

As the best execution imperative makes its influence felt over broader sections of the industry, there will likely be a growing market for integrated tools enabling Trade Cost Analysis. These will have to draw upon strong trade and market data for monitoring the effectiveness of execution arrangements, and support multiple asset classes, including fixed income, FX, and even OTC derivatives.

You can hear:

speak at Fixed Income & FX APAC on a Keynote Panel ‘Generating alpha through smart execution - As the role of the buy side continues to evolve and demand for performance increases, how can you calibrate best execution for enhanced liquidity and transparency?’

Download the agenda today for more information and insights.