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Europe’s paradox: TABB says over 80% of buy side firms trade in the dark but equally complain about the lack of transparency

Tuesday, November 02, 2010
Opalesque Industry Update - With 83% of the buy-side traders across Europe saying they trade in the dark, nearly an equal amount, 74%, cite the lack of transparency as their biggest issue across the market place, what TABB Group calls Europe’s “paradox.”

According to Miranda Mizen, TABB principal, head of European research and author of the strategic advisory and research firm’s fourth annual benchmark study, “European Equity Trading 2010: Manoeuvring in the Markets,” buy-side traders are still hampered by the MiFID post-trade environment now in its third year of implementation. This is causing them to expand their trading strategies amidst persistently low-volume and still-fragmenting markets.

“These low volume markets have slowed the trend towards low-touch channels,” says Mizen. “Throughout our interviews, buy-side traders told us they need the colour, trading expertise, flow and access to risk capital offered by their brokers’ sales trading desks. However, they are sceptical about the lack of improvements in the post-trade environment, concerned that changes to dark trading will work against them if dark pool flow is restricted or if unfinished business is suddenly exposed.”

Armed with the past year’s data and analysis, they tell TABB that they are now in a better position to weed out brokers’ undifferentiated algorithms with 63% saying they have changed the way they trade, using a broader range of strategies, including dark trading, algos and the use of risk. In addition, traders say that customisability is their most favoured feature in current use of algorithms. “As a result,” Mizen explains, “the combination of HFT, fragmentation, lack of transparency and low volumes means buy-side traders require a keener understanding of liquidity’s ebbs and flows, and to be highly discriminating about where they trade.” She adds that TABB Group sees high frequency trading as a percentage of turnover in European equities reaching 38% in 2010, projected to grow in 2011 to 40%.

For brokers seeking increased order flow, the answer lies in helping the buy side help itself, by delivering high levels of responsiveness, especially with algorithm customsation requests, monitoring algorithm performance and providing feedback. Adding a cautionary note, she says that proven performance remains the top criteria for selecting an algorithm, raising the bar to newcomers as non-differentiated algos are weeded out. She also learned that persistently small commission wallets are putting pressure on brokers’ lists because “traders cannot risk diluting the services they need, spreading their payments too thinly.”

Beyond the trading room floor, Mizen concludes, “the buy-side’s challenge is to ensure that policy makers in Brussels and elsewhere across Europe understand the impact of any change in the regulation of their business. As the markets continue to fragment, their ability to use a range of alternative strategies will help them keep trading costs at a minimum. With greater choices, solid analysis, data sets and expanding knowledge, the buy side will have far greater control when they gain better transparency in and across the market place, and once again see thicker commission wallets.”

The 47-page study with 52 detailed exhibits is based on in-depth, one-to-one interviews with 53 buy-side traders from asset management firms dealing in European equities. These firms were segmented into three geographic regions based on the location of the trading desk: the UK, 59%; Continental Europe, 30%; and the Nordic region, 11%. Data and analysis are pan-European with regional data given where TABB saw a difference in opinion, behaviour or trend.

Key areas examined include: new trading strategies employed and changes in trading style in 2010; pan-European trading channels; high-touch vs. low-touch trends, 2009–11e; pros and cons of current algorithms; criteria for choosing an algorithm provider; impact of high frequency trading on trading costs; pros and cons of HFT; brokers’ smart-routing criteria; number of algorithm providers, 2009–11e; top algorithm providers in Europe; measuring the quality of execution in the dark; direct connections to crossing networks; average daily traded value using risk capital (weighted); average number of core and non-core brokers; commission sharing agreements (CSAs); commissions paid, 2009-2010; top pan-European brokers; specialised brokers; value of the sales desk; use of sales trading, 2005-11e; bundled and execution-only commissions in 2010; and commissions split by trading channel, 2009–10.

The study is available for immediate download by all TABB Research Alliance European Equities clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. For an executive summary or to purchase the report, please visit http://www.tabbgroup.com, or write to info@tabbgroup.com.

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