Transaction Cost Analytics Stuck in Neutral: Accelerating At-Trade Adaptation

by David Easthope, April 20, 2010
Product Trends/ Reviews
EMEA, North America

Abstract

With an evolving equities market structure underscoring the need for tools to enhance execution strategy, buy side firms on the leading edge are showing that more technology adopted at-trade can help reduce execution costs and move beyond the “measure it and forget it” attitude that is widely prevalent in the marketplace.

While even elementary Transaction Cost Analytics (TCA) has yet to be fully leveraged by the buy side, those firms that have embraced TCA are moving beyond simple measurement and intermittent evaluation of execution strategy to actually adapting strategies at the point of trade. The at-trade movement involves some increased use of pre-trade analytics, but it also includes the use of sophisticated new technologies to monitor execution at the point of trade and switch strategies based on a dynamic feedback loop.

The financial crisis and the advent of high frequency trading (HFT) have changed the rules of the game for the buy side, making real time adaptation necessary to maintain and improve existing execution strategy, according to a new report, Transaction Cost Analytics Stuck in Neutral: Accelerating At-Trade Adaptation. As the market structure evolves, so must the buy side, particularly as explicit execution costs fall and implicit execution costs are more closely scrutinized.

Specialized TCA vendors and leading execution brokerages are offering more tools to meet this demand. While some promises of real time TCA are just promises of faster data, many brokerages are indeed providing the useful granular data that is a necessary input to these new methodologies. Other leading boutiques are going even further to the edge. These firms are providing specific tools to monitor performance during the execution phase. Traders are being allowed to input smarter parameters to automate the monitoring and switching of execution strategies based on these parameters for stocks during the trading day. In other words, TCA is extending from an ex-post review of execution to an ex-ante prediction of which execution strategies/algorithms will be most efficient.

“The TCA discipline continues to evolve so that leading edge buy side firms can more effectively refine their execution strategies,” says David Easthope, Senior Analyst with Celent’s Capital Markets group and coauthor of the report. “Today, those firms that have embraced TCA are moving beyond simple measurement and intermittent evaluation of execution strategy to actually adapting strategies at the point of trade.”

“While at-trade developments are pushing TCA forward generally, some specific areas will be key drivers of this at-trade evolution, namely intra-day algorithm performance measurement and predictive switching,” says Mayiz Habbal, Senior Vice President of Celent’s Securities & Investments practice and coauthor of the report.

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned subsidiary of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

North America
Michele Pace
mpace@celent.com
Tel: +1 212 345 1366

Europe (London)
Chris Williams
cwilliams@celent.com
Tel: +44 (0)782 448 3336

Asia (Tokyo)
Yumi Nagaoka
ynagaoka@celent.com
Tel.: +81 3 3500 3023

Table of Contents

Executive Summary

3

Introduction

5

 

Back to Basics

5

 

TCA Tools Moving to At-Trade

5

Transaction Cost Analytics Overview

7

 

Role of Transaction Cost Analytics

7

 

Execution Hierarchy

8

The Evolving Role of TCA in Execution Strategy

11

 

Evolution of TCA

11

The HFT Environment Changes the Rules of the Game

14

 

HFT Background

14

 

How HFT Changes the Rules of the Game

16

TCA Not Fully Leveraged in the New Environment

24

 

TCA Is Too Hypothetical

24

 

Step 1: Baby Steps

24

 

Step 2: Advanced Application

25

Advanced TCA Players Provide the Tools

26

 

The Players

26

 

Areas of Innovation: Independent Vendor Tools

26

A Tool Equal to the Task? The Rise of Predictive Algorithmic Switching

29

Case Study: Pipeline Trading and AllianceBernstein

33

 

Background

33

Conclusions

36

Leveraging Celent’s Expertise

37

Related Celent Research

38

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