Key to the highway
Swinging between a high- and low-touch approach can put trade execution at risk, and finding a balance is key, says Steve Grob of Fidessa
In the beginning there was high touch, where brokers provided a high-value, solution-based approach to finding the liquidity their buy-side clients were looking for. This worked in an era of high fees and low scrutiny of what end investor trading commissions were actually funding. But, as markets electronified, and buy-side operations tooled up, a new paradigm was born: low touch. This reflected the buy side’s growing desire for cheaper execution, especially for trades that weren’t that hard to execute, and it also offered a path that minimised information leakage.
The result? Two routes to market with very different price tags. The problem was that brokers had to duplicate their trading infrastructure despite receiving fewer net commission dollars. This spawned the short-lived concept of mid touch, which offered the worst of both worlds, and junior sales traders without the experience or the expertise to manage either. And so the industry muddled along, ignoring the operational overhead of running two technology stacks.
Today, however, the industry is at a crossroads. Regulation, combined with the global economic environment, means that the idea of providing separate high- and low-touch channels is more flawed than ever. A new approach is needed—one that converges technology stacks where appropriate and equips brokers to provide a blended service of premium (high touch) and standard (low touch) services. Most important is that they can be provided to the buy side in such a way that they switch seamlessly between the two, throughout the day and throughout the lifecycle of each order.
Hellhound on my trail
The determination of regulators to increase transparency and accountability remains unbowed. The most recent example is the European move to unbundle the relationship between research provision and trading execution fees. Soon, investment managers will be forced to either pay for research out of their own profit and loss balance, or ensure that execution commission payments are clearly not to the detriment of their end investors. The flip side of this regulatory coin will be a renewed focus on execution outcomes, and so providing the optimum combination of high- and low-touch services will be more important than ever. On top of this, the regulators are doubling down on their requirements over the transparency of the buy side-sell side relationship, which means further costs to keep both high- and low-touch platforms in line. And it’s not as if finding liquidity is getting any easier, especially when firms wish to trade in size.
As a result, a number of initiatives such as intraday auctions, block crossing capabilities and other material, have all aimed to orchestrate the liquidity available. But, because they compete, the resulting cacophony just makes matters worse.
Change my ways
The good news is that the buy side is willing to pay to resolve this complexity, but it requires a completely different approach from the traditional high-low touch separation of old. The fragmented nature of equities trading means that even a relatively low-touch order in a liquid stock needs to visit tens of venues in order to be properly executed. Low-touch platforms therefore need to stretch across many different venues. The challenge to create a single market access fabric is considerable.
Furthermore, sophisticated low-touch algorithms are needed to nullify the effects of this fragmentation and provide good execution outcomes for clients.
Today’s high-touch trader needs a range of technology too. This might be dark-seeking algorithms, smart routing or customer relationship management systems that track who is holding, or
likely to be holding, liquidity. The high-touch desk will often look at the automation and tools employed by low-touch or programme-trading teams for inspiration, and, in some cases, borrow their technology directly.
So while the activities and business models of high and low touch are diverging, the underlying technologies are converging.
This requires careful management to avoid unnecessary duplication and cost while optimising the very different business service a high or low touch client receives. This then allows a standard (low-touch) and premium (high-touch) service to coexist and be interlinked. If architected correctly, the separation between these two can be viewed as a permeable membrane though which orders can travel in either direction, at the client’s discretion, with a higher fee charged whenever the order is in the high-touch, or premium, zone.
It is a simple fact that low-touch service lines were established after high-touch ones, and so made the creation of a second whole new technology stack inevitable. This led to a new set of market gateways, a super-lite order management system that could support low-touch algorithms and a financial information exchange interface for receiving client order flow. But by then the high-touch desk was receiving the bulk of their orders electronically too and, of course, sending them out to market the same way.
The sensible approach, then, is to collapse all the technology supporting both business lines together. This allows more effort to be put into market and asset class coverage, performance, speed and resilience—benefitting both high- and low-touch service lines. It is something that can be extended to other desks too, such as programme trading, and even between asset classes or completely separate business units.
The premium zone is where the real differentiating technology can be found, but because it is now sitting on a converged stack, its operational costs are much lower. This frees up resource to deploy cool, high-touch tools that can quickly solve any liquidity problem.
Intelligent indicators of interest (IOIs) are one way to do this, but only if they can be underwritten by genuine merchandise. Another will be pulling together all the information held within a firm about a particular stock. Other decision support tools will form part of a more sophisticated, but above all technology-fuelled, high-touch service.
This then allows for some intriguing approaches to solving trading problems for clients. One example is that an investment manager may be using a low-touch channel for an order so as to minimise its execution cost. It may be, however, that a smart IOI has uncovered a large block in the same stock over on the high-touch desk. Because they both share the same technology, it’s now easy to communicate the block opportunity to the client and execute it. In this way orders can navigate through high- and low-touch zones so as to achieve the optimum liquidity outcomes for clients.
This is hip
The terms ‘high-touch’ and ‘low-touch’ seem clunky and outdated, as they are simply too crude a reflection of the practical realities of trading today. They may well be part of the lexicon of our industry, but they imply a separation of technology that simply doesn’t have to be there, and this costs money and worsens execution outcomes for clients.
While it is true that the spectrum of trading challenges is getting broader, truly effective trading is about allowing clients to combine a range of different services. Firms that implement a blended approach will be able to dominate liquidity in their chosen areas. What’s more, they will operate at lower costs whilst providing a more valuable service to clients. They really will have the key to the highway.