Some market participants are tepid on the notion. According to a recent Tabb Group survey, 47% of buy-side firms, mostly those with modest levels of assets under management, did not think their brokers were doing anything innovative.
So almost half of investment managers suspect the firms that handle, route and execute their trades are skating by. That’s not a flattering snapshot.
But drilling down below the headline number, there is ample evidence that innovation is alive and well in the brokerage space. And it is being driven by the brokers who are working most closely with their clients to customize strategies and optimize outcomes.
“Some of the smaller clients who were included in that survey probably have very focused trading strategies, and their needs are very specific to what they are trying to accomplish,” said David Don, head of quantitative, execution and risk products at Lime Brokerage, a Wedbush company. “It’s important that brokers work to understand their clients’ specific trading objectives and work collaboratively with them to tailor and tune execution algorithms to meet these objectives.”
Indeed, large sell-side banks have been capital-constrained in recent years, and trading desks have winnowed to a fraction of the size they used to be. This has forced a more clearly delineated prioritization of clients; so for a smaller buy side whose trading is tasked to an overworked junior person working an off-the-shelf algorithm, broker innovation likely would be hard to discern.
A U.S. bulge-bracket firm that had 100 equity traders in 2000 may have had just 5 to 10 in 2016, FIA EPTA Chairman Remco Lenterman estimated on Twitter last year. As banks downsized and sought profits in other lines of business, nimbler, more technology-focused firms added traders and technologists, expanding their capacity for innovation.
Narrowly defined, the word innovation refers to a new method, idea or product, say Edison’s incandescent bulb or Graham Bell’s telephone. But brokers don’t need to reinvent electronic trading to be innovative — in the context of the broker-client relationship, innovation entails doing what it takes to get the trading right, whether that be turning an idea into a solution that cracks a code for a customer, or applying creativity, relationships, and new thinking to add value.
“As both DMA and algorithmic order types have grown increasingly complex, clients benefit from brokers that have developed the expertise to dive deep and analyze how both high-level algorithm decisions and low-level child order parameters impact execution quality,” Don told Markets Media. “Bringing a customized product and quality service to all clients is important, especially in the algorithmic execution space. Technology flexibility is important in all stages of trade execution, from strategy configuration to the choice of order entry protocols used to reach the market, whether it’s broker implemented algorithms or APIs that help clients build their own algos.”
Innovation is a primary focus for agency broker ITG, which has targeted the execution business that has been neglected by the bulge bracket. That entails “ensuring that we take already strong capabilities and make them stronger,” ITG CEO Frank Troise said June 6 at the Sandler O’Neill Global Brokerage and Exchange Conference in New York. “Not just having great technology and great features and functions, but wrapping around that a great client experience.”
The next wave of broker innovation likely will be geared toward democratizing quantitative trading, according to Kershner Trading Group Founder and CEO Andy Kershner. That would vastly expand the universe of high-level quant traders globally, which Kershner roughly estimated stands at perhaps 5,000 today.
“It will be very similar to what you saw when you had access to the market open up in the mid-90s for day traders,” Kershner said. “You had lots of innovation, lots of people coming in with lots of ideas, and lots of software that really changed and knocked out all the market makers. Then high-frequency came along and killed all the specialists and also knocked out some of the day traders. I think now we’ll see a reversion.”
“You’ve got ‘big data’ out there everywhere that everybody talks about, but the moat is access to the data, access to capital, and access to some knowledge of what to do with it,” Kershner continued. “I think in the next three years if you do not have an auto- or quantitative-trading system that’s more than just APIs — you’ll need back-testing, forward-testing, live, the whole package — if you don’t have that for people to sign up for, your brokerage will be left behind.”
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