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COVID-19 Underscores the Evolution in Electronic Trading

 

There is no turnkey response to the COVID-19 pandemic that has left no facet of life unscathed, as nations, governments, industries and society at large scrambled for solutions, and for ways to operate in the new normal.

As we track the road to recovery, we can expect change across all aspects of business and life, with new technologies and forms of communication driving change, and the world of electronic trading, responsible for some 80 percent of trading volume in North America, is no exception.

At the start of the global pandemic, we witnessed the closing of the NYSE floor, increased volatility in the markets, and the activation of the market-wide circuit breakers to allow the markets the opportunity to reset during the trading day due to extraordinary volatility. The temporary close of the NYSE floor, and the move to fully electronic trading, elevated the need for market participants to have a clearer picture of their intra-day trading activity.

Technology has had to step in to facilitate a level of communication that has historically been done by human-to-human interactions, and this will drive a new level of collaboration between asset managers and broker dealers to customize algorithms and refine routing protocols, without bias, to meet best execution expectations. 

This level of transparency and collaboration is sure to accelerate a new wave of evolution in the industry as it is increasingly driven by client demands for transparent and unbiased routing protocols in an environment where regulators are enforcing policy to bring more fairness and transparency to the markets

Rise of Technology in a Post-Pandemic World

The importance of information has become paramount as global market turmoil left economists, investors and strategists with no templates to consult as behavioural science, psychology and health issues, rather than fundamentals, drove markets.

As the pandemic drove traders and broker/dealers to work from home, it created an environment for communications and trading technologies to be leveraged in a way that people never thought possible, creating insatiable demand for tools that can help people to navigate their day-to-day trading activities.

Trading floors at broker dealers and at investment managers have always been rooms where people gather and share ideas, and that need has not changed, but the way in which it is being accomplished has. Today’s institutional investors have to collaborate more with their broker-dealers. They need to be more plugged in than ever to what’s going on, and to have confidence that their broker-dealers are leveraging the tools to use data to make informed, unbiased decisions on an algorithm’s behaviour and routing protocol. The need for real time and accurate insights around how and where trades are being executed, and under what conditions, is paramount to efficient execution.

The COVID-19 crisis has only augmented this need, forcing us to find ways to consume information in ways that are different from what we are used to. This is a fundamental and sustained change that is happening now.

This marks a time of opportunity to develop analytics platforms and algorithmic strategies that are more configurable, with technologies that provide market insights that afford them a level of comfort that they have never had before.  

Perfect Storm

Over recent years, we’ve seen rising demand for transparency from the institutional community and a subsequent regulatory response to meet that demand, whether it is MIFID’s focus in Europe on execution services, or the SEC developing regulation around transparency of ATSs.

There have been pushes on market data reform to create a level playing field for all investors, where all can receive the information they need to make informed routing decisions.

As clients begin to exercise more of their influence, and regulatory pressure mounts, a perfect storm is conspiring to drive technological developments that are in sync and give investors more control over execution quality; even with a great portfolio manager to guide investments for institutions, the implementation of investment ideas comes with a cost, and the institutional community has recognized that they can drive more efficiency by having more say around overall transparency in the execution process.

Where early electronification of trading was hindered by opacity and potential conflict of interest, the client of today and tomorrow will demand routing transparency, driving healthy competition among electronic trading technology providers.

More than ever before, an innovation mindset is driving investors to slowly leave behind legacy systems that prized speed and self-interest at the expense of transparency.

In the years to come, the empowered institutional investor will drive ever greater focus on how and where trades are executed. Trading volumes in equity markets, as well as others that have not yet embraced electronic trading, will increasingly be under the magnifying glass as the market gravitates toward a democratization of information that puts the needs of the main street investor first.

Still Evolving

The market will continue to evolve and the sense of control in order routing that institutional investors desire will be paramount. There will be continued market fragmentation, with three new exchanges, MEMX, MIAX, and LTSE. Fragmentation is only going to continue, and that’s a good thing, because it will lead to more innovation and competition and order types, but institutional investors need to engage with brokers that have the right tool set to optimize execution quality for each and every trade that they put through the system.

To be sure, algorithmic trading has come a long way, and most institutional investors are leveraging some species of choice in routing trades. Some of the larger institutions have worked with brokers to be able to customize or configure strategies in a way that has been more bespoke, but a whole host of others are still using much more commoditized, off-the-shelf offerings that, in years to come, will be increasingly rare.

The goal going forward will have to shift, rather, to ensuring institutional clients have the confidence that their broker-dealers are acting with their best interests in mind, and employing innovative technology to ensure their trading goals are being met, while at the same time empowering broker-dealers with the ability to have an algorithmic offering that they can customize with their own intellectual property and provide a differentiated electronic trading solution.

The role of technology is to help provide an accurate picture of how all of those marketplaces work, and to help synthesize clients’ instructions to figure out how best to access trading venues in a way that meets their needs.

The next stage of growth in electronic trading will be in the electronification of other markets. US equities have so far led the evolution in electronic trading, but we have reached a point where the other developed markets are not as far along in terms of their electronification, like the fixed income and currency markets.

As people start to rethink or re-architect their electronic trading strategy, they will gradually move away from the legacy systems in favour of technologies that are more agile, and which are designed with a fresh perspective on transparency and the ability to control an algorithm’s trading behaviour in real time. Systems that provide clearer choices, a greater understanding of how the execution process works, and tools to incorporate that knowledge into their overall electronic trading, are the ultimate goal.

Two-Pronged Strategy

Our vision at BMO is to empower the institutional client with a bespoke, unbiased, client-centered experience, embedded in deep market structure expertise that is data-driven, transparent, and supported by innovative trading technology. We also provide other broker-dealers with trading technology they can configure and customize to create an offering that they can use to differentiate themselves. We have a two-pronged strategy for leveraging our trading technology, direct-to-client through the BMO institutional relationships, as well as through our Clearpool brand to provide next-generation trading technology to other broker-dealers.

The Clearpool acquisition aligns well with BMO’s commitment to delivering exceptional client experiences, driving an innovation mindset, activating a high-performance culture and simplifying how we do business.

Sea Change

The market is experiencing a sea change, creating an opportunity to develop and embrace new, more agile technologies to benefit all market participants. It’s a holistic approach that is aimed at offering transparency and access to every venue and every order type. The benefits of these changes will be felt clearly throughout the industry as the proverbial playing field is leveled and market participants can better compete as they tailor technology to accelerate the efficiencies that their clients are looking to drive through the execution process.

As new venues continue to arise with new order types, the need for better, more innovative ideas to make the execution process more efficient, will only continue.For more information, contact aine.oflynn@bmo.com and joseph.wald@bmo.com.

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Aine O’Flynn Head, Global Equity Products & Research

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