Trading analysis for money managers is moving beyond traditional transaction cost analysis — ensuring best execution and cost control — to watching over the entire lifecycle of every trade.
Regulations such as the Dodd-Frank Wall Street Reform and Consumer Protection Act and the European Union's Markets in Financial Instruments Directive, which require an audit trail for trades, have meant that verification and compliance issues once the responsibility of investment banks and brokers on the sell side have become a duty of buy-side money managers as well.
Those regulations “were a shot across the bow” for the buy side, said Michael O'Brien, head of product development, Nasdaq SMARTS Trade Surveillance, London.
“Regulators are pushing responsibility (for trading) further and further,” Mr. O'Brien said. “Ten to 15 years ago, we would not have seen the push for sell-side trade control. ... And even just five years ago, manager responsibility for trade control would have been unlikely. At each step, regulators have stepped up their trade-control mandate.”
Ted Morgan, CEO of Abel/Noser Corp., New York, said that along with Dodd-Frank and MiFID, programs and guidance from the Securities and Exchange Commission and the Financial Industry Regulatory Authority also have heightened the need for trade surveillance. “There's guidance from FINRA, pilot SEC programs, a lot of regulations related to trading,” Mr. Morgan said. “There's 605 reports (the SEC rule requiring disclosure of trade execution practices), 606 reports (SEC-required quarterly reports on trade routing), the SEC's tick-size pilot, scans to find layering and spoofing.”
That has meant that money managers have had to increase their monitoring of trades from inception to reconciliation, and it's also meant that firms focusing on transaction cost analysis have had to add more capabilities in what sources called trade surveillance — “the repository of all trading activity along with monitoring any potential regulatory or governance violations,” Mr. Morgan said.
“Trade surveillance tools are pretty new to us,” said Peter Weiler, New York-based president of Abel Noser Solutions, the financial technology unit of Abel/Noser Corp. “Primarily, they were used by the sell side, but now we're seeing interest from the buy side, particularly large institutional managers.”
Trade surveillance monitors such actions as marking the close, or valuing stocks higher at the end of each quarter to inflate the overall return; cross-trading in the same security in the same account to get additional trading costs; and spoofing, or seeking a high number of quotes from brokers and then pulling out of the trade at the last minute to influence the price of a stock without executing a trade.
“Monitoring the lifecycle of a trade from creation through settlement is paramount to understanding its risk and impact” on the funds that hold the stocks being traded, said Drew Miyawaki, head of global equity trading at Legal & General Investment Management America, Chicago. He added that LGIMA “views this surveillance as an integral part of fulfilling our best-execution responsibility.”
Using MiFID requirements as an example, Steven Glass, president and CEO at Zeno Consulting Group, Bethesda, Md., said the need to have trade information readily available for regulators is what is driving managers to move into trade surveillance. Zeno is a consultant to money managers and pension funds on trading issues.
“MiFID II requires all money managers that have operations, strategies or clients in the U.K. and Europe to maintain a process to provide a clear audit trail, and that will apply to their trades,” Mr. Glass said. “It might also apply to trade surveillance. Most managers don't have the platform to do this.”
About 30% of Zeno's clients are mutual fund managers that use subadvisers, which means they have oversight needs that could be met by trade surveillance, Mr. Glass said. While asset owners look at trade costs based on their effects on investment performance, he said, compliance officers are pushing mutual fund managers for trading analytics.
“With trade surveillance, what I think of are tools for brokers and exchanges,” Mr. Glass said. “But there are so many requirements these days. ... Yes, best execution is a requirement, but there are a ton of other requirements.”
