The Great Migration of "Best Execution"

The slow-motion migration of "best execution" responsibility from Sellside to Buyside…

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This summer, the weather won’t be the only thing heating up.

There may also be some sweating around May 20th with the updated requirements of SEC Rule 606. Your broker’s order-routing and the many reports they will spawn, will have more than a few folks reaching for a tall, cold one.

SWEATING

The regulatory intention is to bring Buyside scrutiny of Sellside order-handling. It's not just about the fills anymore; now it's about the routing. The SEC wants to shine a light on things like broker prioritization of execution venues, dark-pool internalization, interaction with inverteds and conditional orders. So yes, the pressure will grow.

But maybe not as you might expect….

For anyone that hasn’t recognized it, Wall Street is in the midst of a slow-motion migration of "best execution" responsibility FROM the Sellside TO the Buyside. All the fancy broker tools are indeed available to everyone on the Buyside now. And not just the core algorithms. A vast array of Wheels, Analytics and Customization of intra-day routing and route-visibility has empowered the Buyside trader in a manner that has never previously existed. So in this light, the whole routing conversation takes on a new hue.

You can expect muted reaction to the onset of the new 606 requirements. The initial finger-pointing will be less dramatic than most people expect, so relax. But there will indeed be some initial fingers pointed at certain Sellside brokers. The Street will take awhile to digest all the excuses - some of which will be legitimate and some not. But you already know what to expect. “...But I’m white-labeling.” “But our data shows…” So it will take awhile to suss-out the fluff.

But then, over time, something unexpected will develop. Eventually, it will be the Buyside trader who begins to feel a little flush.

Because the conversation will start moving from what your broker is doing with that order - to what YOU are doing with it. You know all those endless purveyors of analytics, applied routing logic and newfangled pools who are banging on your door every day? Their very existence will ultimately bring this conversation full circle.

NO EXCUSES

The Sellside is a toll-taker whom the Buyside is legally mandated to utilize in accessing the markets. But the "brains" of the order routing are now becoming independent of the broker you use.

So you must shift your thinking to the paradigm of the utility company.

The Sellside model is becoming something akin to that of the water company or the electric company. Oligopoly ensures their continuance. Yet it does nothing for the general quality of product. This means that the onus is growing upon the Buyside to get THEMSELVES the "best execution" - however they define that. The tools are tight enough now. Big Data has removed all the "excuses" if you will.

This leaves the Buyside trader a very different dilemma; how to master this new responsibility and all these adjacent technologies? This is evolution. On one hand, it is scary for the Buyside trader. On the Other hand, it is how execution should always have been - but never was. Change creates opportunity. Forward-thinking firms and personnel will embrace this development.

Because this shifting responsibility represents the opportunity for the Buyside trader to truly add alpha to the investment process. This is increasingly moving to the individual person-level. Who can more tightly drive their Indy racecar through the hairpin liquidity turns?

For the Sellside, this becomes an opportunity to truly partner with their Buyside customer. That sounds like the current broker-marketing fluff, I know. But the proof will be in the performance pudding. Currently, any REAL electronic coverage person will tell you their most active user of Algo X knows that product’s nuances better than the coverage person themselves - so they effectively become partners. Because like it or not, routing is the new battleground. And I realize that nobody wants to engage in this fight. But snap-on your chin-strap.

WHO?

Traders on both sides agree that liquidity is the Holy Grail of execution performance. The question has always been around how to best source this.

The truth is nobody cares about the minutiae of the algo, router or the wheel. Folks only care about the result: the proper targeting of marketplace liquidity in the moment. THAT is what defines an electronic product as excellent or terrible. It’s the old “features vs. benefits” thing.

Yet liquidity is not a static thing in an evolving market.

So the routing logic truly matters. Execution quality always depends on precisely how those various, competing, route-logics conduct these liquidity hunts. And this lies at the core of the forthcoming 606 requirements.

So all the barking about market-data fees, speed-bumps and rebates are not merely academic debates. These things impact trading costs and thus, best-execution.

So here’s the crux of the matter: who is ultimately responsible for best-execution?

Right now, it is officially your broker. But you and I both know that this isn’t REALLY the case. At least not for any Buyside shop that ultimately wants to grow its AUM.

TALL COOL ONE

So the Great Migration begins in earnest next month. May 20th starts the slow-cooker on the Buyside aspect of this conversation. Personally, I’ll be attending the Securities Traders Conference in Charleston that week. I’ll be the guy with the tall, cool one.

Come join me.