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According to TABB Group in new research issued today, “Execution Cost Management: Improving Margins, Strengthening Relationships,” as buy-side firms re-examine their broker relationships due to reduced coverage, market uncertainty and fewer commission dollars, their brokers are beginning to embrace execution cost management (ECM) systems to quantify trade cost savings.
Variable equity execution cost analysis has been overshadowed by transaction cost analysis (TCA) for several years, but by combining TCA, commission rates and variable trading costs, brokers say that they now realize they need to gain a more holistic analysis of servicing clients to improve the return on relationships.
For some brokers, says Matt Simon, a TABB Group research analyst and author of the report, “ECM is but one component of a complex web of services and business models, while for pure trading shops it is the core measure of profitability.” ECM, he says, includes variable costs – execution fees, messaging charges and clearing and settlement, as well as fixed costs – exchange memberships, hardware, bandwidth and support staff. However, determining execution costs associated with a trading desk, trader or client is difficult. “Reconciling monthly bills with some historical blended execution cost may work for brokers satisfied with the status quo, but to seize on the rare circumstances of today’s markets requires a deep analysis of order flow. ECM requires an accurate and granular set of data as well as having the right tools in place to monitor trading decisions and track results.”
Although many brokers are analyzing their variable execution costs, says Simon, most are only scratching the surface. “Part of the problem is that execution venues disclose varying amounts of cost data to brokers. The results is an inconsistent, untimely set of data that only lets brokers question figures that are clearly erroneous. Unless further regulatory stress is placed on the individual execution venues to provide more accurate execution cost data, these brokers are left with the messy business of assembling the data on their own.”
In the interim, he adds, “CFOs at smaller brokerage houses are burning the midnight oil trying to turn inconsistent raw data into usable information. The consensus view among the brokers we spoke with for this report is that improvements are needed in the analysis of execution costs and solutions to mitigate these costs. However, with resource constraints already tight, few small- and mid-size brokers have the internal resources to build systems to capture, aggregate and analyze all of the needed data.”
Because maker-taker fees are the largest variable execution cost that a broker incurs on a daily basis, Simon explains that given the choice between venues, assuming that liquidity and pricing are equivalent, the decision on where to execute is still important. Using a hypothetical example, he says the cost savings from executing in the cheapest manner possible – assuming the same price existed at all times – in 2008 would have saved a broker 16% in maker-taker fees paid to lit venues. For the institutional brokerage sector, total savings would have been as high as $1.9 billion.
“Although sourcing of liquidity overrules any and all financial incentives of a given execution venue, variable execution costs along with other pieces of key data demonstrate a commitment to execution quality as well as an opening to rate negotiation. Brokers that possess the details about where their orders were executed, how much liquidity was added or removed, when shares were routed to an alternative venue and which systems those orders were generated on will act as key components in future ECM discussions,” adds Adam Sussman, TABB’s director of research.
The 17-page report with six charts can be accessed by TABB Group Research Alliance clients and all pre-qualified media at https://www.tabbgroup.com/Login.aspx. To request an executive summary or to purchase the report, please visit http://www.tabbgroup.com or write to info@tabbgroup.com.
