How are transition managers utilising technology to support clients pre- and post-trade? Ceri Jones takes a closer look at advances in tech and data analytics.
The mantra for technological improvement in transition management (TM) has always been the integration of all aspects of the project from start to finish, including risk analysis, project management, execution and settlements. TM technology has evolved tremendously such that multi-asset transitions can be managed on one all-encompassing platform, improving efficiencies, as opposed to moving between applications, for example when managing equities and fixed income in the same transition.
Transition managers now see the challenge as very much how to make the best use of all the data available, with interesting developments both pre- and post-trade. For example, before the transition, stock level data can be provided for announcements such as earnings, while information can also be provided on macro issues such as interest rate events.
Information at the pre-trade phase can also give a TM a competitive edge if insights can be fed into the proposals regarding costs. “Several TMs have developed analytics showing how much trading they can do immediately, which requires knowledge of the inventory of counterparties,” says Graham Dixon, director of transitions at Inalytics.
“Those TMs that can do this are putting lower cost and risk estimates in front of clients and winning business as a consequence. This use of technology has become particularly important in fixed income. Brokers are not putting capital at risk in the way they used to but asset owners are devoting more of their funds to the asset class.”
Trading efficiency has also been improved by the use of optimised trading schedules that take account of individual stock correlations and marginal contributions to risk.
The proliferation of new equity trading venues has driven the development of trading execution systems that source venues to find liquidity via smart order routing, and then monitor execution quality.
“We believe the focus of technology improvements will be on trade executions to achieve the best execution objective on behalf of clients,” says Mario Choueiri, head, transition management at Pavilion Global Markets. “With respect to the fixed income market, recent advances in technology have allowed for greater transparency in a market that has traditionally been considered opaque, as well as easier access to increasingly scarcer liquidity due to the regulatory capital changes.”
High frequency trading (HFT) is part of the execution landscape, with any order predictability resulting from smart order routing likely to be exploited to the detriment of client orders. Many brokers and TM providers either operate their own venue or have a financial stake in certain dark pools that may be dominated by HFT, and these providers need to demonstrate that preferential routing of orders to these venues benefit the client, rather than being motivated by other financial considerations.
“This has led to greater focus on venue analysis, as well as customisation of algos to mitigate against the influence of predatory HFT activity, to bridge the liquidity gap caused by market fragmentation, as well as to help manage risk,” says Choueiri. “Clients will demand transparency across the entire trading process to better understand the liquidity sourcing preferences and get a clearer idea of what is happening under the hood.”
Venue analysis tools will help determine if a venue is being unduly preferenced or causing too much information leakage. Customisation of algos via venue selection and even real-time venue monitoring is the next stage. For example, some firms allow for customisation of algos on the fly to direct orders to achieve best execution and avoid information leakage. Technology must also be flexible enough to handle the increasing granularity of the data, from milli- to micro-second, or even finer, executions.
Tech can provide a competitive advantage most obviously where a transition is large, complex or multi-asset, taking weeks or months to complete.
“On some dimensions you can put a piece of paper between the providers but when assessing the technology at their disposal the differences are tangible,” says Dixon. “Often a technology solution is the key differentiating factor, for example, where a client has to keep their systems and information up to date throughout the restructuring. If the transition manager can connect their pipes to the client’s pipes so that everyone is up to date and seeing the same information, or to put it another way they can flush data out of the client’s system and immediately replace it from their own system, this gives that transition manager a significant advantage. Often the asset manager model has an advantage in this respect because they have valuation and risk platforms that minimise what the client needs to do. Only two or three transition managers offer this.”
“Often there will be multiple stakeholders and partners in the same assignment so there is a huge advantage if your tech platform can do a lot of the heavy lifting,” explains Andy Gilbert, EMEA head of transition client strategy at BlackRock. “Your tech platform needs to be able to handle volume, different derivatives, trade execution reports. The biggest difference is the scale of potential fund ranges and multiple managers, compared with five years ago.”
After the event, clients like to identify what went right and what went against them. “Tick level data allows the transition manager to bring out what component of that cost was and was not related to their skill,” says David Goodman, managing director, portfolio solutions at Macquarie Group. “Sophisticated transition clients can and do ask for all underlying original tick data and not a restated, re-compiled set of data from third-party brokers. Clients also ask that a TM’s management and compliance should attest that the data is accurate and the capacity in which the executing broker acted for each fill in the transition.”
Implementation shortfall (IS) remains the benchmark of choice, although clients often like to also use a relevant index. The big selling point of IS has always been that by setting the benchmark at the previous night’s close, it is not open to any form of gaming.
“With the increasing share of liquidity in the closing auction versus continuous trading, the relative benefits of using IS could be called into question,” says Cyril Vidal, head of portfolio transition solutions at Goldman Sachs. “While it’s difficult to match the level of transparency of an IS thanks to having an independent benchmark, advanced performance analytics and scenario analysis can provide more comfort to clients choosing target on close strategies instead and achieving overall lower implementation costs.”
“Implementation shortfall is not a perfect benchmark as it captures overnight risk which is considered outside of the control of the TM if they are not able to hedge with ETDs (exchange traded derivatives),” says Tim Gula, associate, portfolio transition solutions at Goldman Sachs. “We find clients want a more complete view of performance and understanding of realised cost, and have found providing intra-day performance and commentary is one way of satisfying this.”
This article features in the Transition Management Guide 2019. Download the full guide here.