January broke many Exchange and Clearing firm volume records thanks to the huge volatility in the markets, especially in the latter part of the month when a roller coaster ride kicked in on many indices. The most notable thing about trading though is that index derivatives and program trades now represent such a large portion of activity. Part of this represents traders taking directional bets on the market rather than specific stocks.
Mondovisione illustrated how significant program trading was when reported that
NYSE indicated that during Jan. 22-25, program trading amounted to 25.2 percent of NYSE average daily volume of 6,135.3 million shares1, or 1,548.1 million program shares traded per day.
Program trading encompasses a wide range of portfolio-trading strategies involving the purchase or sale of a basket of at least 15 stocks with a total value of $1 million or more.
In all markets, program trading by member firms averaged 3,837.5 million shares a day during Jan. 22-25. About 40.3 percent of program trading took place on the NYSE, 0.7 percent in non-U.S. markets and 58.9 percent in other domestic markets, including Nasdaq, the American Stock Exchange and regional markets.
The crazy thing about equity program trading is the process used by many fund managers to trade. It often amounts to creating a spreadsheet detailing the characteristics of the program e.g. number of stocks, sector weights, countries which is then emailed to one or more counterparties. Questions on the trade and related responses are similarly emailed before quotes are received and a decision made. Underlying stock details are then emailed across to the winning bidder and each side uploads it into their respective systems to record and process downstream.
This is ridiculously inefficient and also lacks meaningful transparency.
Bidroute is a venture set up some months ago by some highly respected folks in London, whom I know well. It set out to remedy the current deficiencies by providing a platform that would be “ebay for program trades”. Delivered inside a browser environment, a fund manager simply has to load details of the program and invite offers from counterparties they nominate. All questions and bids are hosted centrally, thereby providing a single focal point for the process [efficiency] and transparency to participants. Moreover, it definitely demonstrates the hunt for best execution.
However, as with any new venture that challenges current practices, it faces enormous obstacles. Upcoming brokers are keen to participate but the top brokers don’t like the idea of transferring opaque business into a transparent environment where they might suffer margin erosion from a competitive auction. Hence they are not “encouraging” clients to participate. Similarly, inertia on the part of fund managers combined with dumbness, means that some firms fail to spot the opportunity to consolidate all those emails in one central place and perceive it as adding to their workload by introducing yet another “destination” that a spreadsheet has to be loaded to.
Most staggering has been the admission by some fund managers that they only send their program trades to one of the big brokers to be priced believing they get a fair price. How this qualifies as satisfying best execution criteria, heaven alone knows.
You would think that this is a no-brainer for fund managers, assuming the commercials were ok. Seems common sense is not so common.