Best Execution & Transaction Cost Analysis
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Best-Execution Mandates Pushing TCA Adoption
September 22, 2008
Regulations requiring broker-dealers to obtain the best price for their clients are helping transaction cost analysis, or TCA, become a ubiquitous feature of trading desks on both sides of the Atlantic.
In the U.S., 90 percent of traditional asset managers had adopted TCA by the end of last year, up from 69 percent in 2005, according to a March report from Tabb Group. That number stood at 70 percent in the European Union--a 7 percent increase from 2005--but is expected to grow to 87 percent by next year. In 2007, U.S. Regulation National Market System (NMS) became effective for market centers in March and brokers in August; the EU’s Markets in Financial Instruments Directive (MiFID) didn’t take effect until November.
In Europe, new trading venues and increased competition mean that “people will be looking for those tools to help figure out their execution strategies in what is becoming a vastly different landscape than it was just a few years ago,” said Adam Sussman, head of research at New York-based Tabb Group and author of the report.
According to Ian Domowitz, managing director of New York-based agency brokerage Investment Technology Group (ITG), the client base for his firm’s TCA offerings is growing faster in Europe than the U.S. With MiFID’s best-execution requirements, “you have to account for performance, so there’s the posttrade aspect. And, in principle, you have to demonstrate that you have a process that improves performance.”
MiFID is “more specific in tracking best execution” than is Reg NMS, noted Bob Hendricks, CEO of William Ryan Group, a business intelligence company that specializes in TCA technology. “The description of what ‘best ex’ means in the U.S. ... doesn’t drive down to all of the different cost elements.”
Of course, best-execution mandates are hardly the only reason for increased TCA usage. Domowitz said he sees two drivers at ITG: “One is regulation and the other is ‘show me the money.’ We see examples where a single client can lose as much as a billion dollars a year in transaction costs. ... If you can improve your performance by a few basis points--especially if you’re a larger shop--the savings can be quite substantial.”
ITG, which in 2006 acquired Plexus Group, a provider of transaction analysis, trade research and consulting services, has a 70 percent market share in the TCA business, according to the Tabb Group report--“ Imperfect Knowledge: International Perspective on Transaction Cost Analysis.” For TCA providers, that transaction was “like Google buying Yahoo,” says the study.
But there’s plenty of room for competition. “TCA’s position in the marketplace is becoming more important as people understand how critical it is not only to increased trading efficiencies but also for general profitability and success,” noted Hendricks of Sea Girt, N.J.-based William Ryan.
Beyond Equities
Just as algorithmic trading has spread to new asset classes, TCA is no longer limited to equities. There is increasing demand to measure trading costs in other areas, says the Tabb report. “Bulge-bracket brokers have been busy in the last two years developing options and FX algorithms. TCA for these products will follow as a way to demonstrate execution.”
Hendricks said that William Ryan is planning to extend its offerings to the derivatives space: “The notion that the same cost considerations and analysis will provide the same benefits in those asset classes is something we and our clients agree with.” According to Hendricks, the firm is hoping to add TCA capabilities for options in January and derivatives in second-quarter 2009.
