May 25, 2006 URL:

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Arthur Lynch
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1 Algorithms and Clearing Wrapped Up in One May 25, 2006 URL: Reprinted in Finance Technology DLPCKH0CJUNN2JVN?articleID= Larry Manley, a hedge fund manager with Manley Asset Management of Chatham, N.J., has found a way to save on trading costs, specifically on those days when his trading strategy involves the use of more than one algorithm offered by two or more sell-side firms. His strategy? He trades through Electronic Specialist (ESP) of New York, one of the new algorithmic trading aggregation hubs that offer central clearing services, which are now offered by several registered broker-dealers. "It's an efficient method for us and gives us far more flexibility in the way we trade," Manley asserts, noting that particularly on those days when he does not have a clear opinion on the overall market trends, he likes to be able to cherry-pick one or two algorithms from different sell-side firms. Manley says he usually chooses a more aggressive algorithm for the beginning of the day and a slower-paced algorithm for the remainder. Offering More Options Algorithm aggregation "offers the best of both worlds," according to Manley. The providers of these hubs offer not only access to a cross-section of highly valuable algorithms from multiple sources, he explains, but also, in the case of ESP, he can choose either anonymous or attributed trading with the sell side. Then, at the end of the day, Manley gets a single, consolidated ticket from his broker-dealer and, as a result, lower closing costs. Manley is part of a growing audience of buy-side traders and analysts testing and assessing these services. Some are singing their praises because of the cost savings the services can provide, but others question their true value and viability over time. Within the past year, independent agency brokers and DMA aggregators such as ESP, Firefly Trading (Boston) and UNX of Burbank, Calif., have begun offering an array of algorithms from multiple sell-side firms for their buy-side clients. The first to market was ESP, which now offers more than 100 algorithms from 20 sell-side firms to more than 40 buy-side customers.

2 The Demand Is Out There Jeromee Johnson, a senior analyst with TABB Group (Westborough, Mass.), is not surprised by the market's interest. Johnson has intimate knowledge of the services being provided as he joined TABB Group from UNX, the newest player in the field. "There are clear-cut dollar savings associated with the use of these services," he says, explaining that the top 10 asset managers conduct high volumes of algorithmic trades daily so the service makes sense for them. Johnson explains that if a large asset manager can pay $12 for a consolidated trade instead of $50 across five brokers, over time they can save a great deal of money. "These [costs] add up, and there can be significant savings involved,... potentially in the millions." But that may be only for a large asset management firm. Johnson questions the usefulness of such services for small to mid-size trading firms. Depending on the volume of trading conducted, there may not be significant cost savings. Another key advantage for the buy side specifically is that ESP, UNX and Firefly can offer various levels of anonymity to traders - the sort of option you don't get when you access algorithms through an order-management system. This results in the option to give or not give information about trades to a sell-side broker. The Same, But Different Of course, there are subtle differences and different stages of development among the three providers. Richard Holway, managing director at Firefly Trading, says his service offers an easy-touse, front-end EMS (execution management system) called ORION, which includes access to the service's central clearing capabilities. He emphasizes that the system provides a standardized user interface to control the various parameters of each algorithm, ECN and alternative trading system (ATS) made available by four major partners - including Bank of America, Merrill Lynch and Piper Jaffray. There are major benefits to working with an EMS with consistent controls across a variety of venues, says Holway, such as risk reduction and the reduced time it takes a trader to get up to speed on the use of the system. "If you don't have a consistent control interface, it is too easy to click in the wrong place, a dangerous thing to do on a trading desk," he says. Currently, Firefly has attracted 25 clients, and it expects that number to reach 35 by the second quarter. The firm also has its own distinct algorithmic offering called Portfolio Profiling and Benchmark Workshop that allows traders to design, customize and manage their own rule sets to quickly change their trading strategies. Firefly is self-clearing, but it manages the central clearing function if clients request a single ticket.

3 Scott Kurland, senior managing director at ESP, touts his firm's middleware technology, known as the Electronic Algorithmic Routing Network (EARN), which aggregates algorithms through a single portal. In conjunction with ESP's central counterparty clearing service, it enables ticket consolidation - or what Kurland calls "trade compression" - across all the various broker and execution venues supported. ESP currently does not offer a front-end system of its own, but does offer access through order or execution management systems. "We have 23 integrated with our system," Kurland relates. He also stresses that ESP offers a "broker neutral" trading system in which traders can see the big ticket and all the smaller tickets underneath and can compare prices to a benchmark. This allows the user to see which brokers' algorithms are performing and which aren't, he says. Kurland also says that the firm has made a great deal of effort to expand the flexibility and transparency levels of its service. "We provide unique ways for participating brokers to receive attribution, and when we send an order to a bulge-bracket firm or algorithm provider, we can be as granular or macro as [the client] wants in terms of providing info about where that trade came from," he says. And for those buy-side traders seeking complete anonymity in their trading activity, that can be supplied as well. ESP works with several outside firms to facilitate its central counterparty clearing service. Spreading Out ESP is planning to go global with its service, Kurland adds. "We have had a lot of interest from buy-side clients using our domestic model to expand our service into Europe," he says, noting that the cost savings for global, aggregated algorithmic trading would be four to five times the savings received by domestic traders. The firm also has applied for a patent for its central counterparty clearing service, which, Kurland says, could potentially be licensed to other firms. Finally, UNX is the latest broker-dealer to enter the fray and currently offers 38 algorithms from five brokers - Bank of America, Credit Suisse, Goldman Sachs, JPMorgan and UBS - along with its own VWAP algorithm. Brady Ballentine, managing director of product development at UNX, won't say how many customers the UNX algo aggregation service has attracted over the past year. And when asked to describe the service, he highlights the convenience factor rather than any cost savings. At this point, the clearing and settlement of broker-provided algorithms occurs directly with each respective broker, Ballentine says. However, within the year, the firm plans to introduce central clearing, he notes. In April, UNX announced that Goldman Sachs and UBS had made a minority investment in the firm and, in light of this new sell-side connection, it remains to be seen how the UNX algo aggregation service will evolve over time.

4 No Friends of Ours Despite the benefits of this combination, the algorithm/clearing services have naysayers. Bob Gasser, CEO of Stamford, Conn.-based NYFIX, a broker-dealer and provider of infrastructure and execution services to brokerage firms, is not an enthusiast of the new algorithm aggregation services and does not see a great need for this type of service. In his view, such firms are disintermediating traditional interactions between the sell side and buy side and, thus, are not friendly to the large broker-dealers. Turning Your Attention Instead, Gasser thinks the focus should be on ticket consolidation efforts that save money for both the buy side and sell side. Also, as a self-clearing network provider, Gasser thinks his firm is in a better position to provide this service in a neutral fashion. "We are trying to create a new business around the ticket aggregation issue and are working with large broker-dealers to find a solution that works for both sides," he says. Bernard Donefer, director of the Subotnick Financial Services Center at Baruch College and author of a new book on algorithmic trading techniques, questions the utility of algorithm aggregation tools, noting that the impact of Reg NMS on such services is uncertain and, over time, these hubs could easily fade away. "How many VWAP algos do I really need, and how many of these aggregated algos are truly unique?" he asks. But others are more upbeat about the long-term utility of such offerings. Madison Gulley, EVP and director of global equity trading at mutual fund giant Franklin Templeton Investments, notes that, "As long as the market continues to disintermediate the sell side and offers multiple choices for liquidity sources and execution venues, the potential for this type of service seems to make sense." TABB Group's Johnson also sees a future, but for a limited number of players. "Is there room for all three? No," Johnson says. "But is there room for at least one algo aggregator? Absolutely." --- The Upshot Firefly: - Uses front-end execution management system called ORION. - Provides standard user interface to control parameters of all participants' algorithms. - Algorithm providers include Bank of America, Piper Jaffray and Merrill Lynch.

5 - Has 25 clients and expects to increase that to 35 by end of this quarter. - Offers independent algorithm called Portfolio Profiling and Benchmark Workshop. ESP: - Uses Electronic Algorithmic Routing Network (EARN) to aggregate algorithms. - Does not have a front end, but integrates with other systems. - Offers anonymity. - Plans to offer service globally. UNX: - Offers 38 algorithms. - Has five participating brokers: UBS, Credit Suisse, Goldman Sachs, JPMorgan and Bank of America. - Offers independent VWAP algorithm. - Plans to offer central clearing later this year. --- For a related story on central clearing and algorithm aggregators, see "ESP Central Clearing Aids Buy Side, Irks Sell Side." Copyright 2004/5 CMP Media, LLC Privacy Statement

The OMS as an Algorithmic Trading Platform: Five Critical Business and Technical Considerations

W W W. I I J O T. C O M OT S U M M E R 2 0 0 9 V O L U M E 4 N U M B E R 3 The OMS as an Algorithmic Trading Platform: Five Critical Business and Technical Considerations Sponsored by Goldman Sachs UBS