Financial institutions continue to move towards best execution in order to better manage rising capital and operating costs resulting from derivatives and margin regulation, as well as satisfy MiFID II obligations for best execution. To support this need among industry participants and clients, Tradeweb and Cassini Systems have teamed up in a collaboration, which aims to offer clients access to life-cycle cost analytics, including initial margin, collateral, clearing fees, brokerage andtrading costs at the point of trade to help with execution efficiency and reporting.
In a DerivSource Q&A, Simon Maisey, Managing Director at Tradeweb, and Liam Huxley, CEO and Founder at Cassini Systems, discuss best execution and how integrating margin optimization analytics at the point of trade can help buy-side firms achieve and demonstrate this.
Q: Firstly, what is best execution to you?
Huxley: Best execution currently is centred around the execution stage and ensuring firms have the best quotes, and the Trade/Transaction Cost Analysis (TCA) to demonstrate their overall execution profile.
Best execution means having a complete picture of all the costs of a trade, including post-trade costs, and understanding the full cost pre-trade. As an example, to execute the same swap it is possible to get two different execution costs depending on the clearing route. Firms need to consider post-trade carry costs on those two clearing routes to determine which quote is the all-in most efficient quote. It is not necessarily the cheapest quote that is actually the best trade. Best execution is being able to merge together the pre-trade execution efficiency and the post-trade carry cost.
“Best execution is being able to merge together the pre-trade execution efficiency and the post-trade carry cost.” – Liam Huxley, Cassini Systems
Q. What is driving financial firms to make improvements to best execution practices today?
Maisey: MiFID I and MiFID II have not necessarily changed how people execute their business but has pushed people to demonstrate and document how they achieve best execution. There is pressure on margins and fees everywhere in the industry, so the biggest driver is efficiency as firms look to become more efficient in how they do business.
Huxley: There have been numerous regulatory changes, from Dodd-Frank to MiFID and Uncleared Margin Rules (UMR) which have introduced new obligations impacting the way and cost of doing businessfor firms. For instance, the introduction of central counterparty (CCP) clearing for some OTC derivatives required firms to post more up-front collateral on OTC derivatives trades. Some surveys show a significant percentage of current collateral posted in the OTC world is cash. The more cash firms need to post, the less they have available for investment, so it creates a drag on the portfolio.
Also, MiFID’s reporting and audit requirements to provide transparency to the end client can also create a squeeze where more firms are now focused on understanding and ensuring they can minimize the impact of the margin and the fees. It is therefore becoming more and more important pre-trade to bring this margin optimization and cost analysis into play.
Maisey: ‘Best execution’ focuses on not just trade-by-trade analysis but being able to holistically see across all of these things and over a period of time. Being able to provide that best execution visibility across the whole portfolio is key. Rather than taking a standalone trade, it is looking instead at what impact a trade will have on the overall portfolio.
Best execution isn’t necessarily about changing the way clients execute a trade or that they were doing something wrong before. The regulatory requirement now is more around demonstrating and documenting the process they followed and being able to show the steps they have taken. Technology can make documenting that process more efficient.
For instance, by integrating with Cassini, Tradeweb is able to bring that all-in cost analysis into the same place clients are doing the trade. This in turn enables clients to work more efficiently and reduce manual errors caused by re-keying data from one system into another. Also, this then provides firms with a convenient and concise way of demonstrating and reporting best execution.
Q: What are the most common operational challenges that firms face today as they move towards best execution?
Huxley: As already stated, MiFID restated the need to have true clarity on all related costs of a trade to ensure best execution. Firms need to factor in post-trade costs such as broker fees, clearing fees, internal costs and importantly the carry cost of funding collateral. The operational challenge is for firms getting transparency and visibility of that into the front office – either pre-trade to actually inform execution and ensure the best price and the best execution but also for post-trade audit and reporting.
The information required to have transparency on those costs tends to be embedded in back-office systems. Sometimes these are not even within the organization – it could be at an outsourced provider who is managing collateral. It has been very difficult traditionally for firms to get visibility onto that information.
Another related issue is that some of the data points – such as fees – are often not calculated by buy-side firms themselves. They receive a monthly fee statement, and they typically do not have any mechanism to understand how to allocate those fees to different trading strategies. It is the same on the funding side. They may have a view on their overall consumption of collateral, but it is operationally difficult to actually understand how that is attributed to different trades.
That is where new technology solutions (such as Cassini and Tradeweb’s integration) come in – that bridge the front end and the back-office systems and can provide visibility on all of that information in a way that is meaningful and an integrated part of the front-office trading process.
Q: What are the biggest advantages of achieving best execution?
Huxley: Aside from reducing costs, if firms are making the right decision, pre-trade, using CCP clearing routes and execution routes that minimize collateral costs, then they reduce the need for post-trade collateral, reallocation and substitution. They improve their post-trade processes as well.
The other advantage is visibility to the end clients. Depending on the type of investment mandate they have, firms need to be able to demonstrate these costs back to their investors, which ties back into the audit trail and the visibility reporting.
Q: What are some of the common strategies and tools that can be used to get that operational capital efficiency from a best execution perspective?
Huxley: There aren’t really common strategies and tools for doing this currently. With the increasing fund/carry costs and cost of collateral and MiFID documentation requirements, it has been a challenge for firms to really understand these costs and to make sure that they are making the right execution decisions. Then firms also need to have an audit trail behind it.
Cassini provides tools which people can use independently. They can model trades prior to going into the execution stage, for example, but that is decoupled from the audit trail. The collaboration with Tradeweb marks the first time that these two things are put together seamlessly to provide best execution.
Q: Why have Tradeweb and Cassini entered into this collaboration now?
Maisey: With MiFID II and the derivatives trading mandate, more business now has to be executed on regulated trading platforms like Tradeweb. The category 3 clients for the trading mandate under MiFID are now coming into scope. More and more swaps business is being done electronically via Tradeweb.
We’ve had some really good feedback from clients on the Cassini solution and so we thought a collaboration would provide our mutual clients a seamless way of executing their trades and getting all the information they need before they do the execution. We wanted to make it integrated with the process a client goes through when they are requesting a price and then executing a trade, rather than just have clients get access the Cassini tool via Tradeweb.
Huxley: Tradeweb is obviously a big player in this space. Cassini is designed to allow clients to access our analytics at each stage in their workflow. But we heard from various clients saying they really wanted to integrate this and be able to have the transparency at the execution points. So that is where those discussions started to emerge, and it made sense to put this all together.
Liam Huxley, CEO and Founder, Cassini Systems
Liam ran investment banking development groups in both the UK and the US before co-founding Syncova which developed the market leading platform for Hedge Fund portfolio margin and financing – providing calculation & optimisation for both Prime Brokers and Hedge Funds. Syncova was acquired by Advent Software in 2011. Liam then founded Cassini with a forward looking concept of providing the buy side with full modeling of all the new costs and constraints created by clearing and related regulations, to allow more efficient trading and portfolio management. He is currently CEO at Cassini Systems.
Simon Maisey, Managing Director, Global Head of Business Development at Tradeweb.
Simon Maisey joined Tradeweb as a managing director in May 2014 and is responsible for the firm’s global business development. During his career, Simon has gained extensive knowledge and experience of market structure, regulatory matters and electronic trading in the fixed income and derivatives markets.