Management intelligence company Acuiti has released a survey report with trading technologies provider Abel Noser Solutions to evaluate how asset management companies are refining their use of transaction cost analysis (TCA).
Titled The Growing Sophistication of Transaction Cost Analysis, the paper’s core message is that TCA is becoming increasingly important as transaction costs increase and as regulatory obligations place greater pressure on buy-side firms to monitor and manage their aggregate trading costs more efficiently.
This survey is based on responses from senior, derivatives-focused executives at 64 buy-side firms globally. It aims to assess how firms are evolving their strategies, expanding their use cases and increasing their sophistication in the application of TCA.
The paper suggests that, over the past decade, approaches to TCA have evolved from a simple measurement focused on basic metrics such as commissions and spreads to a holistic view across multiple metrics, including market impact, employing a wider range of inputs.
As the range of TCA use cases widen with the advance of technology solutions to measure and analyse the data, so too do the asset classes that are in scope for TCA. Unsurprisingly, TCA is most mature and widely used in equities, the report notes, where data availability and standardisation are most advanced.
OTC fixed income derivatives are the most challenging asset class in which to apply TCA, according to survey respondents – with spot fixed income and equity derivatives ranked second and third respectively. Pricing can be opaque in OTC markets and deals are often negotiated privately with limited competition. Swaps are highly customisable contracts, presenting difficulties in comparing pricing and execution quality.
The survey finds that poor data quality is the most significant challenge confronting buy-side firms when applying TCA, particularly for OTC derivatives. This is accentuated by fragmented data analysis within firms – only half of the respondent firms had a single, golden source of data that they use for TCA and other processes including risk and portfolio modelling. As firms look to integrate TCA processes in wider business areas, the paper suggests that data fragmentation across the firm is likely to impair their efforts to improve efficiency.
Currently, just over a third of the asset management firms that took part in this study built their TCA software in-house, while a third outsourced to a vendor and the remainder adopted a buy-and-build approach. The paper suggests that the trend towards outsourcing is likely to accelerate as a more sophisticated range of vendor solutions becomes available.
Significantly, TCA is becoming integrated into trading technology — no longer just a retrospective post-trade calculation but also extending into the pre-trade arena and embedded into firms’ order or execution management systems (OMS/EMS). While 87% of asset manager respondents indicated that this integration was an important factor for their firm, only 43% said that they had already integrated a robust TCA system into their OMS/EMS workflow.
Pulling these conclusions together, 65% of buy-side respondents told the survey that their analysis of TCA had become “more sophisticated” over the past five years, with 12% saying it had become “significantly more sophisticated”.
According to the paper, TCA is becoming more sophisticated in several ways. First, the scope of data and number of metrics being evaluated is expanding to include areas such as market impact and opportunity cost, to evaluate the timing of a trade as well as the choice of venue and counterparty.
But choice of counterparty and execution venue are basic and essential fundamentals in a buy-side trading strategy. Any firm trading in size will also require an understanding of market impact and an ability to measure it.
Similarly, the paper tells us that “more advanced use cases are gaining traction”over the past 10 years: broker selection remains a key use case, it suggests; and trade optimisation has been employed by around half of the asset managers that took part in the survey. But for money managers using TCA, broker selection and trade optimisation have long been primary TCA use cases.
These are a continuation of established trends, rather than ‘new’ or ‘more sophisticated’ developments appearing over the past 10 years – even though they are being embraced by a wider set of buy-side participants.
