11
Apr
Cost-Plus Billing: The Consequence of Growing Your Trading Business
Following up on my last blog about commission sharing arrangements and client commission agreements (CSA credits), I wanted to talk about some of the unexpected consequences (or requirements) that fall out of offering these arrangements. Nothing here is bad or problematic, unless you don’t understand it or are ill-prepared to address some additional client needs.
Based on recent news in the trade press and feedback from recent meetings, it appears that commission dollars and volumes for some agency broker dealers are starting to grow again. That’s good news. We think it’s driven in part by the use of Commission Sharing, CSA agreements and the access to new research.
However, this also has another consequence. Clients want to view their unbundled execution costs, seeing how much they are paying for this research as well as having greater transparency into their execution costs. In fact, it’s clear that clients are asking for cost-plus arrangements.
What does this mean? Well, in order to maintain that client, you’ll need to systematically calculate the specific costs of each trade, including maker/taker fees, complex exchange fees, SEC fees and other charges. Clients now expect you to charge them these explicit fees with an agreed upon mark-up. No longer can you charge the typical $0.04-$0.05 all-in commission fee.
The moment you fail to show these explicit costs and verify the mark-up, you’ll lose those clients and commission dollars to the next broker-dealer who can. You’ll have lost a client and wasted the resources that acquired in the first place. Even as commission dollars begin to rise, no one wants to take for granted a client relationship and lose it simply due to their inability to provide transparency and cost-plus billing.
Are you prepared?
22
Dec
2010 Themes Confirmed: Transparency, Cost Reduction & Compliance Matter
For the past year, Firm58 has been beating the drum in support of a handful of trading themes including market complexity and rate structures, transparency & compliance, and TCA, among others. At times, it seemed like we were the only ones highlighting the urgency of these issues for broker dealers, execution venues and trading firms. As it turns out, we are not alone. The December 2010 issue of Traders Magazine echoes many of the aforementioned topics in their “2010 Review.”
One big theme for Firm58 this year was the way in which brokers are re-inventing their client relationships, and now thinking about how to offer and measure the cost of research. The TABB research, Reinventing the Relationship: Institutional Brokerage Profitability and the September webinar we hosted with Larry Tabb covered this issue at many levels. The bottom line: Commission dollars are down 25% from 2008, and brokerages are struggling to find ways to keep their share, let alone increase that percentage. Traders Magazine addresses this issue in its article, “2010 Review: Agency Brokers Dive Into Research.
“Transparency has also been a big theme for Firm58 this year, and a recent poll in Traders Magazine supports the buyside’s desire for more transparency from the sellside.
A recent poll in Traders Magazine shows that 75% of respondents believe the sellside should provide more transparency as to where the buyside's orders are routed and how they are filled.
We believe there’s growing consensus, and as a result a change in compliance requirements coming that will require visibility into fees at a trade level, including child trades of large, complex orders. Where was it routed? How much did it cost? What rebates did it earn? These are all legitimate questions.
We addressed this in various times through our blogs, “The Wave of Transparency is Upon Us,” “Lightspeed Financial’s Middle Office,” and “Market Structure Changes Post Trade Needs.”
We look for transparency to be more than a buzzword next year and potentially a compliance requirement that will be difficult for many firms to address unless they have the right middle and back office infrastructure. Traders Magazine addresses this very topic in its article, “2010 Review: Dude, Where’s My Order?”
Another theme Firm58 addressed this year was the growing market structure complexity and the changes in fee structures. It’s widely known that Firm58 is the billing solution for many exchanges and execution venues. One of the reasons for our success in this market is our ability to model highly complex and ever-changing fee structures, the maker-taker models, and more. This past year, option markets started to offer liquidity rebates on some equities, and Firm58 has been right there helping them process these trade-related details. You can see an example of this in our work with the Boston Options Exchange (BOX).
Other options exchanges have begun to offer maker-taker rebate/fees, and that is highlighted in Traders Magazine’s, “2010 Review: Options Exchanges Cotton to Maker-Taker.” Just this week we announced our relationship with CBOE Holdings’ C2 Options Exchange.
Finally, Traders Magazine also has an article this month on TCA. The article, “TCA is OK But Needs Work” states that “institutions have expressed ‘disappointment’ and ‘frustration’ with trade-cost analysis’ inability to identify opportunities for institutions to improve overall performance by wringing new efficiencies out of the trading process.” This issue was at the heart of a recent post, “The Expanding Significance of Explicit Costs TCA“ by one of our founders and Managing Director, Sam Mele.
At the center of this TCA issue is the need for trading firms to have more information at their finger tips to make not only better decisions about trade routing and execution but client performance and profitability. With commission dollars significantly down, explicit cost TCA will become a much larger issue over the next two years. Brokerages that understand and address it will have a distinct advantage over their competition for those hard-earned and dwindling commission dollars.
Big themes, big issues, hard problems to solve. As a subscription-based software provider with a strong track record of success, Firm58 is well-positioned to help address these important revenue, cost reduction, and compliance issues for capital markets firmst large and small.
16
Nov
The Expanding Significance of Explicit Cost TCA
Without question, measuring implied trading costs is an important gauge of a broker’s performance, but the current definition of Transaction Cost Analysis (TCA) is far too narrow. In addition to implicit costs, a comprehensive TCA program needs to include explicit trading costs as well.
Historically, TCA has focused on the measurement of execution quality. In other words, did I get the best price for an order relative to the time the order was placed? Measuring the trade timing success of brokers, venues and algorithms, with benchmarks such as VWAP or “implementation shortfall” is critical but does not paint the full TCA picture.
What is missing from traditional TCA is the calculation of explicit costs. Once believed to be easy to estimate, commissions paid to brokers, regulatory fees and most significantly exchange fees are today very difficult to measure due to the ever-increasing market fragmentation, the introduction of liquidity based fees and rebates and the frequency of fee schedule changes. In our experience at Firm58, on-demand visibility into explicit costs, as well as reports detailing the most economic venues, assets, traders, etc. can help broker dealers understand how to not only reduce expenses, but also make strategic decisions about where to funnel order flow.
Measuring market impact by comparing trades against benchmarks composed of price, time, and volume (implicit costs) in combination with measuring the fees actually levied by all trading constituents (explicit costs) is the only comprehensive form of TCA. In today’s increasingly fragmented market where margins are shrinking, explicit cost TCA is even more important, and accessing this information in a timely manner can result in significant savings and more proactive decision-making. As profitability becomes the key metric for success, competitive firms are actively seeking a comprehensive TCA program. Are you?
