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?