Ross Lancaster

According to a recent Acuiti report, fixed income and equity derivatives specifically are asset classes where surveyed asset managers confirmed they commonly apply TCA. 

In addition, buy-side respondents also affirmed that TCA is increasingly being applied to commodities and listed and OTC fixed income derivatives. 

Ross Lancaster, head of research at Acuiti, said: “Over the past decade, TCA has gone from a retrospective, compliance-focused process to one in which valuable insights can be driven across the trade workflow. 

“As firms find more use cases for TCA, the need for high quality, real-time data also increases, which is causing challenges for some firms. However, for the firms that can achieve data quality across asset classes, there is significant value to be gained both in terms of trade optimisation as well as in alpha generation.” 

While 76% of the surveyed asset managers confirm that they use TCA for regulatory and compliance purposes, use cases for TCA continue to evolve with ever-more advanced and sophisticated applications gaining traction. 

Specifically, the whitepaper highlighted that in the last five years, 65% of respondents had increased the sophistication of their analysis of TCA data. 

While broker selection remained a key TCA focus, half of the asset managers responded that the technology is also being used for trade optimisation, while alpha creation was cited by around a third of firms. 

Looking ahead to future applications, increasingly embedded TCA within firms’ workflows appears to be within sight. As an example, Acuiti’s report highlighted that 87% of respondents recognised the importance of integrating TCA into OMS/EMS processes, despite less than half currently possessing that functionality.

Read more – Conscious usage of TCA: Making trade analytics more actionable

The whitepaper, ‘The growing sophistication of Transaction Cost Analysis’ was carried out by Acuiti in partnership with Abel Noser Solutions, a Trading Technologies company, surveying senior executives across 64 asset management firms globally.

Peter Weiler, executive vice president and managing director, data and analytics at Trading Technologies, said: “The findings in the study correlate with our own experience at Abel Noser and TT in which asset managers and other clients are looking to increase the applications of TCA across both asset classes and the trade lifecycle.”

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Regulatory burden has been a key concern for market participants since the Global Financial Crisis in 2008, with the report from Acuiti – in partnership with FIA – adding that new frameworks are ‘lengthy and complex’, requiring significant resource mobilisation to navigate current regulatory requirements.

Most respondents felt that the level of European regulation on their respective firms was disproportionate, however it’s worth noting that nearly a third of respondents were indifferent on this viewpoint.

Looking at specific EU regulations, Investment Firms Directive (IFD) and Investment Firms Regulation (IFR) were highlighted as the most challenging, with more than half of respondents expecting ‘critical’ or ‘major’ challenges associated with the implementation of these regulations.

European capital regulations, including IFD and IFR, have constituted a major compliance burden for principal trading firms, with significant implication for the prudential requirements that these firms have become subject to.

The report noted that the cost implications have pushed various principal trading firms to give up their Mifid II licences or relocate their headquarters or specific trading desks outside of the EU.

Interestingly, when looking at the risks on the horizon within the European listed derivatives markets, regulatory risk was found to be the second largest risk that respondents were most concerned about – coming in just slightly lower than cyber risk.

“Regulation is a constant of listed derivatives markets – when one framework takes effect another is usually coming down the line,” Acuiti said in its report.

“While market participants frequently support the objectives of regulation, often there are unexpected consequences from rule proposals. These then require substantial lobbying efforts to counter or moderate.”

Brexit

Elsewhere in the report, Acuiti explored the impacts of Brexit just over four years since the UK’s exist from the EU. Looking at the impact Brexit has had on London as a financial centre, most respondents (51%) believe that the city will remain a financial centre but at diminished size and influence.

Despite initial viewpoints that Brexit would lead to regulatory independence from the EU, the report suggests that appetite for this routed has shifted.

A key portion (41%) of respondents felt that the UK should pursue some divergence from the EU, however, noting this should not be done at the expense of equivalence with the bloc’s regulations. A larger proportion (45%) felt that the UK should seek convergence with EU laws to reduce regulatory fragmentation.

“While the European listed derivatives industry has faced multiple challenges during the last five years, its market participants are viewing the next five years ahead with optimism,” Acuiti said in its report.

“Challenges have not dissipated, with the effects of Brexit still playing out, cyber risk rising as a threat to systems and regulation imposing a constant and heavy burden on operations. However, confronting this multitude of challenges had also created a fortified and resilient industry.”

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According to the report, the expected boost in headcount follows a period of strong performance by prop firms and marks significant uptick from last year’s survey which found just 63% of firms preparing to expand their trading teams.  

Wage appreciation in trading remained high with around 50% of those surveyed noting up to a 10% increase for trading roles in the last year but had slowed in comparison with previous years. The UK saw the greatest jump followed by the US. 

“The last few years have been strong ones in terms of business performance for many proprietary trading firms,” said Ross Lancaster, head of research at Acuiti. “As wage appreciation slows, firms have the confidence to expand their teams and continue to grow their businesses.” 

The report also found that just under a fifth of proprietary trading firms surveyed that outsource their trading screens to an independent software vendor (ISV) are currently planning to build inhouse systems. 

When asked how firms were planning to change their headcount throughout 2024, hiring developers was the second priority after hiring new trading talent, with around 75% of those surveyed expected to add new staff in this area. 

According to the report, 31% of firms surveyed already build their trading screens in-house while 28% use upwards of four providers. 

Those firm’s building front ends in house were mainly ultra-low latency firms and firms using predominantly algo but not ultra-low latency. None of the point and click firms surveyed said they built front ends in house. 

Around 45% of firms surveyed, when asked how satisfied they were with the cost of third-party technology providers, said they were either quite or very unsatisfied.  

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Asia-Pacific, and Brazil were touted as key areas of focus for firms as they looked to grow, with onshore India specifically cited as a region for expansion by various respondents. 

The breadth of opportunities available when it comes to trading in fresh jurisdictions, is clear to see by various recent market moves which has seen a surge in partnerships and investments across both frontier and emerging markets.

Speaking to The TRADE in October, emerging markets expert Mark Mobius highlighted the significant potential of these jurisdictions specifically: “The big boy on the block is going to be India for of a range of reasons, they’re developing at an incredible pace, for example their technology which is getting better and better every day. India is definitely number one on the list. 

“[…] We’re finding companies that are most profitable and have great growth opportunities in Brazil, Taiwan, South Korea, Turkey, South Africa.” 

Read more: Mark Mobius sits down with The TRADE to discuss the ever-evolving emerging markets space

Following a strong start to the year, sentiment is soaring across the prop trading landscape. Looking ahead to the next three months, 24% of respondents stated that they were ‘very optimistic’ about the environment for their business performance.

Over half (51%) of those surveyed were also positive, responding that they were ‘quite optimistic’. No firms held a negative outlook, with the remaining 24% neither optimistic nor pessimistic.

Elsewhere, the report found that as prop firms continually look to further expand their reach globally and continue to confront the ever-increasing regulatory burdens, there is a clear disparity in terms of approaches either side of the Atlantic.

Read more: Regulators ponder global conformity in the face of regional disparity

Senior executives from EU firms were found to be spending significantly more time on regulation than their US counterparts.

Almost half of EU-based proprietary trading firms were found to spend between 26% and 50% of their time on regulations, whereas in the US 70% of those surveyed responded that typically just 1-10% of their time was spent on regulations. 

Will Mitting, founder of Acuiti, explained: “This quarter’s report highlights the extent of the challenges facing firms.

“One major issue for both firms in the EU and the UK is that new rules coming into force are typically automatically applied to Mifid II registered firms. So, while the initial regulation contained within Mifid II was appropriate, the level of increased rules over the past decade is creating significant pressures on firms.”

The report surveyed senior executives from more than 100 proprietary trading firms globally.

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In 2023, Spain joined a growing list of European countries set to introduce new restrictions on instruments aimed at retail investors, which would ban the promotion of CFDs and restricting leverage on other instruments.

In response, none of the surveyed retail brokers either strongly or somewhat agreed with Spanish regulators’ intentions, while 69% strongly disagreed with them.

Looking at the impact these regulatory restrictions would have on listed markets in the EU and UK, just over half (51%) of responds believe there would be an increase in listed volumes, with 10% of that portion expecting a significant increase, while 41% expect a slight increase.

Meanwhile, only 14% of respondents expressed that there would be a decrease in listed volumes, while 34% expect no change.

The report found that should retail flow to listed markets increase, there would be significant benefits.

Proprietary trading firms which took part in the survey predict that significant flows into listed derivatives markets would improve liquidity, provide greater opportunities for institutional firms and increase revenues.

Of those surveyed, less than 10% predicted that the move would result in increased volatility in the market.

“This report suggests that restrictions on retail investment in bilateral products such as CFDs will boost engagement with listed derivatives markets. This will bring greater liquidity and more diverse flow to the markets in Europe,” Will Mitting, founder of Acuiti, told The TRADE.

“For incumbent institutional firms this provides an opportunity. As volumes in listed markets grow, institutional clients are likely to trade more while some institutional sell-side firms see opportunities in targeting retail investors if they trade listed derivatives.”

Mitting did, however, emphasise that the report also found that restrictions on retail flows to CFDs will result in retail focused brokers expanding their offerings to institutional investors, “which will increase competition for incumbent institutional sell-side firms”.

“These shifts are likely to cause significant disruptions and innovation in European institutional markets,” stressed Mitting.

Looking at how a ban could impact competition in institutional markets as retail brokers seek to replace retail revenues with institutional flows, no surveyed sell-side respondents expected a significant increase in competition, however, 53% stated that they expect a slight increase in competition, while the remainder (47%) expect no change.

Acuiti stated that this potentially reflects an under-appreciation of the challenge and ambitions of retail brokers found in the report, emphasising that while clearing firms are likely to see benefits from retail brokers moving into futures and options, execution-focused focused brokers will inevitably face grater competition.

“Increased retail participation in the listed derivatives space will only accelerate the sell-side demand for modern, scalable technology,” Francesco Margini, chief product officer for cleared derivatives at ION Markets, told The TRADE.

“This is essential for supporting large scale client onboarding and significantly increased transactional volumes across execution and clearing.”

The report highlighted that the growth of retail investing added depth and improved liquidity in US derivatives markets, attributing it as a key factor in the significant growth that US listed market have seen since 2019.

Retail brokers which have the advantage of being technology-led, will likely put them in good stead as they approach listed and institutional markets.

Despite the challenges that may arise due to regulatory restrictions for European retail brokers, Acuiti concluded that with challenges comes opportunities and the potential for reinvention for the affected parties.

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Respondents to the survey anticipate a split in liquidity between onshore and offshore, with a bias towards the incumbents having existing liquidity and retail flows as an advantage.

Most respondents (39%) stated that once regulatory frameworks are fully established in onshore regulated markets, 26-50% of listed crypto derivatives trading volumes would be conducted onshore.

The second highest percentage of respondents, 32%, anticipate that 51-75% of trading volumes would be conducted onshore. Only 4% of respondents stated that all volumes will be onshore.

However, with the prospect of digital assets trading onshore venues mimicking traditional financial markets thanks to upcoming regulatory and market structure changes – the lack of weekend trading and clearing offered by traditional venues was noted by respondents as a challenge.  

When asked how much of a challenge the lack of weekend trading on regulated onshore entities would post, almost 40% of crypto native firms and 30% of traditional finance firms said it posed a significant challenge.

The report also noted that given the 24/7 nature of the crypto market, the lack of weekend clearing offered by traditional financial markets could expose investors to risk of price moves and increased margin requirements.

“Clearing in traditional finance is by its very nature a daily process and no clearing activities take place over the weekend. That means that most regulated onshore digital assets trading venues will also limit trading hours,” said Acuiti in its report. “Crypto is, however, a 24/7 market and, while clearing goes some way to mitigating counterparty risk, there is an inherent build-up of market risk over the weekend.”

Acuiti’s report found that over 65% of traditional firms either agree or strongly disagree that they would prefer to trade on venues with lower initial margin requirements.

Similarly, over 65% of traditional firms either agreed or strongly agreed that a model in which firms can access a venue directly as well as through a broker will be of benefit to the overall crypto derivatives market.

Cross margining between different crypto assets was also found to be important in firms’ decision on where to trade, with 47% stating that it would be crucial, while 42% felt it would be a significant factor.

Of those surveyed, 86% stated that more institutional participation on regulated trading venues will be the largest positive impact for the entire crypto ecosystem, while 14% believe the move will encourage greater opportunities for native crypto firms and early traditional finance adopters.

Among the respondents, 0% felt that the move would have no positive impacts, would lead to less trading on offshore markets and significantly more retail participation.

While several major jurisdictions have introduced some form of licencing for exchanges to allow them to offer services to clients in that region, Acuiti noted that comprehensive regulatory frameworks that reflect the nuances and full scope of trading in digital assets are only now being developed in the major jurisdictions.

The EU has developed the Markets in Crypto Assets (MiCA) regulation will take effect from next year, while the UK government has revealed plans to develop a separate framework based on existing regulations where possible. Elsewhere Singapore, Hong Kong and Dubai have also launched or are developing comprehensive frameworks.

“Innovations in native crypto derivatives market structure have valid applications in onshore regulated markets,” said Will Mitting, founder of Acuiti.

“Ultimately the native market structure of crypto derivatives will come together with the traditional market structure to create the market of tomorrow. Many of the innovations in the crypto native world, such as real time margining and risk management, will inevitably become part of global markets across both traditional and digital assets.”

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This follows asset managers having reduced OTC exposures in the wake of the ‘uncleared margin rules’ and other post-crisis reforms. 

The report confirmed that OTC trading represents considerable operational costs, with ISDA agreements coming out on top as the greatest challenge for OTC market participants according to respondents.

The complexity and cost of trading under an ISDA agreement is a particular worry for smaller firms as the cost of signing and maintaining agreements with multiple counterparties becomes burdensome. 

Will Mitting, founder of Acuiti, highlighted that this reduction in OTC exposures represents an opportunity for the market to offer listed products aimed at solving client requirements: “As asset managers continue to innovate and meet investor demands for thematic, ESG and climate investments, the sell-side is well placed to offer access to listed products that can serve these requirements.”

The OTC market has been key for the buy-side for many years, allowing them bespoke, often complex, products for their portfolio needs.

However, as strategies evolve in complexity, asset managers are seeking alternatives in their bid to gain tailored exposures to equity derivatives. So far, investors have encountered several stumbling blocks, as Acuiti explains: “Investors have faced a trilemma with no available products in the post-crisis world offering capital and margin efficiency, low trading costs and customisability.” 

Nevertheless, there is a growing offering of exchange traded products in recent times, coming on the back of the rise of thematic investing and ESG, said the report.

These alternative products are aimed at “marrying the benefits of the OTC with the listed market,” specifically the customisable aspect without the associated costs (e.g. arising from ISDA agreements). 

Despite ETF markets and currently available listed products meeting the demand to some extent, the Acuiti report confirmed the existence of a significant gap in the market for a customisable listed product.

Mitting addressed the changing OTC landscape and suggested that the answer could lie with custom basket forwards (CBFs): “[however] the rising costs and complexity associated with OTC derivatives has forced firms to look for listed alternatives. Our study suggests that CBFs can solve the investment trilemma for firms offering a margin efficient, customisable product with low trading costs.” 

Acuiti’s ‘Solving the Investment Trilemma’ report was commissioned by Nasdaq and coincides with the launch of its custom basket forwards (CBF). 

Part of the survey’s findings showed that banks see potential for CBFs to offer a new product and therefore engage new clients, bringing greater capital efficiency to the market.

In addition, for the buy-side, the top benefit of CBF’s was ‘no need for an ISDA agreement’ followed by ‘lower counterparty risk’.

Alessandro Romani, vice president, head of European derivatives at Nasdaq, said: “The Acuiti report provides great insights to the industry trends behind the increasing demand for tailored equity exposures, as well as the challenges and complexity of managing them, with the use of OTC derivatives.

“With the launch of custom basket forwards, Nasdaq is well positioned to provide asset managers and sell-side firms with an alternative solution to OTC equity swaps, based on a listed and CCP cleared derivatives contract.”

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The report focuses on the rising cost of trading, finding that 33% of surveyed respondents are currently reducing their presence in some markets or products as a result, with 29% highlighting that they are trading less overall due to these high costs.

As firms realign their focus, the Q4 2023 report saw FX come out on top as the area that firms were most likely to be expanding, a significant reversal when compared to 2022, where FX was an area wherein the fewest firms were seeking to expand. 

Will Mitting, founder of Acuiti, said: “Proprietary trading firms are looking ahead to 2024 with optimism and planning expansion and increased investment. However, exchange costs are an increasing burden for many firms, which are trading fewer products and markets than they would if fees were lower.”

The report also found that of the areas firms are already trading, plans are to grow footprints in equity options and cryptocurrency. Additionally, looking at the trading new asset classes, several firms confirmed they plan to expand into fixed income – specifically into cash government bond markets.

Alongside this expansion, the report also highlighted that almost a fifth (mostly from Europe) of firms are planning to decrease their exposure in the cash equities asset class. According to Acuiti this “signals a worrying trend in a market already suffering from poor liquidity”. 

Elsewhere, almost two thirds of firms (63%) are set to make higher than average investments, with algorithmic trading tools, connectivity to new markets, and market data the top priorities, according to Acuiti.

In addition, prop firms’ technology investments for 2024 were also expected to be ‘significantly’ above average by 23% of those surveyed, while 40% of the respondents confirmed a ‘slightly above average’ increase in investment.

Aleksey Larichev, managing director at Avelacom, said: “The report reveals that proprietary trading firms are willing to invest in improving their connectivity to markets, including exploring new ones. This shows their plans to expand and optimise their current trading setups. It’s a positive sign that the market is in good shape and working to stay competitive.”

The Q4 ‘proprietary trading management insight report’ surveyed senior executives across more than 100 firms across the globe, in partnership with Avelacom.

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This is specifically as a result of offboarding, a highly disruptive process which is also costly due to the process of finding and onboarding new prime brokers, highlighted by respondents as a significant drag. 

Over the past five years the number of prime brokerage relationships has been reducing. After internal decisions to consolidate, the next biggest contributors to this trend were existing providers withdrawing from the market, or firms having been offboarded by their existing providers, the Acuiti report asserted.

Of the respondents, 53% of respondents were ‘quite concerned’ and 16% ‘very concerned’ about the impact on their business a market withdrawals of one of their FX PB providers would have.

Notably, the Acuiti report found that more than a third of respondents did not have an executable back up plan in the event of being offboarded by core FX PB providers.

Aside from the impact on liquidity from these situations, Acuiti’s latest report – the rising risk of FX prime brokerage consolidation – also found that operational disruption from moving to a new provider is a key concern.

Ross Lancaster, head of research at Acuiti, said: “Hedge funds are highly reliant on their FX PB providers and it is no surprise that levels of concern are high across the market. There is an opportunity for expansion among the sell-side to meet the demand from hedge funds both to access unique trading opportunities in emerging and frontier markets but also to reduce operational risk associated with the dependence on specific providers.”

As it currently stands, 71% of respondents are currently looking to maintain their existing level of providers, while 24% considering changing or increasing providers.

Capturing new or unique trading opportunities among the main reasons for 24% of hedge funds looking to change or increase their number of FX prime brokerage (FX PB) providers, according to Acuiti report. Other key motivators were seeking to reduce costs (primary reason) leveraging the strengths of new providers’ offerings, and capital efficiency.

Read more – Market participants deep in preparation as FX market changes ramp up

For those hedge funds looking to increase their number of FX PB providers, another of the key motivations came down to achieving geographical diversification and accessing unique opportunities in the international FX market.

However, this could prove challenging if the market continues to consolidate, as Andy Ross, global head, prime and financing, financing and securities services, Standard Chartered, explained: “At the same time, with ongoing growth in the global market place, hedge funds from across the world are looking for a partner that can provide access to a broad spectrum of currencies to optimise their trading strategies.”

“The survey shows that hedge funds are encountering an increasing challenge in finding a prime broker for FX PB and firms have no executable back up plans in the event of services being withdrawn by their core provider.”

Acuiti’s report found that 61% of respondents highlighted that the ability to add any global currency to their tradable universe would enhance their trading strategies, “representing the desire to expand horizons, as opportunities in established markets are subject to increased competition. In a related finding, 38% of respondents said that they had missed opportunities as a result of not being able to rapidly and cost effectively trade a new currency or market.”

The prevalence of consolidation in this space has been a hot topic in recent months, with significant market moves from key players. Back in September, Cowen’s prime brokerage and outsourced trading business was acquired by Marex just six months after TD completed its purchase of the business.

The following month, TS Imagine and Cassini Systems announced a partnership as they sought to increase market share in the hedge fund and prime brokerage space. With the move, Cassini’s intelligent analytics across over the counter (OTC) and exchange traded derivatives (ETD) products now available via TS Imagine’s offering.

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A report by Acuiti, commissioned by Trading Technologies, found that trading in APAC holds significant potential for firms if challenges unique to markets within the region can be overcome.

Overall, 37% of respondents said that trading in APAC markets was more profitable than trading in Europe, with just under a third of hedge funds noting that the profitability of their trading strategies was significantly higher in APAC than in Europe.

However, although the region presents significant profitability, various challenges exist for European firms trading markets across the region.

Among the challenges, more than half of respondents cited finding the right local partners when required as the most challenges aspect of trading APAC markets.

Other major challenges included understanding local rules and regulations as well as gaining access to regional derivatives markets via their preferred clearing firm.

“APAC is the fastest growing region for listed derivatives trading volumes, and that is fuelling interest in trading in the region among European proprietary trading firms and hedge funds,” said Will Mitting, founder and managing director at Acuiti.

“At the same time, many exchanges have invested in technology and processes designed to make it easier for international trading firms to connect and trade. This is creating a virtuous circle of growth that is set to continue.”

Understanding exchange rules and risk management requirements were found to be the least challenging aspects of trading APAC, with less than 20% of respondents citing these as an issue, respectively.

Elsewhere, technology requirements were lower down the list of challenges, given substantial investments made by third-party front office vendors over the past decade to expand connectivity to exchanges in APAC. This has resulted in reduced cost of entry for clients when engaging in new markets.

“Trading Technologies has long recognised the tremendous trading opportunities in the APAC region. This study clearly demonstrates that these opportunities have only grown,” said Keith Todd, chief executive of Trading Technologies. 

“European hedge funds and proprietary trading firms are among those poised to benefit as they learn more about how to navigate some country-specific challenges through education and the right partnerships.”

Earlier this year, a separate Acuiti report found that trading firms are increasingly looking to diversify their trading strategies through entry to new markets, with over half of respondents confirming definite plans to expand to new regions within the next three years.

From the list of respondents, 76% were found to be looking to expand to Asia – with Taiwan specifically top of the priority list, while 67% expressed that South America is a region of focus.

Read more: More than two thirds of traders are looking to diversify through Asia and South America expansion

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