The buy side and Transaction Cost Analysis

Monday, November 1, 2010 Stamford, CT USA — Although institutions in Europe and the United States have made Transaction Cost Analysis (TCA) a standard part of their equity trading operations, it remains to be seen if the system for analyzing trading effectiveness will live up to its early promise: Can TCA evolve beyond a process useful in compliance and high-level performance assessment and into a tool capable of generating actionable and even real-time analysis that helps institutions lower trading costs and improve outcomes?

A new Greenwich Market Pulse reveals that, by and large, institutions are satisfied with their TCA systems and providers. However, the study results suggest institutions' relatively high levels of satisfaction are related mainly to the use of TCA as a tool for compliance and some general tracking of overall trading desk performance. Digging a bit deeper, institutions express disappointment and even frustration about the inability of TCA systems to generate analysis that provides opportunities for institutions to improve overall performance by wringing new efficiencies out of the trading process.

A new special report on TCA from Greenwich Associates analyzes these study results and presents a list of recommendations to help institutions maximize the value they generate through TCA.

"There is definitely a need for a 'check-the-box' type of product that satisfies compliance standards, and current TCA offerings seem to function well in this capacity," says Greenwich Associates consultant Jay Bennett. "But for institutions hoping that TCA can provide them with a more sophisticated tool, our research suggests there is still much work to be done."

A Cornerstone of Compliance
From September 27 to October 4, 2010, Greenwich Associates interviewed 114 institutions in Europe and the United States about their use of TCA. All of these institutions are large and active stock traders ¿ the majority have at least $3 billion in assets under management and generate at least $5 million in annual brokerage commissions on equity trades. Three-quarters of these institutions use TCA as part of their investment processes.

Almost all the institutions that employ TCA use these systems as part of their compliance functions. "Institutions' satisfaction with TCA as a compliance tool seems to drive the relatively high marks they give to their TCA vendors for quality in several key areas, including flexibility/customization, ease of extracting data and confidence in results," explains Greenwich Associates Director of Institutional Marketing Jennifer Litwin.

TCA as a Management Tool
Many institutions also use TCA as a management tool. Among the 286 institutions participating in Greenwich Associates' 2010 U.S. Equity Investors Study earlier this year, 45% employ TCA to identify outlier trades, 39% use TCA to measure active trading results against a benchmark and 36% use TCA as part to assess the performance of traders on the internal desk.

"I think TCA has become a must-have for the trading desk, and it has started to be a new way of looking at the value-added by the dealing desk among the directors of the company," says a study participant representing a large Spanish investment management company.

TCA Shortcomings
However, institutions are not impressed with the "actionability" of their TCA vendors' analysis. Approximately 30% of institutions describe the analysis they receive from their TCA systems as actionable; 20% say it is not actionable. Almost 55% are on the fence. "Institutions also raise serious questions about the costs of TCA systems and about the quality and reliability of the data going into and coming out of TCA systems," notes Greenwich Associates Equity Products Manager Kevin Kozlowski.
Among the additional factors cited by institutions as challenges they face in their current use of TCA are the following:

  • Only one-in-five institutions say the accuracy, richness and depth of their core trading data is consistently adequate.
  • 45% of institutions say assigning the correct benchmark for each trade is either problematic or extremely problematic in their TCA process.
  • Almost 40% of institutions cite a lack of credibility of current TCA results in the support of best execution requirements as an ongoing challenge.

Only one quarter of institutions that use TCA have tied trader compensation to TCA results. "In our TCA research, traders and their managers have both warned that, because they feel TCA systems fail to take into account all the variables that affect trade outcomes, buy-side traders would game TCA systems if their compensation was tied to those results," explains Greenwich Associates consultant John Colon.

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