Transaction cost analysis (TCA) has risen steadily up the equity trading agenda over the past decade and is set to become even more important in 2019. Over eighty percent of equity trading desks already use TCA, according to Greenwich Associates, which confirms that one of the top nine major market trends this year is the further embedding of trading analytics into the equity trading workflow.

Regulation continues to be the driving force. New order handling disclosure rules from the Securities Exchange Commission are about to do for transaction transparency in the US what MiFID has already done in Europe. Like MiFID, the SEC rules require broker-dealers to report on how they route and handle orders while also giving investors the information they need to assess the impact of routing decisions on order execution quality.

With trading analytics becoming ubiquitous across buy and sell side trading desks, and as broker-dealers converge their high and low touch businesses,  it is increasingly important that institutions have right tools to find and access liquidity and optimize routing. Regulations are leading to more complex market structure and prompting new ways of trading. In this environment, it is essential to have market gateways linking all relevant trading venues, as well as a smart order router (SOR) in order to find the best execution.

“Over 80% of equity trading desks already use TCA.“

Greenwich Associates

Like other elements of the operational framework for equities trading, market gateways and SORs have become commoditized and it no longer makes sense to develop and maintain these in house.

At the fundamental level, market gateways should provide robust and reliable low-latency connectivity to all relevant trading venues with the capacity for high trade throughput. They must handle multiple protocols with the ability to normalise messages into a standard FIX format, and offer message validation, translation and enrichment, with configurable routing.

Data flow management should allow for order flow aggregation and intelligent routing of multiple orders to multiple global venues. The pain with market gateways is having to follow all the various market upgrades that happen over time. Outsourcing this part of the puzzle allows brokers to trade seamlessly without having to worry about keeping up with market changes.

The SOR's task is to find the best liquidity to fill an order, whether that order comes direct from the client (DMA) or from the Broker algo box (DSA). The SOR sits somewhere between the algo box and the market gateways, and should offer sophisticated routing strategies which account for differing costs of execution styles; both indirect costs of market impact and direct costs like ‘maker/taker’ pricing.

The SOR also needs knowledge of the characteristics of specific markets in order to make the best decision. It has to implement the specificities of the market, such as what order types the market accepts. This becomes even more important as the market structure and transparency requirements of the latest generation of regulations precipitate new ways of trading. Under MiFID II for example, the SOR must deal with the complexity of exchanges, multilateral and organised trading facilities and systematic internalisers, as well as the implications of large-in-scale, size-specific-to-instrument and other new trade rules. And it must keep up with the ongoing evolution of trading and market practice.

Utilizing advanced market gateways and SOR components from a provider that can keep pace with market evolution is key to meeting today's TCA challenges for both high and low touch business.

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