Richard James, head of CEM execution services at J.P. Morgan, explains the importance of aggregators as a pre-trade visualisation tool.
Profit & Loss: Generally speaking, do you feel that there is a growing client demand for aggregation tools and services on single dealer platforms (SDPs)?
Richard James: That depends on whether you view aggregation as a fee-based execution tool or a market visualisation tool, which are the two flavours of aggregator available in the market at the moment.
There are those that tend to aggregate the underlying ECN liquidity, giving the client a view on how they can navigate the market in order to get out of risk quickly. Demand for this type of aggregation is relatively low at the moment.
Then there are those aggregators, such as ours, that function primarily as a visualisation tool, providing a view on where liquidity is distributed in order to help clients feel confident in how and when to use an algo to execute. We are seeing growing client interest in this form of pre-trade transparency.
P&L: Why do you think aggregators aren’t being used much as an execution tool?
RJ: Firstly, while clients like the idea of having their orders executed externally, most also realise that there is a significant benefit to them in accessing the internalised pools of liquidity within banks.
Secondly, the fundamental challenge of operating in the market with an aggregator is that the client expects a 100% fill ratio, but this is not always possible to achieve or guarantee, especially when they want to define the limit price of the trade.
If you’re aggregating liquidity across 10+ venues, you simply can’t see and access all the available liquidity out there all of the time. Some banks have tried to limit the number of liquidity venues to get around this problem, but I am not sure this is the right approach.
Many clients have got used to executing through SDPs where you almost always get a 100% fill on the prices you see. With our own SDP – J.P. Morgan Markets – we operate an all or nothing policy and also apply a P&L tolerance in an effort to ensure that the client is able to access the liquidity that they have clicked on. This has proved popular with our clients as it helps reduce the execution risk they take when clicking and trading on our platform.
By adding an aggregator as an execution tool is in many ways asking the client to take back some of this execution risk and it is clear that this approach won’t work for everyone. However, the use of an aggregator as a visualisation tool to help aid order placement is something we feel all clients would benefit from. That JP Morgan allows the client to compare the aggregatable price vs our risk price in the same trading pane allows clients to quickly compare our price versus that of the underlying market.
P&L: OK, so when considering your aggregator as a visualisation tool, how do you differentiate it from other offerings?
RJ: We have co-mingled the underlying aggregated ECN view and compared it against our risk price, making it very easy to compare the two as they are visually different, and it is obvious to the client at the time of execution which liquidity stream he is accessing. This means that the client can always see which of the two streams offers the most aggressive price at the time of execution.
This might even be a little disadvantageous to us because, in order to make the two streams comparable, we’ve had to apply the agency execution fee to the aggregated stream. That contrasts with some other models out there where the fee is applied post execution and the two streams are not as easy to directly compare as they are not available within the same execution widget.
P&L: From your perspective then, does the growth of aggregators on SDPs necessarily go hand-in-hand with the growth of algo trading?
RJ: Very much so. The challenge right now is to get people who have traditionally been point-and-click traders to start considering executing via algos, and I think that the visualisation that you get from aggregators and pre-trade TCA tools enables them to weigh up the expected cost of the different execution methods we provide.
This is also true post-execution, where clients are already using a number of the post-trade TCA reports we use to assess the performance of our fee-based algorithms.
However, having an independent third party start to provide clients with the ability to assess and compare the performance of different banks’ algorithms would be a great thing for the FX market.
I think it would also help highlight the value of hybrid algorithms, that access both external and internal pools of liquidity. That said, we have recently gone live with an updated post-trade TCA suite aimed at providing our clients with greater transparency on the performance of our algos.