Trading Costs Improve as Transaction Cost Analysis Spreads

Stricter transparency standards in Europe spurred further adoption of TCA across asset classes, while trade execution improved amid low volatility.

Source: Elkins/McSherry, a State Street subsidiary

Source: Elkins/McSherry, a State Street subsidiary

Transaction cost analysis continued spreading beyond stocks to other assets last year as asset managers and broker-dealers sought to comply with stricter transparency standards in Europe.

“2017 was the year for multi-asset TCA, driven by regulatory requirements,” said Kevin O’Connor, global head of analytics products at ITG, a global TCA provider. “Great strides were made for fixed income, foreign exchange, and derivatives.”

These regulatory requirements included the second iteration of the European Union’s Markets in Financial Instruments Directive, or MiFID II, as well as the EU’s new rules on Packaged Retail Investment and Insurance-Based Products, known as PRIIPs. The pair of regulations, which took force the first week of 2018, targeted transparency improvements in trading and investment products.

MiFID in particular has spurred interest in transaction cost analysis by demanding that asset managers take sufficient steps to obtain the “best possible result” when executing trades for clients, including factoring in costs.

“The best execution mandate has pushed up the utilization of TCA by our clients,” said Brian Fagen, head of execution strategy for Deutsche Bank in New York. According to Fagen, asset owners are asking for information in a much more specific way. “That’s driving a new wave of work in the space.”

[II Deep Dive: Transaction Cost Analysis Makes Leap to Bonds, Foreign Exchange]


For bonds, currencies, and derivatives, calculating and standardizing trading costs is a tricky business, said Mike Googe, global head of post-trade transaction cost analysis for Bloomberg in London.

“When a trader receives an order, the first thing they do is price discovery,” he said. “Because there is less liquidity in fixed income than stocks, traders have to evaluate multiple price sources and dealer quotes. Using this and additional market context, traders can better inform their analysis of what conditions will get better results.”

And transaction cost analysis is evolving to focus more on pre-trade costs. “In the past TCA was after the fact, but now we’re seeing greater definition around tools that define pre-trade costs,” Fagen said. This trend is “creating a much more front-to-back virtuous cycle that can be used to inform and change the way a firm actually transacts,” he added.

Another positive development in transaction cost analysis, according to Thornburg Investment Management’s equity trading head Thomas Garcia, is an expansion from measuring just the quality of the buy-side trading desk to also measuring the quality of the sell side – the brokers and algorithms to which the traders are routing their orders.

“Are my orders going to dark pools or are they getting routed to the best places?” he asked. “Are the orders going first to the exchange that pays the most, or to ones where brokers pay the exchanges the most?” The best priced trades, Garcia said, will probably be at the exchanges where brokers are paying.

Trading execution improved in 2017, according to II’s Transaction Cost Analysis report. While volatility fell sharply in the stock market last year, the survey showed that market impact, or the price difference between when an order is received and when it’s executed, slid even further on average.

The average decline for the main two measurements of market impact, the volume-weighted average price and implementation shortfall, was 26 percent. The VWAP decreased 13 percent, while the implementation shortfall plunged 39 percent.

Meanwhile, volatility, as measured by the CBOE Volatility Index, dropped 14 percent.

The decline in volatility allowed for traders to take more time before pulling the trigger on their orders. Execution data from the New York Stock Exchange showed that the amount of trades taking zero to nine seconds slid to 73.7 percent from 75.9 percent last year. At the same time, the amount of trades taking 30 to 59 seconds increased to 5 percent from 4.9 percent, and the amount of trades taking 60 to 299 seconds climbed to 8.9 percent from 7.7 percent.

“Volatility was tame, so traders could spend more time in the market, getting the trading costs they expect,” said David Griffin, vice president of trade cost analysis at Elkins/McSherry. “That helped lead to the decline in market impact costs.”

In a low-volatility environment, traders can take the time to evaluate different tools, such as algorithms, and assess different trading venues, added Griffin’s colleague, Jacqueline King, a research and product development specialist at State Street Global Exchange. “That allows them to control costs better,” she said.

A month into 2018, however, volatility started to kick back up, with the VIX spiking amid a stock market rout. If this higher volatility continues, it could boost trading costs this year. “We will need to monitor the impact,” King said.

In any case, it’s important to realize that transaction cost analysis isn’t the be-all and end-all, Garcia said. “We care about it, but it’s not the bible,” he explained. “We look at it as a way to enhance some of the things we do. But in the end, we’re trying to do what’s best for the asset holder, not for TCA.”