ROUTING ANALYTICS COME TO EUROPE WITH PLATO-CLARITY.
By Jeff Alexander, Founding Partner, and Linda Giordano, Founder & CEO, of Babelfish Analytics.
In the same way that race car drivers tweak and tune their cars to push for maximum performance, traders need to ensure that their tools are working at maximum efficiency. While traditional Transaction Cost Analysis (TCA) is useful for understanding high-level trends and general hindsight guidance on improvement, it doesn’t contain the necessary granularity to provide direct causal linkages to cost. Routing analytics provide the diagnostics that enable traders to cut through marketing hype and comprehensively understand what is working and what isn’t. An algorithms’ basic description usually does not deliver ‘professional race car’ level performance. Just as Lewis Hamilton couldn’t win a Grand Prix in an off-the-lot Mercedes AMG GT R, traders using off-the-shelf algos often feel frustrated with performance. Evaluating trading performance without analysing route level data is akin to evaluating a race car without ever opening the hood.
Clarity was the first product to address the need to analyse routing behaviour and offers the only platform that takes into account every action in the life of an order. Data that resides in Order Management (OMS) and Execution Management (EMS) systems is generally sufficient to perform traditional TCA, allowing a trader to understand portfolio manager instructions and market conditions to determine a trading strategy. However, TCA is neither comprehensive nor granular enough to measure the efficacy of the tools used to implement that strategy. Both unfilled routes, which indicate venues where routes were sent and includes information such as size, limits, and order types used, and filled routes, with properly granular timestamps, along with risk factors and accurate strategy categorisation, are necessary to evaluate an algorithm. This data only resides with the broker.
For example, some algorithms that are labelled ‘aggressive liquidity seeking’ may have built-in features that attempt to capture the spread or rest at midpoint prior to aggressive taking. In fast markets, this will create a tremendous amount of opportunity cost, which will convert into realised impact. Volume-Weighted Average Price (VWAP) algos may also rest in venues that offer economic benefits to the brokers, rather than seeking out the best liquidity sources, which can also result in excess realised impact cost.
Without the ability to collect all the underlying data associated with their broker algorithms, a trader cannot understand where inefficiencies lie, where costs are coming from, and which strategies provide the best experience. Much like parent-TCA, routing analysis is also a ‘multi-metric’ process, which requires a comprehensive dataset. Depending on the objective, it may be necessary to evaluate algos with different metrics. A focus on reversion is useful for algos with passive objectives, however, it is myopic for aggressive algos or even in fast markets, resulting in missed liquidity and excessive opportunity costs. Fill rate can be deceptive if constraints like minimum fill quantities and limits aren’t taken into account. These are just a few examples, but the bottom line is that traders often make the mistake of approaching routing analysis with the same template as traditional TCA. Routing analysis is not a ‘one benchmark fits all proposition’, but inefficiencies are not something that traditional TCA captures, and without reviewing routing data, trading costs will be higher than they should be.
In Europe, MiFID II mandates that investors institute a process to evaluate their algorithms to achieve best execution and to ensure that algos are sound. Currently, Plato-Clarity is the only commercial platform that can collect both the unfilled and filled routes and trades, process the data, and deliver these crucial transaction-cost analytics and warehoused data. Babelfish Analytics, the creator of Plato-Clarity, has teamed up with Plato Partnership to offer the platform across Europe to both the buy- and sellside, and to create a new standard for routing analytics.
One of the biggest challenges that any analysis operation faces is gathering, normalising, and processing data. For traders attempting to understand and integrate their broker’s routing activity into larger optimisation or performance models, this has been a frustrating and fruitless project that almost always results in endless cost, wasted resources, and inaccurate outcomes. In order to produce the Plato-Clarity application and consulting analysis, Babelfish has established a solid broker network and collects historical data in Babelfish’s standard, comprehensive format, which is already commonly in use. This data is normalised, priced, and processed into an easily digestible format and delivered using a variety of secure formats to an authorised destination to offer a comprehensive data warehousing solution.
The Plato-Clarity consulting platform is a fully functioning analytical solution. Subscribers alert brokers that they are participating and Babelfish will take care of the rest. The processed data is delivered in a series of highly customisable ‘tableau’ dashboards that illuminate aggregated venue and sequencing activity, internalisation, transaction fees and rebates, momentum and signalling, comparative broker scorecards, and proprietary metrics that enable traders to understand the trade-off between liquidity sourcing and information leakage control.
Additionally, if desired, periodic written consulting reports are available that contain actionable steps on how to customise algorithms to maximise performance. Babelfish analysts have decades of experience understanding market microstructure, transaction cost analytics, and algo engineering, which they can apply to your specific trading needs. They will help you work with your brokers to oversee controlled experiments and develop customisation plans. The ability for firms of all sizes to access a fully resourced ‘outsourced’ research team is invaluable.
While routing analytics are still in their infancy in Europe, Babelfish has been working with US-based investment managers for almost five years and has had significant impact on the industry. Early client-driven research resulted in the significant curbs in detrimental practices, such as the overuse of single-dealer platforms, which increased signalling, and vast broker internalisation, which led to missed trades and higher impact costs. Additionally, algo providers and venue operators now routinely mitigate the impact that price feed latency has on midpoint prices because Babelfish proved the relationship between stale midpoint prices and venue toxicity. Because of Babelfish’s influence and inspiration, these practices became more heavily scrutinised, and findings were validated by academics and regulatory bodies around the globe. Equally as impactful, however, are the firm specific benefits that are identified through regular and rigorous venue and routing analysis.