The process provides valuable insight on broker and venue performance. The aim is to identify the spread between potential and actual execution costs, and then establish whether there are systemic reasons for that spread. Not only does it rely on the trade data held by the buy-sides in their order management systems, but market data as well. It is, inevitably, a data-intensive process. Asset managers package up the data relating to that month’s activity and ship it out to the specialists, who then crunch the numbers and compare the results with various sets of market data and produce reports about how effective that month’s trading has been in terms of certain absolute measures. The importance of TCA in today’s markets is evidenced by the prominence of several third-party specialist providers. It enables traders to measure not only implementation shortfall – perhaps the most obvious and easily measurable performance indicator – but other execution benchmarks including the widely deployed Volume Weight Average Price and other algorithms. Since the abolition of the concentration rule to allow a multiplicity of execution venues was explicitly designed to enhance competition and consequently services, TCA plays a valuable role in the post-MiFID, post-RegNMS securities markets. It enables buy-sides to assess which brokers are achieving their benchmark, and which are falling short of expectation, and gives them documented evidence of the true cost – measured by implementation shortfall, fees, commissions and decoupled research costs.īuy-side firms are also using TCA to assess the relative costs of the venues used for execution, and are able to engage with broker strategies on a more informed level. Similarly it can be taken downstream, where there is significant buy-side interest around measuring the execution performance of a brokerage firm as a whole, or of particular strategies offered. They can take it all the way upstream to establish how their own decision-making process, and the time it takes to make an instruction, impacts the cost. TCA enables asset managers to measure performance at various different stages in the investment management process. TCA’s journey into the spotlight has also been driven by regulatory pressures to demonstrate best execution. Calculating these costs has become critical and the credit crunch has only hastened a process that was already underway. However, what the ban on bundling and softing couldn’t reveal was the hidden costs involved in each transaction: investment delay, price appreciation, market impact, timing risk and opportunity cost, known as implementation shortfall. When broker fees and commissions were decoupled from research costs, part of the true price of transactions immediately became more obvious to all observers. Transaction cost analysis (TCA) in particular has been promoted from bit part to star player. Asset managers are looking for more comprehensive information regarding order execution, both to measure performance of their chosen brokers and to demonstrate value to their investors. It has proved to be a fertile combination for trade analytics. Many are considering broadening their broker list to ensure that no sources of liquidity escape them, whereas others are looking to direct their efforts and their commissions to a narrower group of trusted, full-service brokers. Buy-sides are looking for better value from their broker relationships and weighing up their choices for each trade: to place their faith in automation and self-directed trade or to shun algos and computer models and opt for the experience and skill that comes with more high-touch channels. In these challenging market conditions, the demand for transparency is accompanied by a need to impart greater cost controls and efficiencies throughout the transaction cycle. Custodians, trustees, consultants and investors themselves are making more forceful demands for their agents to open their activities to sunlight and scrutiny. Documented proof of skill, accuracy and integrity between fund managers and their brokers has become a tangible asset. One of the consequences of the credit crunch is the demand for greater levels of transparency at each stage of the order flow. With increased industry demands for transparency, TCA has been promoted from bit part to star player, says Richard Hooke, of Fidessa
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