Forefront Communications

FinOps Report: Fund Managers Find COVID-19 Makes Best Ex Best Effort


Alexandra Hamer

Alexandra Hamer

Complying with “best execution” requirements is nothing new for fund managers, but some could easily end up failing to meet their fiduciary obligations this year due to circumstances beyond their control — the unprecedented market volatility and remote working generated by the COVID-19 pandemic.

About a dozen operations managers at US fund management firms who spoke with FinOps Report over the past week acknowledged they were concerned about whether their firms would be able to fulfill their best execution obligations, but none was willing to explain how their firms would address any potential issues. Instead, they claim there is only so much they could do to ensure some of the intertwined key components of best execution such as price discovery, execution quality and cost reduction given the reduced liquidity and intraday price swings over the past few weeks. Market volatility is far higher than that experienced during 1987’s Black Monday, the 2008 global financial crisis, and even the end of the Great Depression. The heightened market data traffic has also generated gaps in data necessary to analyze execution quality, acknowledge market data experts.

Market volatility will also likely impact the accuracy of transaction cost analysis (TCA) reports which measure explicit costs such as fees, and implicit costs such as market impact. “Fund managers use TCA to evaluate the quality of their own and their brokers’ execution performance based on their barometer for acceptable performance,” explains Jim Toes, president of the Security Traders Association, the New York-based trade group representing traders at fund management firms and broker-dealers. “Brokers will differ in performance and the fund managers can find any outliers who fall outside the range.” Fund managers, says Toes, do understand that transaction costs are likely to have increased during the pandemic and will be comparing the execution quality of the broker before and during the COVID-19 pandemic. Broker-dealers who deviate too far from expectations could find their relationships terminated.

However, judging broker dealers or themselves through TCAs won’t be easy for fund managers. “As a rule of thumb, the greater the market volatility the lower the accuracy of the TCA,” cautions BXS’ Grampone. The reason; one of the key metrics used for implicit costs– a comparison of the price of execution to the value weighted average price (VWAP) might be skewed if the broker-dealer or fund manager cannot retrieve precise market data, such as tic data, to make the analysis or the data is stale. Grampone says that BXS audits quote data by monitoring for erroneous quotes, erroneously wide quotes and crossed/locked markets to compare trends and detect outliers. Case in point: if BXS detects a single quote with a 20 cent spread in a security which has an average quote spread of only two cents, BXS would remove the quote from its analysis for being an outlier.

“The fund manager needs to have all of the right market data at the time the trade is executed and historic data on how it previously executed an order in the same equity,” says Patrick Flannery, chief executive of MayStreet, a New York-based market data management platform provider. The right data includes full-depth order book data immediately before and after trade execution as well as trade data. The data can be sourced either directly from exchanges via their proprietary data fees, in a consolidated manner via the SIP or in a consolidated manner via third party vendors, such as MayStreet, Refinitiv or Bloomberg. Because SIP data only includes top-of-book data many brokers and their fund manager clients don’t use it to determine execution quality. “With the amount of market data traffic essentially doubling overnight beginning in late February, market data systems run by fund managers and brokers have become strained resulting in gaps in data that managers need to perform their analysis of execution quality,” says Flannery. “It can be very challenging to get pristine data, meaning no data loss of any kind and to also have it GPS time-stamped at the nanosecond level.”

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