With George Molina, Director of Asian Trading, Franklin Templeton
As a buy-side group, we have been working on IOI reform for over four years, trying to find the best guidelines, drawing up a code of conduct and planning to push those reforms out into the industry. For a while, progress slowed due to disagreements over the definition of “Indication of Interest”, specifically around the natural/non-natural flow. Over the last three to four months however, progress has picked up again after the Investment Association and AFME in Europe worked on a code of conduct for IOI.
Here in Asia, we have met as a buy-side group three times in the last six weeks and are due to release guidelines at our forum in May. We have also been working with the sell-side, who have taken up the initiative, as well as Bloomberg, who are running an IOI system from their terminal. The next stage is to push the reforms out to the rest of the industry.
The main concern the regulators have is about what is real and what is not real. This concern is warranted, because it is important that the liquidity is there when the broker puts out an IOI, and it is a good starting place to begin constructing these new standards.
Whether this should be regulated behaviour or a behaviour driven by the industry is an interesting question. On the buy-side, we would like to take this initiative and drive forward our interpretation of IOIs. Having said that, we have been trying to do this for several years, and still haven’t come up with a proper code.
The problem with IOIs has always been the lack of transparency because of the perceived interpretation that brokers sometimes were fishing with IOIs – that they weren’t real. But on closer examination, it appears that they were not fishing, it was just the way in which they interpret their flow. For some brokers, if they were going to commit their capital and hedge a position, they would need to buy those shares, and as such would send out an IOI. For others on the buy-side, they may not actually have that position. It comes down to the different interpretations of what an IOI is, which is why we are trying to put these guidelines in place.
Another problem relates to the updating of IOIs. For example, an IOI is sent out in the morning. As the day progresses, you would expect to see the size of the IOI decrease as it is updated, but that does not seem to happen. Why aren’t those IOIs being updated? Why aren’t they more accurate or more transparent? This may relate to the cost of the systems. System costs are high and there doesn’t seem to be much of a technology budget on the sell-side to develop them. It will ultimately fall to the houses that have already been working on this for several years to design and implement better systems.
Much of the reform effort involves altering the existing parameters in systems that people are currently using to make them a more workable framework that people can continue to use without having to redesign systems from the bottom up.
And as MiFID II comes along, there will be increased scrutiny on why specific brokers are chosen by the buy-side. We have the flow in place, but an IOI is going to be another tool which can be used to prove to our clients and the regulators why we are working with a specific broker. It is the buy-side taking further control of its liquidity – a trend that is likely to continue.
It hasn’t been easy to come up with the definitions and it has been a real challenge trying to find a solution that the brokers agree on. Previously, we had given anonymous feedback to the brokers when we felt that the IOI wasn’t transparent enough. Unfortunately, that didn’t work as Bloomberg had made the ranking buy-side trader information public.
Standardisation of transparency works both ways. The buy-side can see more clearly whether what the brokers have is real or not real. The sell-side is then better able to judge interests from the buy-side and as such know who they should be targeting with the IOIs. It is likely that the IOS landscape will become more competitive when there is more widespread recognition that IOIs are an important tool for both the buy-side and the sell-side.
Execution management systems will already have the IOIs installed and it is simply a matter of these systems being further upgraded. A key feature is that this is an area that has not been driven by specific regulation, which means that developers can develop new products with relative freedom.
The future of IOIs
As IOIs grow in importance, there are likely to be further developments regarding how they work: they can become target IOIs, or actionable IOIs. Depending upon regulation and on where the trading desk sits, they may also end up being anonymous IOIs from buy-side to buy-side. There are many ways in which IOIs can reduce market impact by increasing anonymous flow back to both the buy-side and sell-side. This is also helping to bring back some of the liquidity sitting on the trader’s pad which they are not willing to stop, because of concern that it might be leaked.
Another thing that is important with IOIs is that everybody has to participate. If there is a broker or a client who does not want to use IOIs, then they should not be receiving IOIs from anyone else. This was a challenge faced by the industry where some firms were asking to see everything but not letting brokers show their flow.
The role of the broker
The ultimate responsibility lies with the broker as they have to know how much of the flow should be shopped to which type of client. There can be too much information on IOIs, and the buy-side needs to trust the broker’s expertise here.
IOIs need to be made to work successfully. Given that they have been around for over ten years, the information is out there but in order to find the best way of execution, we need to make it useful for everyone.
One concern is how this would impact the smaller brokers. In terms of technology cost, a smaller broker might be at a disadvantage if they do not have these tools. This is where the FIX Trading Community plays a very important role. As they continue building up their coding to accept more of these different IOI definitions, this will ultimately make it easier for the smaller buy-side and sell-side firms.
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