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Transaction analysis: an anchor in volatile markets

Published

December 2022

As uncertainty stalks markets and remote work proliferates, the ability to find liquidity and measuring trade performance is critical. Fixed income desks around the world, who apply the analytics of ‘Best Ex’ and Transaction Cost Analysis can refine their trade process to gain insight on costs, asset allocation, and assess counterparty execution performance. It’s a dynamic that underscores a recent shift: where the use of best trade execution tools once focused on fiduciary duty to clients, now, they offer a way to help gain an edge.

The genesis

Best Execution requires financial institutions to provide the most favorable order execution for investors in given market conditions. The concept of Best Ex has existed since at least the 1930s, and with regulators’ increasing focus on investor protection, institutions are required to demonstrate compliance.

MifID II is an iteration of Best Ex regulation, and while it is European, the global footprint of many institutions impacted by the regulation means Best Ex has had global impact since its rollout in 2018. Yet many firms still have no systematic way to show they meet requirements. So how can compliance be demonstrated?

At ICE Data Services, Best Ex can help measure trade execution quality relative to comparable fixed income transactions in the market. With the recent coverage expansion in 2022, ICE’s BestEx service now covers 97% of the ICE Index universe.

When a bond is bought or sold, the transaction price can be compared to our Continuous Evaluated Pricing (CEP™) as a benchmark or other relevant reference price. The data fueling CEP is gathered from several sources: relationships with buy and sell side firms, arrangements with dealers and electronic trading platforms, and through public reporting systems operated by the Municipal Securities Rulemaking Board and Financial Industry Regulatory Authority.

To generate CEP, a rules-based pricing application is applied, overseen by a team of evaluators. This systematically captures and incorporates market information, to produce a pricing process responsive to market conditions. This continuous, independent evaluated pricing for fixed-income securities is a contrast to operators which provide limited coverage or only end-of-day pricing.

ICE’s BestEx service is a quantitatively driven approach, building statistical distributions around our CEP or other reference price. At the most general level, a distribution is based on the asset class, tenor, trade side, and trade size. A percentile score is given to each trade based on where the price differential falls within the distribution. This effectively allows for relative comparison between different trade sizes and asset types, eliminating the need to normalize trade to price differences based on different fixed income asset types. Additionally, BestEx will score a trade multiple times before and after the trade time to account for the context of the trading environment at and around the time of execution.

The ability to measure relative trading quality against a price benchmark is only one element of best execution. Over the past few years, best execution in the industry has evolved to include bond and trade-specific factors, such as trade intent, size, speed, likelihood of execution and more. As a result, large institutions which were early adopters have recognized the opportunity to better analyze their trades. Enter: Transaction Cost Analysis.

The evolution

Asset managers have traditionally lacked a robust set of tools to measure their trade costs comparatively - a contrast to the sell side, which have transparency on pricing and enjoy an information advantage. Although common and heavily used in equities, fixed income can now benefit from growing advancements in Best Ex and Transaction Cost Analysis (TCA). What was once a regulatory requirement has become an important set of metrics for traders, fund managers, and those who decide on asset allocation.

TCA provides a measurement of transaction costs, taking the liquidity of different instruments into account. For example, a trader may achieve Best Execution for both a high yield bond and a Treasury - but their differing liquidity profiles mean they may have very different transaction costs.

Importantly, TCA allows asset managers to monitor the elements of a trade in greater detail - for example: the cost to implement individual fixed income trading strategies by asset class and liquidity, how long a particular counterparty took to execute a transaction, whether they execute trades for a certain type of bond faster than others, and metrics which can be adjusted for regions and currencies.

As a result, ‘BestEx’ committee meetings have become more frequent and influential within asset management firms, along with investment in ‘Execution Analysts’. With the data to identify, monitor and adjust different trade factors, asset managers can more precisely tweak their strategy. In short, the transparency offered by these tools enables asset managers to make more informed decisions.

Investor pressure on costs has also been a motivator for adoption. As best execution analysis becomes more widespread across fixed income, asset managers can proactively demonstrate to clients that they are reviewing trades to ensure value-add - or “Execution Alpha” for portfolios. Investors are actively seeking transparency around execution costs and asking more specific questions. In response, asset managers have taken steps to ensure they can respond to these new inquiries.

For the sell side, these tools represent the opportunity to win more business. By applying independent analysis to measure relative execution quality, they enable brokers to demonstrate their efficiency to asset managers and potentially gain more trade volume. TCA also allows dealers to gauge their performance relative to peers in a specific bond asset class, and further narrow this down by industry sector.

As the sophistication of Best Ex and TCA evolves, those who utilize these tools will be better positioned to analyze performance and hone their Best Ex strategy. And in a world of growing cost pressures, the ability to transparently demonstrate efficiencies to a range of stakeholders, may be more crucial than ever.

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This document contains information that is confidential and the proprietary property and/or a trade secret of Intercontinental Exchange, Inc. and/or its affiliates (the “ICE Group”), is not to be published, reproduced, copied, modified, disclosed or used in any way without the express written consent of the ICE Group. This document is provided for informational purposes only. The information contained herein is subject to change and does not constitute any form of warranty, representation, or undertaking. Nothing herein should in any way be deemed to alter the legal rights and obligations contained in agreements between the ICE Group and its respective clients relating to any of the products or services described herein. Nothing herein is intended to constitute legal, tax, accounting, or other professional advice.

The information contained herein is provided “as is” and the ICE Group makes no warranties whatsoever, either express or implied, as to merchantability, fitness for a particular purpose, or any other matter. The ICE Group makes no representation or warranty that any data or information (including but not limited to evaluated pricing) supplied to or by it are complete or free from errors, omissions, or defects.

Trading analytics available from ICE Data Pricing & Reference Data are a point in time output and as such dependent on and take into account the information available to ICE Data Pricing & Reference Data at the time of calculation. ICE Data Pricing & Reference Data does not have access to all relevant trade-related data or dealer quotes, and the utility of the output may diminish depending upon amount of available data underlying the analysis. The inputs utilized in each of the trading analytics services described herein depend on the methodologies employed by each such service and may not be the same as the inputs used in the other trading analytics services. There are many methodologies (including computer-based analytical modelling) available to calculate and determine information such as trading analytics described herein. ICE Data Pricing & Reference Data’s trading analytics may not generate results that correlate to actual outcomes, and/or actual behavior of the market, such as with regard to the purchase and sale of instruments. There may be errors or defects in ICE Data Pricing & Reference Data’s software, databases, or methodologies that may cause resultant data to be inappropriate for use for certain purposes or use cases, and/or within certain applications. Certain historical data may be subject to periodic updates over time due to recalibration processes, including, without limitation enhancement of ICE Data Pricing & Reference Data’s models and increased coverage of instruments. Although ICE Data Pricing & Reference Data may elect to update the data it uses from time to time, it has no obligation to do so.

Fixed income evaluations, continuous evaluated pricing, end-of-day evaluations, evaluated curves, model-based curves, Fair Value Information Services related to securities are provided in the US through ICE Data Pricing & Reference Data, LLC and internationally through ICE Data Services entities in Europe and Asia Pacific. ICE Data Pricing & Reference Data, LLC is a registered investment adviser with the US Securities and Exchange Commission. Additional information about ICE Data Pricing & Reference Data, LLC is available on the SEC’s website at www.adviserinfo.sec.gov. A copy of ICE Data Pricing & Reference Data, LLC’s Form ADV is available upon request.

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