The evolving role of best execution analysis

Overall complexity in the market, combined with a general lack of available market data from a centralised/regulated source, is driving the evolution towards sophisticated pricing models that use both dealer contributed and electronic data to support best execution determination. Regulatory mandates are pushing more liquid parts of the OTC market to become more electronic.

Electronification is imminent for the global capital markets. Advanced trading technologies have already begun making an impact, with algorithmic strategies and smart-order routing (SOR) gaining popularity. With more choices for execution, traders have to overcome market fragmentation. To make the most effective decisions related to best execution, traders need specific analysis of each tool and venue they use. TCA systems that analyse the SORs for efficiency in finding liquidity, venues for fill probability and opportunity costs, and order types for information leakage and market impact are becoming vital. These systems will either support or provide constructive input for changing the trading choices made on behalf of portfolio managers and, ultimately, to the asset owners to whom they have a fiduciary duty to ensure best execution.

Driven by inherent market limitations and challenges, at least in the short to medium term, the following factors will continue to play a vital role in the development of best execution analysis platforms in the OTC market:

• Basic market and transaction data generated by various electronic trading venues that exist in the OTC market
• Any proprietary post trade data that can be captured via consent from buyside and sellside market participants
• Derived evaluated pricing that provides more reliable context into specific OTC instruments (especially important in those instruments that lack liquidity and therefore lack consistent transaction history)
• Reliable measurement of liquidity to provide certain level of confidence in data and transparency

As the OTC markets become more regulated and standardised, similar to what we have witnessed in the equities markets, firms will need to think about best execution analysis and TCA as essential parts of their risk management process, particularly as execution analytics move from post trade to the entire trade lifecycle. As regulation across the globe looks to push more assets into an equity-like structure that involves pre and post trade transparency, best execution analysis will be applied across these products. Conventional wisdom dictates then that increased regulation is likely to increase TCA usage within asset management firms. The emergence of SEFs in the US and organised trading facilities (OTFs) in Europe are part of the process of increasing transparency in certain OTC markets, which will aid the use of TCA in these markets.

S&P Global provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.