Still Working on Execution


New York – In assessing the future of the research industry, it is easy to get ahead of the curve.  We have been talking on these pages about the future of disclosure, transparency, and de facto unbundling in the research space for several years. And although this is a fruitful discussion, it does not reflect the current state of affairs in the industry.

Most, if not all, of the effort at present is being directed towards the measurement and assessment of best execution. Here there remain a number of questions.

One question is how is best execution measured and when do we know if we have achieved it.  Probably the most pervasive measure of execution is VWAP (volume weighted average price).  The measurement issues associated with VWAP are well known and include conditions under which the traders may distribute or concatenate trades over time simply to achieve VWAP. Further, shops that embrace VWAP will be less willing to execute small cap (illiquid) stocks.

Another issue relates to Reg NMS (the rule of best price). The rule dictates that the execution should be at the most advantageous price possible for the client under the current market conditions. Pursuit of Reg NMS introduces its own distortions into the market, including a drive by the larger players into the ECN space and into dark liquidity pools.

Although not directly related to Reg NMS, a recent settlement by Morgan Stanley with the SEC related to the execution issue highlights other concerns. The SEC charged that Morgan Stanley had violated section of the 15(C)(1)(A) of the Exchange Act of 1934 regarding the use of undisclosed mark-ups and mark-downs with certain clients. Additionally, the SEC charged that Morgan had delayed retail transactions within its automated transaction system.

Execution depends on the liquidity of the stocks traded. For example, large cap stocks will have a more liquid market than small caps. As well, the execution depends on order size, meaning that the smaller retail orders will have higher execution costs.  And of course, execution will depend on market conditions-i.e. up markets as opposed to down markets and volatile greed/fear cycles.

As a starting point to transparency, The SEC has indicated that it will view everything that is not execution as research. Some of this “research” will be eligible for 28(e) and some will not. CSAs and CCAs will have a dramatic impact on the research industry. This is not to minimize the work of the trade cost analysis firms over the past 10 years, but it seems that, given the moving landscape of regulation,  more work will be required before we get a clear, disaggregated view of the execution versus the research spend.


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