2nd April 2008

Beyond equities-the next phase in algorithmic trading

Bob McDowall
Senior analyst-Europe Securities & Investments

2008 The Tower Group, Inc. May not be reproduced by any means without express permission. All rights reserved.

Agenda
Where does algorithmic trading stand? How is client demand for algorithmic trading changing? Fixed income & multi-asset trading Cross-asset trading How to access market and estimate liquidity The credit crunch Future limitations?
2008 The Tower Group, Inc.

Conclusions

Where does algorithmic trading stand?

How far have we come?
From Single Stocks, to Programs, to DMA, to Algorithms

How critical a role are algorithms playing in buy-side trading?

Algos as % of buy-side flow over time..20% and upwards?

Is algorithmic trading getting really commoditized?

There has been commoditization, but still room for differentiation (aggressive marketing, true client service, liquidity pools)

What are major factors that will impact this space?

March towards Electronic trading, Market structure (Reg NMS, MiFID)

What is the impact of algo trading have on agency broker strategy, IT decisions, staffing etc?
2008 The Tower Group, Inc.

How is client demand changing for algorithmic trading?

What do clients really care about in algo space?
- Algorithms themselves, or other factors: Liquidity Pool behind the Algo? Client service? Customization?

How is Reg. NMS and MiFID impacting client demand for algorithms?
- Drive buy-side to use aggregators to execute trades?

Where will algorithmic trading be in 2010?

- What will matter then? What wont matter anymore?

2008 The Tower Group, Inc.

Source: TowerGroup

Fixed income & multi-asset trading

Fixed income- limitations - the current environment Foreign exchange- opportunities - limitations Commodities (energies and metals)?

2008 The Tower Group, Inc.

Cross-asset trading
Advances in algorithms Electronic trading through ECNs Buy-side development of their own algorithms Technology and operational pre-requisites for successful cross asset trading

2008 The Tower Group, Inc.

How to access market and estimate liquidity

Fragmented markets but how fragmented in Europe? Algorithmic trading: fishing in the dark pools. Where are the dark pools of Europe?
So, financiers observe, small pools suck larger pools liquidity; yet tinier pools drain other drops, and so on to aridity. Michael Mainelli Z/Yen Group

2008 The Tower Group, Inc.

The credit crunch!

Is algorithmic trading the villain, the victim (or the fool)? How well are algorithmic models performing in the current environment? How will algorithmic trading emerge from the credit crunch?
The dark pools clearly limit the market impact on trading.in volatile markets, the stats that we see are that the public exchange volumes skyrocket and the dark pools and the internalization engines out there stay somewhat static in their absolute volume. Ivy Schmerken- Advanced Trading 2007
2008 The Tower Group, Inc.

Future limitations
Fragmentation in Europe how far and how quickly? Convergence or divergence in usage Regulatory constraints- transparency and risk models Algorithmic trading and risk models and the role of the human dealer?
2008 The Tower Group, Inc.

Source: TowerGroup

Conclusions
Short-term to medium term slowdown in the development of advanced algorithmic trading- limited advances in fixed-income Future advances will seek to demonstrate transparency, risk neutral or risk reduction in their application The human trader still has a significant role and in some cases a reprieve

2008 The Tower Group, Inc.

Source: TowerGroup