The New Sell-Side Trader

Brokers are morphing into execution consultants to advise the buy side on selecting algorithms and measuring performance.
In fact, brokers may have no choice but to reinvent themselves since the traditional role of the sales trader--to offer market information and analysis--has diminished as a result of electronic trading. "Broker-dealers don't have as much market color on individual stocks because orders are going down fragmented information channels," Goldman Sachs' Silverman said at the trading technology conference. To address these information silos, the sell side is giving the buy side tools, such as algorithmic trading, to analyze the data, he added.

Because stocks are trading in smaller quantities, creating more trades, and across more venues, the job of the trader is that much more difficult. It's challenging for a human to assimilate and analyze information on thousands of stocks, says Silverman, in an interview with Wall Street & Technology, InformationWeek's sister publication. But an algorithm can sort through thousands of issues and give information on individual stock or sector trends in real time, he says.

So does this mean that algorithms are replacing the sales traders in their role of providing market analysis?

"It's not replacing the sales trader or the information," Silverman says. "I would say it's enhancing it. The sales trader is still there, giving you the high-touch service, but now there are a lot of tools [that] can add additional types of color that it would not have been possible to push to the customer probably three or four years ago."

For example, Goldman Sachs and other brokers are creating tools that will choose the best algorithm for a particular execution.

Similarly, Deutsche Bank is "going to give customers the ability to send their orders to an algorithm that will choose an algorithm based on liquidity measures and urgency," said Gregg Sharenow, director of execution marketing group at Deutsche Bank, at the same trading technology conference.

The changes brought about by electronic trading aren't "the demise [of the sales trader], it is reinvention," Goldman Sachs' Hale says. The firm has expended a tremendous amount of effort over the past five years reinventing the role of the trader and sales trader, she says. While this person focused on single shares 10 years ago, today the trader services the client on multiple products and has deeper knowledge of options and options volatility, how to trade portfolio trades, and when one strategy is better than another, Hale says.

Institutional sales staffs will be more computer savvy and quantitatively oriented, brokers say. "People spend a big chunk of their day interacting extensively with these tools, and they're getting their arms around the newer tools--algorithms in particular--[learning] what their strengths and weaknesses are," says Dave Cushing, managing director of execution services analytics in Lehman Brothers' equities division.

After spending tens, if not hundreds, of millions of dollars on building algorithms and the underlying market-data infrastructure to support the tools, brokers plan to apply the same disciplines to futures and options trading via the same platforms. "Algorithms are going to warp across asset classes into [foreign exchange] and fixed income," says Raymond Killian, president, chairman, and CEO of Investment Technology Group, an agency broker that also provides equity-trading services and transaction research.

Unlike bulge-bracket firms that have investment banking and mergers-and-acquisitions activity to generate revenue, ITG has to focus on the electronic side. "Our skills are the intellectual-property content of our technology. We spend 23% of our budget on technology--it's our only weapon," Killian says.

In their role as execution consultants, brokers will be in a race to roll out new functionality. "Brokers will become aggregators of financial technology," predicts Robert Flatley, managing director of electronic trading services at Banc of America Securities. "Because we're now the owners of those applications, there's interest in having [direct market access] interoperate with program trading, algorithmic trading, FIX [Financial Information Exchange] order routing, and the existing blotter on the desktop," he says.

To add value, Tabb Group's Iati says brokers need to integrate the various components of electronic trading. Say the buy side is using Lava Trading, Credit Suisse First Boston's algorithms, transaction-cost analysis from Plexus Group, and research from Lehman Brothers. "The buy side has all these tools on their desk. It's confusing for them and their workflow isn't easily manageable," Iati says. "Wouldn't it be good to have a seamlessly integrated order-management system, direct market access, algorithmic trading, research, pre-trade and post-trade analysis?"

Financial Insights' Grossman points to the need for more product differentiation, education, and documentation on the performance of algorithms from brokers. "The battle is going to be fought on the transaction-cost-analysis front," he predicts. Transaction-cost analysis "is part of the education equation. You need to show people when they should be using algorithms, which algorithms they should be using, and the way to show that is through the pre-trade and post-trade transaction analysis."

As these quantitative tools continue to evolve and the buy side becomes more comfortable using algorithms and transaction-cost models, will the consultative role of the broker still hold? "I don't think that technology is going to lead to disintermediation or job destruction, not by a long shot," says Lehman Brothers' Cushing. Right now, he adds, "the buy side is feeling a little overwhelmed by having to assimilate all this technology and is looking to the sell side to provide solutions. So our role has been enhanced to the extent that we have been asked to help navigate this new world order."

Image by Gerald Bustamante/Veer