As the Securities and Exchange Commission continues to explore ways to evaluate the current market structure, Michael Lynch, head of execution services for the Americas at Bank of America Merrill Lynch, spoke with Traders Magazine about some of the issues concerning the markets and investors, as well as the future of electronic trading.
Traders Magazine: What is the biggest issue the desk is facing today?
Michael Lynch: The biggest issue for us is that there are so many things in flux from a regulatory perspective. We'd be encouraged if the SEC narrowed their focus to the most pressing issues. There are a number of open commentaries regarding May 6, plus the Concept Release, that need to be addressed.
TM: Can you give some examples?
ML: Sure, one example would be naked access. Or the debate about whether circuit breakers are really the right answer to what happened May 6.
TM: If there was one regulatory item that you would like to see get passed or addressed, what would it be?
ML: I think the single most important item I'd like to see addressed is naked access. Filtered access is the concept we have supported. We're not sure about the how naked or filtered access will play out, but unfiltered access could have some very negative impacts on the marketplace and is high on the risk charts in terms of what it could mean to the marketplace.
TM: What is the next big development in algorithmic or electronic trading?
ML: We have many new products that are coming through the pipeline, such as the Exchange Traded Funds algo--ETF aX. It's an algo that trades across asset classes to source liquidity at the best price. But the ETF algo is just the beginning. The exciting part is taking what we've learned in equity market and applying across other asset classes.
TM: What other asset classes?
ML: We want to take the same logic and algorithmic technology and bring it to futures, foreign exchange and then into Treasuries and interest rate swaps. Eventually--anything that trades on a screen. The goal is to bring algorithmic trading across the asset universe.
TM: How long could this take?
ML: While this will be a massive change for some of these markets, we don't think it will take the fixed income asset classes the same amount of time as the equities markets to get up to speed. They can take cue from equities. It's a natural progression--we're in the early stages trying to find solutions for clients and then measuring how effective they are. There's a good story here as the notional size of these markets and the business being done on the screens lends itself to the technology. There is a lot of start up technology vendors in the fixed income space already.
TM: There was a recent report from Tabb Group suggesting the volume of trades coming to a desk electronically will match those arriving via phone call. Do you see this trend developing?
ML: I think the blend between low-touch and high-touch trading depends on everything from market volume to volatility, clients' wallets and the demands placed on those wallets for goods and services. It can depend on client requests for capital, the new deal calendar, etc. There is no doubt the percentage of trading volume going electronic is a growth story, but I do not see it as a replacement of the high touch sales trader.
TM: What about the future of the high-touch trader?
ML: I was a high touch trader and ran the desk. High touch and position traders are essential, providing clients with market color, capital provision, risk arbitrage and research content to name a few things. We continue to invest in the high touch area in order to distinguish ourselves with our clients.
TM: Talk about the challenges of market fragmentation? How does it affect your business?
ML: Fragmentation definitely provides the market with more competition and innovation. It is very important to know that when you manage the execution stack we examine all facets of liquidity. All in all, fragmentation has been a good thing for the market, but made things more challenging for us in terms of increased capital investments on our side to process the data as efficiently as possible. At the end of the day, it is the broker-dealer's responsibility to make market fragmentation a non-issue for clients. We see it as an opportunity to show our clients Bank of America Merrill Lynch's knowledge of market microstructure and our ability to manage these developments.
TM: What about so-called market data latency? Is it a real problem?
ML: Data latency is a challenge for us in terms of managing it and making the right investments. We see this as part of our responsibility to clients; to constantly monitor market data latency and deliver the quickest, most complete feed to our execution engines. It is a constant source of capital investment. Data latency is no more of a problem than having good quantitative research, strong risk controls and a stable platform. We compete across all these aspects and competition tends to weed out poor performers. The market, left to its own, will arbitrage out all time latencies.
TM: Are you missing hitting bids or taking offerings to co-located firms?
ML: I would say I've haven't taken every offer or hit every bid that I ever wanted to--but that isn't necessarily a function of co-location. Also, that is to say high-frequency traders may not get their fill, either. The market is perfectly imperfect--there will always be multiple people on bids and offers who don't get filled.
TM: Do high-frequency traders have a time and place advantage? If so, is it wrong or unfair?
ML: To single high frequency traders out and say they have a single time and place advantage is incorrect. I'm an agent for my clients from the largest mutual funds to the smallest retail clients. It's my job and responsibility to make the investment in cutting-edge technology to give all my clients the same advantage. The high-frequency trading community has pushed the sell-side to invest in technology and try and get its latency as close to zero as possible.
TM: On the recent implementation of equity market circuit breakers--even if the circuit breakers work, what does that mean? Does it mean that we won't have another flash crash?
ML: We believe that circuit breakers were an appropriate interim step; however, we believe that logic would dictate that limit up/down would be a better long-term solution. This, plus the elimination of "stub quotes," combined with market collars are steps to improve the gaps exposed on May 6.
TM: Is having the biggest dark pool on the Street important to Bank of America Merrill Lynch? (Some of your rivals think it is, while others say no.)
ML: No, quality is the most important feature. We believe that with our proprietary anti-gaming technology which was recently extended to include three levels of protection: ping detection, participation protection, and more recent order segmentation we can achieve both quality and quantity.
TM: Why are buyside firms connecting directly to broker dark pools, as Tabb Group says, and not using algos?
ML: They are using proprietary pools of liquidity and they offer less information leakage than that of an aggregator.
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