Investment Operations

MiFID II Fuels Investor Demand for Transaction Cost Analysis

Clearstream Digital Assets

The implementation of MiFID II last year pushed the already rapid adoption of transaction cost analysis (TCA) systems by institutional investors into overdrive, according to research by Greenwich Associates..

TCA systems have been proliferating on buy-side trading desks for the better part of the past decade. Over the past 12 months, that expansion has been driven by institutions in Europe, where, after the official start of MiFID II and its robust best execution requirements, a full 95% of institutional trading desks report using TCA—up from the 75% range in 2017.

In the U.S. and Europe, about two-thirds of all buy-side trading desks and 88% of equity desks are now using TCA. TCA use has reached 60% in foreign exchange and 38% in fixed income. “Greenwich Associates expects adoption rates to continue increasing across asset classes as tools mature and traders become more appreciative of the benefits,” says Richard Johnson, Principal of Greenwich Associates Market Structure and Technology and author of The State of Transaction Cost Analysis—2019, which looks at TCA adoption across asset classes, identifies the leading players in the space and highlights important trends in the industry.

TCA: Compliance and Beyond
Many new TCA adopters implement the system for best execution purposes. Almost 90% of buy-side firms that use TCA on their trading desks say the platforms are also used by their compliance department, mainly for best execution reviews.

However, institutions are also applying TCA to increasingly sophisticated uses more central to their investment process. Thirty-six percent of buy-side desks have implemented “alpha profiling,” or the process of tracing execution performance back to the point when the order was generated—not just routed for execution. In practice, this means looking at how portfolio managers construct their trade list and the instructions they place on the order—the alpha profile. This technique, which is used for the moment primarily in equities, has generated less-than overwhelming results to date, with only 35% of users saying it has been successful or very successful.

Going forward, buy-side firms are looking for their providers to help them do more with TCA by helping to identify better trading strategies through detailed analysis of trade performance, peer comparison of data across similar firms and scenario analysis. “Calculating trade performance against various benchmarks and across venues is now the baseline and just one part of TCA,” says Johnson. “True value comes when traders are able to take this information and apply it to improve performance going forward.”

Vendors and the Search for Revenues
In equities, the TCA business is dominated by ITG, Abel Noser and Bloomberg. Together, these three firms account for more than 80% of the market, with a dozen other smaller vendors competing for the rest of the business.

Despite the value of TCA, vendors may face headwinds in monetizing their offering. Over 20% of traders tell Greenwich Associates their firm does not pay for TCA, and another 39% do not know whether or how their firm pays for TCA.