Algorithmic Trading and Direct Market Access Fernando Ripolles, Director UBS Investment Bank       

Introduction Electronic trading is dominating institutional trading and this trend is set to continue Compliance, operational risk, real-time updates…. Direct Market Access has become a permanent feature of a buy-side dealer’s toolbox Already well established in the US and will become more established in Europe Algorithmic trading is the “new kid on the block” Quantitative models are extensively used by the sell-side – and not only by the prop desks! Buy-side dealers on both sides of the pond are steadily increasing usage of broker models

Terminology Worked order flow Direct Market Access Algorithmic Trading Sending electronic orders to your usual sales-trader for manual acceptance. Traditional trading process similar to telephoned orders. Direct Market Access The ability of a buy-side trading desk to route orders directly to an execution venue without intervention by a sell-side trader The sell-side provides memberships, technology, trade support and credit Algorithmic Trading Placing an order of a defined quantity into a quantitative model that automatically generates the timing and size of market orders Typically constrained to trade to a benchmark, price or time In-house or vendor provided models or broker provided models Smart Order Routing Algorithmic model for managing multiple liquidity sources Can be applied to both DMA and Algorithmic Trading

The business case for technology For “plain” order routing, FIX enhances the business process and is a complement to the phone. But for products and services such as…. Direct Market Access Algorithmic Trading Efficient Crossing and Internalisation Smart Order routing FIX is a prerequisite as these services cannot be accessed or carried out manually!

Buy-Side Order Flow by Execution Service 2004 Source: Tower Group, Edhec Risk Advisory

Buy-Side Order Flow by Execution Service 2006 Source: Tower Group, Edhec Risk Advisory

UBS Dealing conference – Question 3

UBS Dealing conference - Question 4

E-Orders and E-Turnover 2004 - 2006 Source: UBS Electronic trading currently represents some 80% of orders and nearly 40% of value in the European Cash Equities business Four years ago the corresponding numbers were 15% and 5% respectively

Electronic Trading by Client Nationality Q4/05 Source: UBS But, numbers vary significantly from country to country Regional differences in software suppliers Regional differences in composition of client base

Latest statistics from UBS- February 2006 Up to 80% of all orders in European Equity markets entered the Bank electronically More than 38% of the value of all orders in European Equity markets enter the Bank electronically More than ¾ of the Bank’s largest customers trade Equities electronically The total number of clients connected to the Bank for trading Equities is higher than 2,500 globally A majority of connected clients subscribe to multiple services e.g. single orders, lists, DMA.

UBS Execution Services - Before Client UBS Equity Trader OMS VENDOR Orders / Fills / Allocations FIX engine Sales Trading Portfolio Trading Manual Execution Risk Teams Markets

UBS Execution Services - After Client UBS Equity Trader OMS VENDOR Orders / Fills / Allocations FIX engine Direct Execution Services. DMA/DSA/ DCA Portfolio Trading Sales Trading DMA Strategy Centre Manual Execution Risk Teams Crossing Engines Markets

UBS Direct Execution Services Direct Market Access (DMA). True DMA, Hi performance, Underlying market order types available, customisable client checks. Direct Strategy Access (DSA). VWAP / TWAP Volume Inline Hidden Auction PRISM / Price InLine Direct Capital Access (DCA). Pre-agreed liquidity in your selected universe of stocks.

Questions to ask of yourself Investment style? Goals and benchmark? Discretion / room for judgement ? Orderflow profile? DMA, DSA or/and DCA ? Remember only 4 ways to trade: Orders to humans Orders to market yourself Orders to a computer / robot Orders to a book

Questions to ask about others Which providers ? Relationship / Trust New or existing Silo or open Other services ? Technology skills Business skills Credibility Direct execution services ? DMA v DMA VWAP v VWAP Pre and post TCA tools Business process around the technology Reporting

Direct Execution: the connectivity problem Buy side Order Management Systems Lack sophistication Suffer version lag Broker facing not market facing Execution management systems Struggle with buy side backend integration Don’t get access to all the broker secrets Broker tools Contain the broker secrets Generally access only one broker

Direct Execution: what can FIX offer? The buy-side is increasingly adopting direct market access and algorithmic trading – making the case for co-ordination and standardisation. Instead of using proprietary interfaces to each broker, apply a standardised FIX format to communicate algorithmic orders! The human capital behind the algorithm is proprietary, but the format of communication does not have to be secret. Insist on the exchange of ‘Rules of Engagement’ documents amongst buy-sides, vendors and brokers. The FPL working group is working to ensure that the interface requirements between buy side trading applications and sell side algorithmic servers are covered by the FIX protocol to avoid fragmentation.

Direct Execution: how can I go live… Enhance proprietary OMS to support Algorithmic trading, DMA There are different ways to achieve this…. Check if you OMS provider has already certified with the broker Integrate your OMS with a broker tool Execution services AND functionality Use a stand alone application Connectivity going forward No longer 3 simple models Hybrid model is likely to prevail

Conclusion Robo-trading The Human Factor Execution services and platforms Broad range of relevant offerings in the market. Market facing vs broker facing. Tighter control of execution process. Increasing demands on transparency The Human Factor Training and skills Stock, Sector and Market Expertise Market funnies Broker services and funnies Useage plan and creativity Trading desks must step up to benefit !!

Appendices

Appendices DMA Checklist Costs and Benefits DSA EMS

(True) Direct Market Access check list Direct insertion of the order onto the exchange. Full control of order by client without broker intervention High performance / Capacity / Reliability Breadth ( markets ) / depth ( functionality ) Broker must own the exchange links Segregated pipes Safety (Fat finger protection / custom client checks ) Anonymity

DMA – Costs and Benefits Time ~ resourcing Ownership of Execution risk Expertise Infrastructure Benefits Speed to market Price Anonymity

Direct Strategy Access (DSA) check list Performance Range of Strategies offered Business process ( eg Strategy risk managers ) Access to all liquidity within the firm (IXT) Rocket scientist quotient (brain power) Market knowledge Ownership of pipes Reliability / stability / ease of implementation

DSA Costs and Benefits Costs Benefits Applicability of strategy Intellectual property Non human execution (Unexpected events) Benefits Outsourcing of execution risk Non human execution (Pub/Sun factor) Consistency of execution Price Impresses the regulator and the boss (Buy side) Scale (Sell side)

Execution Management Systems (EMS) OMS were typically designed in a world where the broker owned execution process. ( Buys side handed out orders ). Buy side now require sell side like systems. EMS = a staging post between the OMS/PMS and broker/market How ? Enhancement of the Order Management Systems Single broker applications Multibroker applications

EMS Check list Range of markets supported Integration with OMS Parent / Child functionality Real time market data Mousetrading – Order manipulation from depth screen Watch lists and Customisable blotters etc. Remote trading triggers Men on motorbikes and Training courses

Contact details Fernando Ripolles Direct Execution Services fernando.ripolles@ubs.com +44207 568 6015 UBS Investment Bank, 1 Finsbury Avenue London, EC2M 2PP