Interview with Guillaume Lemarchand, Global Head of Execution, BNP Paribas

1. What do you expect MIFID 2 to change for your business? How will your

business change as a result of MIFID 2?

I anticipate that MIFID2 is going to be a clarification exercise more than anything else, and do not expect to be the catalyst of a radical change in our business model, nor in the business models of our competitors. The fate of Brokers Crossing Networks will be of particular interest though, and will potentially yield changes in strategy. I also hope that the revised regulation will induce further playing field leveling, as some national inconsistencies do persist and have worked to the disadvantage of continental brokers like BNP Paribas – issues like the ‘Riskless Principal’ flag usage for instance.

I do expect MTFs and Exchanges to be more affected than the Sell Side as the difference in regulatory treatment between those two categories of venues is quite significant; but I do not anticipate massive changes on this front either, as the regulators will work under constraint. They need to be careful not to impose too costly compliance requirements, in order not to impede the painful emergence of sustainable (ie profitable) alternative venues.

2. With the liquidity becoming more concentrated, do you think buy side really

needs access to all the alternative liquidity?

I am not sure to fully agree with the “concentration” statement. You’re probably right in the lit space, as the landscape seem to have pretty much stabilized. The fact that a number of MTF initiatives have failed does not necessarily mean that liquidity will be easier to grasp. And let’s face it, despite all the marketing noise, failed MTF initiatives had never been significant pools of liquidity anyway. Any a new type of alternative venues is emerging.

The main difficulty is that we now have to venture in the dark space. Granted, as of today, one could question the real interest for the Buy Side to access the liquidity offered in Dark books of Exchanges and MTFs; they so far remain an epiphenomenon, and their liquidity is mostly made of small-sized market makers orders. But statistics show they are growing at a fast pace, and they should ultimately become of some significance; moreover, since the main Brokers are all connected to those pools thru existing lit pipes and SORs, they will natively be made available to the Buy Side. So even if the Buy Side does not really need access to that Dark Liquidity, they’ll have it!

What has become more important to the Buy Side is systematic access to the Brokers Crossing Networks, where an increasing share of trading is made, in the dark. Those pools are significantly deeper and more persistent than the Exchanges and MTFs dark books, as they’re mostly made of “real” institutional orders. Some brokers had even started interconnecting their BCNs, and accessing that liquidity had become easier. As MIFID2 is looking at framing the BCNs and could stipulate that those can no longer be

interconnected (to prevent the formation of a “preferential group of insiders” and ensure a sufficient level of transparency), the Buy side will probably have to split their large orders into several brokers operating BCNs.

3. Do you think the trading community will start going back to simple algos and less

complex liquidity, or will the race for sophistication continue?

In the 3 regions where we operate, we have witnessed very similar evolution patterns in the algorithmic trading acceptance

Invariably, you’re first faced with incredulity: “algos will not work in this market or segment as it is so specific that only an experienced dealer can handle it”. Quickly, this changes into partial acceptance: “ok that works for the large caps, but small caps or complex orders I’ll trade them myself”. Then you start addressing particular stock segments, trading patterns or client requests. Eventually you end up creating tons of specific algos, making sure you assign a military name to each new weapon in your arsenal. So many that you’ve now blurred the message: clients and brokers no longer know what to use, and stick to only a handful of algos.

And when you look at what Clients use most, you unsurprisingly find out that the Buy side traders mostly rely on 3 algorithms only for over 95% of their flow: Vwap, Volume participation and Implementation Shortfall. When you then take a deeper look into the algo boxes, you also realize that most recent “innovations” by the Sell Side are mere parameterized combinations of those 3 basic algorithms.

I am not saying that we only need 3 algos and that the rest of the weaponry needs to be binned. Our most sophisticated Clients still ask for custom algos and dedicated Desk Service. But I guess that the main challenge for the Sell Side is to make sure their suite of algos remain readable and intuitive to the Buy Side. At BNP Paribas, we have therefore opted for a slightly shorter product suite; Our large research teams spend more time tracking the behavior of our core algos than repackaging old algos into new ones, making sure our core algos remain best in class in terms or absolute performance and standard deviation. We also keep investing in pre-trade, intraday and post-trade analytics as those are fantastic tutorials, which help us as well as our Clients decide which algorithmic combination works best.

Meanwhile, the innovation race continues, but on other fronts. This maybe invisible to the Buy Side but SOR algorithms have been heavily invested in as Dark venues come with all sort of different order placing logics; anti-gaming logics have been incorporated; algorithms have also become part of the standard Listed Derivatives trading kit. Eventually, I believe in the development of contingent portfolio trading algorithms, even if those would probably be best developed on vendors trading platforms, not by the Sell Side.

Guillaume Lemarchand will be speaking at TradeTech Europe 2011 on 12 - 14 April, 2011. Visit www.tradetech.com for details.