Fidessa's Fragulator Provides Insight into Global Regulatory Initiatives

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Fidessa’s Fragulator® Provides Insight Into Global Regulatory Initiatives
By Jessica Titlebaum

This week Fidessa released a global version of the Fidessa Fragmentation Index (FFI) and Fragulator [1] tool to help the global equity community better observe fragmentation trends in the markets. Fidessa’s Steve Grob, Director of Group Strategy, sat down with MarketsWiki’s Jessica Titlebaum to discuss the motivations behind these free, web-based services.

Q. Why did you start developing these tools?

There is a lot of regulation and technology coming together around the world. The natural, historical monopolies are being challenged and replaced by a huge array of alternative execution venues which, in many cases, operate completely different business models. In the States, you call them Alternative Trading Systems (ATSs), in Europe they are called Multilateral Trading Facilities (MTFs) and in Japan they are known as Proprietary Trading Systems (PTSs). In addition to these lit venues, there is a growing number of dark pools.

Besides technological advancements, there are also regulatory initiatives that are driving the markets. These also differ from region to region. In the States, there is Reg NMS and in Europe we have MiFID. We all have the same objective but a different way of achieving this objective. In Canada, you have a hybrid of MiFID and Reg NMS. Even in places that don’t have a regulatory mandate for best execution, the free market forces are redefining the relationship between broker and buy-side in light of these new venues.

If you are a broker, you need to understand how and where to point your smart order router. If you are a buy-side participant, how do you know you are getting the best, good enough or even adequate execution if you can’t measure your broker's performance against the macro picture of how the stock is traded? If you are a high frequency trading guy, how do you spot and back-test arbitrage opportunities between these different venues?

With all this in mind, we launched the Fidessa Fragmentation Index back in 2008 and the Fragulator in 2009, initially covering European stocks. We've now added coverage for the USA, Canada, Japan and the rest of Asia.

Q. Can you explain the difference between the two products?

Yes. The first product is the Fidessa Fragmentation Index (FFI) that uses a mathematical formula to measure how fragmented a stock or index is. The higher the number, the more fragmented the stock is. Since stock fragmentation is provided in a single number, you can immediately track, measure and compare the rate and level of fragmentation going on around the world.

Q. How does the math work?

The FFI is based on a mathematical principle called the Herfindahl Index which is commonly used to measure market concentration. We take the inverse of that to get the market fragmentation.

Q. The American indices are much more fragmented than the European ones. Why do you think that is?

The reason is simply time. Things happen in the States first and migrate outwards. So this tool helps identify trends in stock fragmentation by tracking the rate and speed at which fragmentation is happening.

It is important for market participants to understand this information because you have to ask, at which point do I need to invest in smart order routing technology? Or, if you are a high frequency trader, when do I need to set up offices in other countries?

Q. What does the Fragulator do?

While the FFI is giving us a high level view of what is going on, the Fragulator will dive into detail. It provides a breakdown of where the stock is traded, over any time period. It is formatted locally for how each market is structured. So for example, you can compare the average trade size between lit and dark pools, or the Value Weighted Average Price (VWAP) between different execution venues.

If I am a broker, it also tells me what venues I need to be connected to and it can tell me where to go first depending on the size of my order.

Also, besides giving you the domestic breakdown, the Fragulator provides a global perspective of where each stock is traded. This is particularly important, for example, when you consider Canadian listed stocks because many of them are traded south of the border too. What you need is two views - the first to show domestic fragmentation between, say, Toronto and Chi-X Canada and the second to show the complete geographic breakdown of where a stock traded, say Toronto and NASDAQ.

Q. What does this say about the global markets?

This raises some questions about best execution. If I am a trader in Canada, do I stick to Canadian rules or do I follow the global rules?

What we’ve done is come up with a way of taking data from a number of global venues and organizing it in such a way that anyone can do this sort of analysis. We are providing a lexicon for market participants to compare this information. Users can then make their own decisions on what regulation is working and where and how it is impacting the markets globally.

Q. Do you have further plans for these fragmentation analysis tools?

We have a full suggestion box but one of the ideas is to compare fragmentation over different asset classes. For example, we can measure fragmentation between options and the stock by looking at, say, Microsoft stock and Microsoft options. It will be interesting to analyze the correlation between fragmentation levels of the stock and the correlating stock option.

Q. Have you ever seen Fraggle Rock? Do you really call this tool the Fragulator?

A. Yes, it's a cool name isn’t it? The name came from thinking about a fragmentation calculator for the past two years. When you put those two concepts together, you get the Fragulator.