Transaction Cost Analysis A-Z

Transaction Cost Analysis A-Z — November 2008

Foreword

This A-Z is the first step of a number of research initiatives that will make possible a better understanding of execution risk and performance and ultimately provide tools and technologies that lead to more efficient trading systems. Far from being restricted to equity markets alone, MiFID has so far prompted reaction mainly on infrastructure related to trading in listed securities; more changes can be expected in other markets. As such, our effort will continue both in the fixed income and the listed derivatives space in the very near future. Finally, I would like to take the opportunity to thank the partners that have made possible the creation of the ‘MiFID and Best Execution' research chair hosted by the EDHEC Risk and Asset Management research Centre. CACEIS, NYSE Euronext and SunGard have committed a significant amount of time as well as financial and technical support to the team, allowing us to offer material that, we hope, will be useful to investment firms involved in the execution process.

After nearly ten years of debate, the final implementation of MiFID is radically transforming the European capital markets landscape. New entrants such as Chi-X, Turquoise or Equiduct, new operating models developed by major brokerage firms or former central exchanges, along with the development of advanced execution technologies such as algorithmic trading, form what can be called the MiFID revolution. Core to the change is the obligation of best execution, which is one of the pillars the regulator has imposed for a more competitive environment. But at the time the European directives were drafted, there was no consensus on what constituted best execution; indeed, there is still no consensus. Transaction cost analysis (TCA) lies at the very heart of the best execution obligation and it is expected to become a tool that no intermediary and market participant can ignore. The literature on TCA is abundant but it remains difficult to find an overview of TCA techniques that allows investment firms to develop a view on which of the many approaches could or should be taken. The objective of this report is to provide a comprehensive view of what TCA is, shed light on the main underlying concepts and document the tools and techniques that have been developed in the academic and professional worlds.

Noël Amenc Professor of Finance Director of the EDHEC Risk and Asset Management Research Centre

3 An EDHEC Risk and Asset Management Research Centre Publication