TECHNOLOGY IS KEY.
Russell Dinnage, Head of the Capital Markets Intelligence Practice at GreySpark Partners
In 2019, equities Delta One derivatives trading desks are becoming increasingly prevalent, stand-alone lines of business within Tier I and Tier II investment bank equities trading franchises. The reason: Delta One trading is fundamentally a fees-driven business linked to products structuring, issuance, price-making, OTC trading and on-exchange market-making in which related services such as dividend trading, equity financing and equity index arbitrage can be easily linked.
The past decade has seen sellside equities trading franchises suffer due to post-financial crisis declines in volatility and ongoing implementation of US and European regulatory regimes. This has led to bank retrenchment from universal coverage of all equities trading services and the increasing focus of buyside investors on accessing liquidity in passively-traded instruments. However, one bright light remains equities Delta One derivatives trading which is still a profitable enterprise for those institutions technically proficient enough to construct economies of scale.
While sellside equities Delta One desks are in a period of ascendancy in 2019, they are also in a period of transition. Existing in-house technology components are approaching the end of their functional lifecycle, which was repeatedly extended at significant cost to operators. During the lifespan of these systems, the vendor landscape of equities Delta One derivatives systems changed significantly, which – in turn – influences the technology options and choices for sellside franchise operators.
Our understanding of the significant challenges and changes facing leading sellside equities Delta One derivatives trading desks is borne out by the findings of an analysis of 10 such leading franchises. The top-line findings of this analysis are three-fold:
- Average Age of Platforms – At an average age of 10 years, trading platforms within the assessed bank franchises are well outside nominal legacy limits for front-office technology;
- Average Spend on Platforms – Inclusive of nominal operational running costs and – in specific instances – necessary, vendor-provided bolt-ons, average platform spend per franchise is USD 17m. This relatively high level of cost is due in part to the challenges associated with maintaining no longer fit-for-purpose legacy systems by augmenting or altering functionality in response to changes in the characteristics of the bank franchise or client base; and
- Imminence of Replacement Decisions – 7 out of 10 of the assessed banks are set to make ‘buy or build’ decisions in the context of legacy system replacement within the next two to three years.
These top-level findings from a diversified sample of sellside equities Delta One derivatives programme trading built-and-bought platforms is indicative of the simple reality that the first generation of automated trading solutions were built in-house and continue to form the core backbone of these franchises in a relatively unreconstituted manner. GreySpark found that the overwhelming majority – 80% – of assessed Tier I sellside cash equities and equities derivatives businesses operate in-house built programme trading and Delta One platforms separately from one another.
Assessing the attributes of ‘Built & Bought’
For Tier I bank technology decision-makers and purchasers, the question thus becomes: What key functionalities of sellside built and bought programme trading platforms allow for the expression of competitive differentiation within the confines of equities Delta One derivatives trading and market-making on a bank franchise-by-bank franchise basis?
To answer this question, strategists and decision-makers must look past those functional areas in which vendor-provided solutions – acting as core, underlying technology or as a strategic bolt-on to an in-house built platform – perform well across the board. Rather, the answer lies in those areas in which vendor solutions typically remain deficient in 2019. Driving competitive differentiation forward furthermore requires an understanding of the reasons why vendor solutions remain deficient in particular functional areas.
In 2019, there are three programme trading vendor solutions for equities Delta One derivatives trading that, in GreySpark’s assessment, perform well from a Tier I or Tier II bank requirements perspective in meeting core, commoditised functions. Compared to bank users’ ideal states, which are represented by the highest possible score, collectively, the strengths of the three vendor solutions lie primarily in the at-trade areas ranging from basket pricing to trading and order/trade performance benchmarking. However, functionality across the three solutions is limited within the areas of pre-trade and post-trade analytics.
For Tier I banks, these analytics can and should be a focal area of competitive differentiation. Those banks – with a large footprint across geographies, asset classes, instruments and client segments – are the largest repositories of client, pricing and trade data. In order to take advantage of their knowledge asymmetry vis-à-vis other market participants, they must undertake the challenging task of corralling, analysing and ultimately acting on the insights within their vast data store. Fortunately for global Tier I banks, the regulatory challenges associated with the EU’s European Markets Infrastructure Regulations (EMIR) and revised MiFID II should facilitate the utilisation of their bank data. Both regulations require banks to create golden source data repositories and map their data inventories and flows in order to efficiently comply with the mandates of the regulations.
Equities Delta One derivatives trading vendor solutions targeted at Tier I and Tier II banks perform more variably in non-functional attributes than in the functional areas assessed. Although the vendor offerings, on average, display strong degrees of flexibility and resilience – and the quality of support offered by each vendor was also rated as meeting Tier II bank requirements at a minimum – other key criteria are underserved. Specifically, the extensibility, performance and latency requirements and – crucially – scalability of the three un-augmented solutions were assessed as being inadequate in meeting the needs of Tier I equities Delta One derivatives programme trading franchises.
Assessing the necessary architecture & technology
Investigating the profile of vendor technology offerings for programme trading associated with equities Delta One derivatives against the needs of Tier I and Tier II bank franchises in the areas of trading and market-making, in particular, illuminates and categorises functional areas into commoditised areas versus those in which competitive differentiation opportunities remain. The findings for 11 particular capabilities uniquely relevant to Tier I and Tier II investment bank franchises, clearly distinguish:
Commoditised Functions – In 2019, FIX List and basket trading functionality – specifically, order aggregation, wave trading and benchmarking – including the ability to manage multiple baskets with multiple accounts for global execution from one front-end system are no longer points of competitive differentiation among the three assessed solutions. The same is true of the management of multi-region baskets within a global distributed deployment and the ability of vendor solutions to provide traders with market-, region- and sector-based filtering of the products or instruments available to trade as well as order aggregation, wave trading and trade and order benchmarking.
Competitive Differentiators – The sophisticated use of bank data lies at the core of those functions currently underdeveloped in vendor software. Whether required as part of liquidity sourcing in the form of identifying crossing opportunities arising internally from the bank’s own client liquidity, as part of analytic functions such as pre- and post-trade reporting on execution quality or in performing pre-trade allocation, analytic capability that relies on bank data remains an operational pain point for Tier I and Tier II franchises using vendor technology for programmatic trading associated with equities Delta One derivatives trading, providing opportunity for competitive differentiation.
A granular analysis of 9 characteristics relevant for the trading architecture and technology of the three assessed vendor solutions targeted at Tier I and Tier II sellside equities Delta One derivatives trading and market-making franchises demonstrates that there are areas of commoditisation and competitive differentiation, as there were in the analysis of trading capabilities shows:
Commoditised Characteristics – Multi-hub architecture support as well as high availability and disaster recovery are largely commoditised among vendor solution. The same is true of integration and API availability – where these support the integration of bank-proprietary trading algorithms – and audit trails, albeit to a somewhat lower level.
Competitive Differentiators – Volume remains an area wherein banks can move out of the pack and differentiate themselves from their competitors as scalability, throughput and end-of-day downtown requirements leave significant room for improvement. Furthermore, extensibility of vendor-based systems remains sub-standard, a likely reason that analytics driven by bank data also fall short of Tier I and Tier II franchise requirements and remain competitive differentiators among the trade functionality capabilities outlined above.
An end to the ‘Buy vs. Build’ debate
GreySpark believes that – for those banks seeking to defend, restart or grow anew Delta One derivatives trading franchises in 2019, the era of equivocation regarding ‘buy versus build’ decision-making is at an end. In short, ‘buy’ has won – even for the largest Tier I universal banks – and the only questions that remain in 2019 surround: ‘Which system?’; ‘Under what conditions?’; ‘With what functional capabilities?’; and ‘When?’
©Best Execution 2019