SHOW AND TELL: THE NEW SERVICE PARADIGM.
Francesca Carnevale offers insight into the ever-changing equity trading landscape.
This year could be an important watershed. The three super trends that have brought the trading desk to this point are well scripted: unbundling, regulation and technology. All promise to redefine the business set and all look, this year at least, to be bedding in relatively comfortably.
However, there’s a new round of market talk about paradigm shifts; or at least that 2017 will be a tipping point of some sort.
This time around, say commentators, any paradigm shifts are built on stronger precepts: extensive regulation, enhanced market governance and compliance; improved cross-border access and market harmonisation. This is not even mentioning cheaper and more responsive technology. It has allowed all segments of the securities trading market to work alongside each other on better terms, accommodating macro market shifts with greater ease; all in support of the adoption of best practice. “There are still aftershocks from the financial crisis,” says Stephen Anikewich, head of US compliance for NICE Actimize. “However, the dust is settling, giving both the buyside and the sellside more time to be proactive rather than reactive, particularly with regards to compliance.”
It has repercussions for both the front and the middle office. In this mix, technology is king suggests Andy Nybo, managing director, TABB Group, bringing much needed flexibility and efficiency. “Front end costs are down to a basic level,” says Nybo. “Matching engines, for instance, can be bought off the shelf for a fraction of the price ten years ago. Moreover, for the buyside barriers to entry for new strategies has never been lower. New and smarter strategies can be launched at low cost and quickly.”
In part, because it will be harnessed to analyse masses of data. At one level, is it about “those signals and alerts that can be useful to the trader,” he says. Moreover, it will help optimise the desk. “Right now, traders don’t have good enough systems that could allow them to ignore as much as 90% of the market and focus on the 10% that relies on expert knowledge and understanding,” he adds.
Front to back
It illustrates the growing convergence between the front and back office, as one seamless operation. In this regard, regulation has put the same onus on both the buyside and the sellside trading desk. It is not quite a level playing field though. As Volker Lainer, vice president, product management at enterprise data systems provider GoldenSource explains, the sell side has a wider set of compliance and governance demands upon it, including the rather onerous BCBS 239, which looks to potentially create all kinds of problems for firms even as they struggle to comply with the multi-dimensional MiFID II/MiFIR regulation set; not least around the management of data.
The problem, says Lainer, is that in response, “firms have looked to deploy individual solutions to meet different requirements. Unfortunately, this approach has only created silos of duplicated effort, data spend, infrastructure and governance. And there is a bigger problem around the corner if firms continue down this path. For example, under Basel 239, banks are required to house all their information in one place, with tight governance frameworks wrapped around the data. However, if at the same time, a bank is solving MiFID II issues through a separate data repository, they will be (by definition) moving further away from Basel 239.”
Help may be at hand. Advisory firm Deloitte in a recent paper deepens this discussion by distinguishing what it calls RegTech from FinTech (essentially legacy systems); a necessary bifurcation of definition if firms are to manage their risk exposure effectively (see pages 62 & 67). Deloitte acknowledges that existing (or FinTech) technology has been used to address regulatory requirements for some time, but like Lainer agrees that it has often resulted in siloed solutions.
Duncan Higgins head of electronic products at ITG puts another spin on the technology and regulation axis. He says this particular ticket is written on the tie-up between regulation and the commercial offering of the trading desk. “Regulators hold people to the standards they market to their clients, and technology helps them demonstrate it” he says. “It is the convergence of commercial practice with regulatory compliance. In other words, you must do exactly what you say you do, and show it, because both the client and the regulator can hold you to account. It applies to the buyside and their clients as well as the sellside and their clients. It is all very well that you say you are going to follow your best execution policy for instance; the issue is how do you show that you actually do it.”
Higgins says that it is an important service paradigm and one that distinguishes the prized players from the also-rans. “Regulation ultimately holds people to the standards they set,” he says, “Good technology keeps them there.” Anikewich at NICE Actimize describes this as a “holistic compliance and business approach,” based around intelligent analytics that can identify hidden risks via profiling, trending, behavioural deviation and predictive technology as well as the invariable trading skills on offer.
The sum of all the parts
The result is an enriched trading environment in which, in an ideal world, all bases are covered. Already there are signs of a more benign backdrop. For instance, continues Higgins, in the past, there was a clear and inverse relationship between block trading volume and market volatility. As he tells it: “We had two distinct volatile periods in the last year: Brexit and the election of Donald Trump as US president. On each occasion block trading volumes were higher, activity in our crossing networks was at record levels where both events signalled an interesting shift; illustrating the ability of buyside traders, backed by enhanced datasets and technology, to trade unencumbered, confidently even, in a volatile environment.”
Consultants GreySpark explained in a 2016 report on the evolution of the sellside trading desk, that the sellside’s rationalisation of the trading business would result ultimately in a more local-focused business model, with the buyside outrunning and outgunning it as a more globally-focused operation. That may yet play out; but the anchor of each is technology that allows firms to shift between appropriate business strategies, dependent on market dynamics, budgets, the underlying investment strategies and profits.
The reality is that the trading desk is still defined by infinite variety, based on strategies employed, size and location. As TABB’s Nybo says: no one size fits all. However, the new economics of the trading desk will continue to redefine operations in larger sellside institutions and among the larger buyside operations. Nybo explains the challenge of recent years has been felt most by smaller operations that don’t pay enough revenue to the larger broker-dealers for them to continue supporting the business; or which have had the resources to spend on compliance and technology; with the result that they may exit and divert resources to another trading segment. Equally, opportunities for high volume proprietary trades and even volatility trades have in advanced markets been few and far between as market investor sentiment has generally improved.
The pertinent question then for the larger bank-based broker dealer operations is whether regulation ultimately provides opportunity or continues to generate ties that bind their business model further. Lainer at GoldenSource and Nybo at TABB think the future might be constrained further for the cash equities sellside as it juggles already thin resources and operates in an environment in which volumes at best remain stable. Certainly, the pressure is on as unbundling and evermore exhaustive regulation threads through the sector and continues to impact revenue.
For independent brokers, the procession has in many instances however, been revitalising. Higgins, for his part, says that the shift by the bank cash equities trading desks towards their larger
buyside clients that can provide reliable and substantial flow through their platforms, has opened up new opportunities for sellside firms such as ITG, which now offers a two-handed strategy; the invariable customised service for institutional clients and “for those firms not in a position to undertake significant investment in people and technology and reporting, we can offer all that and offer trading algorithms which all rolls into best execution, enlarging and leveraging business across the value chain.”