TRENDS IN EQUITIES TRADING: THE JUICE RUNS DRY FOR THE SQUEEZED SELLSIDE MIDDLE
Russell Dinnage, Head of the Capital Markets Intelligence Practice at GreySpark Partners.
In 2020, global capital markets consultancy GreySpark Partners observes Tier I to Tier IV investment bank cash equities and listed equities derivatives franchises globally facing new commercial and post-financial crisis regulatory adaption pressures that are, subsequently, incentivising many institutions to structurally and technologically evolve their historic trading and market-making businesses in one of two possible directions:
• The pursuit of on-exchange / on-brokerage platform volume; or
• The pursuit of niche instrument type, markets or services specialisation.
Banks that reject this binary choice and, instead, continue to defend a cash equities trading and services business capable of competing at the same level of depth as Tier I universal institutions for buyside client market share continue to face a redefinition of their historic role within the asset class’ hierarchy.
Specifically, GreySparks’ observation in 2014 of the development of a so-called squeezed middle in sellside cash equities trading is the result of the concentration of buyside client services provision within a very small handful of Tier I banks or across an extremely long tail of niche specialists.
Consequently, GreySpark believes that investment banks still active in cash equities and listed equities derivatives markets must in 2020 and out to 2022, choose the characteristics of the business model for their franchise going forward in accordance with their buyside client base characteristics and technological capabilities:
• Flow monster; or
• Niche specialist.
The resulting industry change linked to strategic decision-making regarding the selection of one of those two possible business and trading model paths involved a protracted period of bank retrenchment from historic universal models during which investment bank business lines consolidated in home markets and core markets.
Specifically, through to 2022 – and over the long-term – GreySpark believes that key sellside cash equities business and technology decision-makers will coalesce their thinking around two simple truths:
• High-touch execution services will become unsustainable for all but the highest value buyside clients, and can be offered only for the facilitation of block-size risk trades and for programme trading; and
• All other equities executions services will transition to low-touch channels.
Successfully executing on these objectives will require banks to support the development of cash equities trading technology sophistication within the buyside client base, and also to re-imagine the traditional role of the bank’s own equities sales-traders such that they become highly adept at creating competitive advantage, regardless of whether the products traded are fully liquid and executed on a low-touch basis or are less liquid and thus require some level of high-touch manual intervention.
Supporting the development of equities trading technology sophistication within the buyside client base
GreySpark believes that the future of the sellside cash equities and listed equities derivatives business model can be found in the creation of a depth of low touch-centric buyside client equities trading services founded on buy and build technology decision-making.
The current vendor-provided technology landscape supports this transition through the use of platforms or solutions wherein the out-of-the-box functionality is commoditised and standardised for all users, and where the need to create competitive differentiation by collaborating with a vendor-provider to build additional functional capabilities in-house – typically via the integration of existing in-house built OMS or EMS using APIs – is accepted as a given (see Figure 1 and Figure 2).
For the investment banking cash equities and listed equities derivatives franchise, the transition to low-touch, automated trading-centric buyside client franchises inverts the historical technology paradigm. Specifically:
• Historically, low-touch and automated trading functions were added to core trading technology stacks focused on high-touch functionality.
• Going forward, technology deployment decisions must prioritise low-touch and automated trading as core features, with limited high-touch functionality available for the select business workflows in which they persist.
Bloomberg LP’s decision in April 2019 to decommission its long-standing cash equities order and execution management system SSEOMS – which was widely utilised by the small-to-medium-sized asset management, investment management, hedge fund and wealth management buyside community globally, as well as by a wide range of inter-dealer and non-bank brokerage firms – exemplifies the opportunities available to investment bank equities traders now to incentivise changes in long-standing client behaviour. Despite the fundamental shift in the buyside cash equities trading technology landscape represented by the SSEOMS decommissioning, GreySpark believes that many investment banks remain unwilling to capitalise on the opportunity presented to them to become the new, preferred cash equities order and execution management technology vendor partner needed by their small-to-medium-sized-by-AuM buyside client base.
Specifically, the transition away from SSEOMS offers an opportunity for sellside agency brokerage franchises to undertake a fundamental re-imagining of their equities trading technology stack and front-office personnel.
The current vendor-provided technology landscape supports this transition best through the use of platforms or solutions wherein the out-of-the-box functionality is commoditised and standardised for all users, and where the need to create competitive differentiation by collaborating with a vendor-provider to build additional functional capabilities in-house – typically via the integration of existing inhouse built OMS or EMS using APIs – is accepted as a given.
High-touch vendor-provided equities trading systems still offer investment bank buyers and their buyside clients a wide array of functionality in 2020 and with increasingly prevalent levels of functional capabilities commoditisation. These systems also overwhelmingly meet investment bank requirements to execute trades electronically, albeit with significant manual intervention. However, in transitioning these sellside equities franchises and their associated technology stacks to low touch-centric flow business models, bank decision-makers commonly acknowledge in 2020 that successful buy and build implementations require a technological shift from narrow but deep functionality – prevalent in systems such as Fidessa – to wide but shallow functionality, particularly in terms of high-touch depth of functionality.
The breadth within a given functional area of the low-touch equities trading technology stack remains, in 2020, less commoditised than electronic functionality available in high-touch systems. For investment bank equities franchises refreshing their technology stack with a view toward highly automated low-touch services, the selection of best-of-breed low-touch solutions thus provides significant scope for competitive differentiation.
Re-imagining the role of the sellside equities sales-trader
GreySpark believes that flow and, particularly, super-flow monster sellside cash equities franchises must fundamentally re-imagine the role and responsibility of buyside client-facing front-office trading staff in order succeed over the medium-to-long term. This transition requires shifting the focus of equities sales-trader activity from execution on behalf of the buyside client to empowering and educating the client in the use of the full breadth of self-service services on offer to them – particularly within the realm of bank-provided pre- and post-trade low-touch services. In this manner, investment bank front-office personnel become amplifiers of the capacity inherent in the technology-driven services offered to buyside clients across a range of electronic channels.
Since 2017, global Tier I and Tier II sellside equities franchises are in the third equipment wave, wherein they are replacing existing in-house built, legacy systems with new, fit-for-purpose vendor-provided offerings in the period out to 2022. More specifically, Tier I institutions are now observed as seeking to replace legacy in-house built platforms, while Tier II institutions are implementing fit-for-purpose platforms specifically designed for low-touch trading to replace existing systems that frequently originated in the high-touch space but which were subsequently augmented and expanded to provide low-touch services in the post-crisis period.
Consequently, investment bank equities trading technology investment programmes currently underway in 2020 or commencing in the near future should be an inflection point that allows serious consideration of the nature and function of the client-facing trading salesforce. The equities trading sellside salesforce of the future must be highly adept at providing value to buyside clients and in creating competitive advantage, regardless of whether the products traded are fully liquid and executed on a low-touch basis or are less liquid and thus require some level of high-touch manual intervention.
Enter the role of so-called Smart Data analytics. In 2019, the global financial services industry spent an estimated USD 50bn on the raw, historical markets and transactions data inputs required to fuel a broad spectrum of daily trading activities across all major asset classes, according to GreySpark analysis (see Figure 3).
This estimated level of spending on the externally-sourced data inputs sold to asset managers and investment banks, for example, by exchange groups, inter-dealer brokers and specialist vendors such as Bloomberg, FactSet and Refinitiv comes at a precarious time for the industry at-large.
At issue is the growing electronification of cash equities, fixed income and currencies markets and the availability – or lack thereof – of the granular, real-time intelligence required to support meaningful, daily decision-making processes and workflows across a range of front-, middle- and back-office functions. GreySpark believes that these types of real-time intelligence data inputs are set to become more important from a client performance analytics and competitive differentiation value creation perspective to buyside and sellside markets participants over the medium-to-long-term.
• Creating an actionable, real-time overview – Tier I to Tier III CIBs typically use different trading platforms and systems on a desk-by-desk, region-by-region basis, making it difficult for sales-traders to pull all the data consumed by all relevant systems together in a meaningful fashion such that they can then act on client order or trade crossing or pricing opportunities in a more informed, real time or near-real time fashion.
• Evidence-based decision-making within an agency trading business model – Tier I to Tier III CIB cash equities and cash FX market and trade data spend fell from pre-crisis historic heights to settle in 2017 at roughly 30% to 40% of total annual spend on execution technology. And while the majority of institutions in each tier still provide a global buyside client base with access to the historic pricing data, liquidity and market-making services required to facilitate agency trading, the profitability of their trading franchises are nonetheless increasingly undercut by a raft of new, non-bank liquidity providers utilising the same algorithmic trading business models originally pioneered within the CIB arena to arb both bank and non-bank competitor pricing on a tick-by-tick basis. As such, the use of Smart Data and Smart Data analytics toolkits by CIB trading desks to provide their buyside clients with optimised data insights creates competitive advantage through its ability to derive client type- and market conditions-specific insights that can be used to directly inform evidence-based, block size trade or transaction decision-making on an order-by-order basis.
The inclusion of Smart Data analytics capabilities into the institution-wide data strategy equation can create new opportunities over time to not only offset the depreciation of data assets, and they can also drive the uptake of cultural understanding that Smart Data is an investment class in and of itself – one that is capable of creating distinct markers as to how ITO expenditure on overall data quality maintenance can act as an engine for commercial growth.