With a steady increase in multi-asset class trading on consolidated technology platforms among the big investment banks, broker-dealers and systems vendors risk being “swept away” if they remain unprepared once the gradual uptake becomes explosive, according to Michel Debiche, president and CEO, of Quantia Capital Mangement, a New Jersey-based hedge fund.
“A multi-asset integrated trading platform which allowed you to hedge, trade foreign exchange, go into futures, trade equities as automatically as possible over a few days would be very powerful indeed,” says Mr Debiche. Such a system, he adds, would also generate significant cost savings and added value provided it had sufficient operational support. “But, right now, it would be extremely awkward to make all that happen.”
While the path that leads to the ‘holy grail’ of true multi-asset class trading on a single platform might be some way off and there is no clearly defined timetable, changes that have already taken place could be a precursor to a revolution of some magnitude. Driving the change, investors are seeking reduced transaction costs, access to higher liquidity and further opportunities for arbitrage. Looking back, however, progress has been far from pretty.
Electronic trading is clearly evolving and industry participants are starting to witness advances across various instrument classes, but it is far from uniform. Although the rationale of consolidating the trading of asset classes seems logical, a number of factors are holding back developments.
With electronic trading infrastructures already fairly well entrenched in the fixed-income and equity markets, and with derivatives and foreign exchange (FX) of both listed and over-the-counter (OTC) securities a little further back, one might well ask: Are market participants really ready to move all these products onto a single trading platform? And, all this at a time when many IT initiatives chase hard for company resources.
Discussion of the key trends driving the adoption of multi-asset class trading took centre stage at a recent roundtable event in New York, organised by research firm Celent Communications. Speakers included experts from ICAP Electronic Broking, HSBC, Barclays Capital and Quantia Capital Management.
Placing matters in some context, Harrell Smith, manager of Celent’s securities and investments practice and panel moderator, stated: “The history of capital markets is really one of segmentation and siloed asset classes. Trading desks are not only divided by asset classes - foreign exchange (FX), equities, derivatives - but also by these asset classes’ constituent products.”
Consequently, what we are seeing today are separate cash and derivatives desks with different budgets, specialised traders and operational infrastructures. And, one of the problems for a growing adoption of multi-asset trading will require a significant ‘buy-in’ across financial firms going forward, with senior managements needing to realise that “a new business alignment” is required, according to Mr Smith.
Shockingly poor
With respect to the role of e-commerce during e-trading, he added somewhat controversially that it was hard to imagine communication between the different trading areas in some organisations could be as “shockingly poor” as it sometimes appears.
In addition to the questions of what actually constitutes a multi-asset trading platform and which assets would be traded on such platforms, probably the biggest problem for adoption is uncertain customer demand. As Mr Smith says: “How many clients after all want or need an all-in-one solution? Additional systems and re-implementation costs are perceived to be quite high, and by relying heavily on one single vendor, firms runs into the same types of concerns they had after the dot.com blow-out when a lot firms went under.”
 Chris Biscoe, Barclays Capital | “I think the trend is just starting to gather momentum,” states Chris Biscoe, head of e-commerce at Barclays Capital and a panelist at the New York event. “Certainly, there is an interest in combining operational and risk management efficiencies on the part of brokers. And, vendors are looking to grab market share through innovation,” he said. |
When it comes to platforms that trade multiple assets, Mr Biscoe adds, “Ultimately, I think what we are expecting is that if we build it…then the buy side will come.” A large percentage of the buy-side are already conducting simultaneous multi-asset class trading and also via the algorithmic route. In fact, this has been the case for a long time among isolated pockets of buy-side firms.
Nevertheless, the notion that the buy-side will be trading across five or six products on a single platform is hard to envisage in practice now, Mr Biscoe contends. Instead, he sees a variety of different customer interests spanning various asset classes. “And, we [Barclays] want to be as flexible and broad as we can in supporting this.”
He believes the asset classes, which are ripe for further innovation and true simultaneous trading, include exchange-listed derivatives and the FX market – the latter offering “a huge opportunity”.
Highlighting a trend that has in many ways already begun, Barclays has now consolidated all electronic trading for fixed income, FX, equities, commodities, futures and options under the single BARX umbrella. With single dealer systems, the trend towards multi-asset trading continues, although execution is often via third-party platforms such as Barclays’ BARX page on Bloomberg.
Celent’s Mr Smith says the sell side has seen the reorganisation of trading desks, the end objective being “to provide integrated trading solutions to serve more complex trading strategies of clients and to consolidate trading relationships in an era of shrinking margins and headcount.”
According to John Shay, executive VP of sales and marketing at ICAP Electronic Broking in New Jersey, who is responsible for defining e-broking business strategy and direction: “Although we represent the sell-side, through the purchase of BrokerTec in May 2003, ICAP was able to cross-connect its positional technologies in US ‘off-the runs’ treasuries and combine it with BrokerTec’s already established position in active treasuries to provide a single front-end platform to clients.”
Existing system
He adds: “To a certain extent we have already a multi-asset trading system. Right now, we operate a single front-end platform which enables us to trade nine asset classes simultaneously, although it is in the inter-dealer space - the wholesale market.”
In October, the firm was scheduled to launch a medium-term interest rate swap offering, which Mr Shay described as “pushing further out on the curve.”
In relation to the buy-side, there has been a move to more advanced trading strategies, especially within the hedge fund industry. However, buy-side trading firms are also “feeling the IT budget crunch” and are looking for a cost effective, scalable solution for multiple asset trading, Mr Smith observes.
Perhaps one of the most obvious examples of multi-asset trading integration has been in the front-end market place. Broker-sponsored firms - such as prime broker heavy weights Morgan Stanley and Goldman Sachs now offer trading in equities, FX, options and futures - all on a single trading electronic platform.
Advanced execution management systems (EMS) also now handle different asset classes, including foreign exchange. And, all major order management systems (OMS) providers today offer multi-asset trading capabilities and have extended aggressively into more esoteric asset classes such as derivatives.
But hindering both the level of e-trading is the fact that the level of adoption of electronic trading among different asset classes, which varies considerably today both in the dealer-to-client and the inter-dealer marketplaces.
Mr Smith explains: “Commoditised and deliverable cash products have led the way, while derivatives - in spite of some recent successes - have only begun moving onto e-trading platforms over the last 18-24 months.”
First, electronic communications networks (ECNs), alternative-trading systems, broker sponsored and independent trading platforms have all developed more or less on a product-specific basis. Second, exchanges remain geographically dispersed and focus more or less on a single asset class.
On a third point, direct market access (DMA) platforms are still referred to as primarily equity only portals. And, in respect of the development of different communication protocols, FIX has been successfully applied to fixed-income and derivatives.
With regard to the client, Mr Smith added that “distinct boundaries” exist between asset classes and the different products within them. Within fixed-income, for example, he pointed out that clients must interact between a range of trading desks if they want to trade swaps, repos, credit derivatives, or any of their underlying cash products. In relation to derivative pricing services such as SuperDerivatives, these firms are following a multi-asset business model and expanding beyond their core products from which they became better known.
While stock exchanges are only slowly embracing multi-asset trading, there is a trend towards product diversification, particularly as a number of publicly listed exchanges look for additional growth and revenue opportunities. But as Mr Smith notes, trading securities simultaneously on exchanges “is not as easy as it sounds”.
Add to that the problem that US exchanges are not permitted to trade unlisted over-the-counter (OTC) products and regulatory concerns standing in the way of true side-by-side execution and the picture becomes cloudy. The US is characterised by a multi-market regulatory regime that has “a history of not working well together,” Mr Smith also added.
Following the New York Stock Exchange's (NYSE) definitive merger agreement with Archipelago Exchange (ArcaEx) in April, ArcaEx will be adding options via its purchase of the floor-based Pacific Exchange (options only), with the plan to leverage the equity platform to trade options electronically.
 Leman: nowhere near a golden standard | James Leman, managing director, head of execution trading, HSBC (Americas), says in terms of a potential timeline for rapid evolution of multi-asset trading one should pay close attention and “keep your eyes” on NYSE’s hybrid market going forward. |
In a similar vein, Nasdaq is making parallel moves, and the Chicago Mercantile Exchange, which executes a significant amount of business in FX futures, is working with Reuters to trade spot FX. And, eSpeed, a bond trading platform affiliated with Cantor Fitzgerald, has leveraged its technology into handling foreign exchange and other instruments.
Costs and profitability
Turning to the issue of costs, Mr Leman said: “Cost and profitability and anticipation of the future are driving many of the decisions that are being made today. In my experience, brokers particularly are having to look to their most sophisticated customers and their demands to accept a lot of their priorities.”
He added that one of the “key determinants” in the market place will be the driver to cost-efficiencies in using OMS and engines to handle multiple asset classes and transactions. He believes the big challenge going forward will be how further advances will be made to “cross fertilise” trading capabilities – especially on secondary trading – following the merger of listed and over-the-counter desks in the equities space in recent years. He views listed derivatives – both futures and options – as “a natural outgrowth” from that.
Quantia Capital’s Mr Debiche contended that events could be five years further ahead today if it were down to him. He observes however, that there was something of the “first over the wall” syndrome about developments, with many players waiting to see who would make the first move.
He says: “While demand [for multi-asset trading] may not be that apparent yet, pressure will certainly start coming from the hedge fund community, but also from the traditional buy-side players, who will be driven by a similar set of factors.”
Such factors include globalisation, the search for returns from a broader source (domestic as well as international), arbitrage opportunities, a desire to manage risk more effectively and to lay off the risks, as well as concentrating on where you believe you are adding alpha or value. Accessing reduced transaction costs and greater liquidity will also come into the mix. Hedge funds are already “starting to look over the fence”, he adds.
Citing an example of a global index manager that has $5bn under their belt, wishes to access the Japanese equites market and is looking for beta, Mr Debiche said that you could “easily get to four asset classes” on an integrated basis.
Mr Debiche also believes that the ‘next-in-line’ asset classes for adoption will encompass more of an expansion in portfolios of options, interest rate derivatives that will allow investors to hedge interest rate risk, and foreign exchange that facilitates global trading of all kinds, which “you would definitely want to add to your platform,” he asserts.
Within the middle and back office “the rallying cry continues to be consolidation, not only through direct transactional costs but through reduced operational risk too”, says Mr Smith. As noted, electronic trading platforms are witnessing huge competition for new and related products, with these platforms leveraging their strength in core cash products and moving into related instruments.
In fixed-income, in the inter-dealer trading space e-Speed has expanded into FX and is making inroads into equities, while BrokerTec (ICAP) has successfully moved into the repos and short dated interest rate swaps. On the dealer-to-client market, TradeWeb and MarketAxess are both rolling out CDS systems. Elsewhere, there may be some inertia among certain platforms to move into product areas where other players have a more dominant foothold. This could hold back cross fertilisation of products on single platforms.
On the post-trade side, lack of a centralised multi-asset clearing house is also a major industry issue. Although this is not in itself a deal breaker, it does pose a significant logistical challenge.
HSBC’s Mr Leman argues that the industry is nowhere near where it needs to be in the post-trade space and has not reached a “golden standard”. Worryingly, many systems are 15-20 years old in some organisations, while there is also an inertia to change due to economic constraints.
Mr Debiche, who has 14 years’ experience in quantitative electronic trading, says for him the topic of back-end processing “touches a nerve”. He says the importance of issues confronting the back office and post trade processing “cannot be emphasised strongly enough” in terms of operational, compliance and legal aspects. It is also something the hedge fund community have only “discovered belatedly”. Along with other panellists, he made a call for stronger and more in-depth support in terms of trade processing and allocations.
It might be straightforward booking 2000 trades, but as Mr Debiche points out if you cannot clear, settle, or book collection on those trades, you soon realise “what a big number 500 or 2000 is when you have to write manual tickets to fix the problem”. Mr Leman adds that while part of this is related to budgets, delays have sometimes been “part of a strategy” in certain circles, but at some point the industry had to move forward. And, as with standards adoption, “some of the biggest obstacles will also be the biggest faciliators of growth once they are overcome and fully embraced.
“Fundamentally, it’s a case of brokers having to rethink their roles. Where do they add value and what it is they are providing to the buyside community,” he asserts.
The role of the broker as coach and educator to clients is likely to take on greater sigificance. But Mr Debiche says this will be “a huge task for the sell-side” to execute. With many brokerage firms having significant intellectual property investments together with their algorithmic trading systems, Mr Debiche argues that brokers will need to educate their clients more fully on how to make the best use of these systems and services that they may not fully comprehend.
“The broker has to stop and say: let’s go over what the needs of the client are, what services do we offer, and then define the best match between what the client‘s requirements are and what the brokerage firm has on offer, ” concludes Mr Debiche.
Hard economics will spur investors to pull the trigger
James Leman, managing director, head of execution trading, HSBC (Americas), foresees a trend for brokers to become coaches for investors who decide to “pull the trigger themselves” over their investment decisions.
It is reflective of the maturation of the industry. Just as in the first industrial revolution, shop floor workers moved from their machines and lathes into provision of more value-added services. Mr Leman said that part of the driver will be sheer hard economics.
“Brokers are effectively operating sophisticated factories, where the cost base of what it takes to deliver [these services] is not that defined, sliced and diced – and brought to the attention of customers,” he says.
In the future brokers will need to have an “arsenal of tools” at their disposal, which will encompass customisation and knowing more precisely what customer requirements are. Consequently, there will be “different price points” at which transactions happen, Mr Leman argued.
“Brokers will have to demonstrate their value in this new enviroment,“ he states. “And, it revolves around what the customer feels he must do versus what functions or services they should entrust to the broker to perform.”
This all calls for a far more personalised service, with the sales forces and product teams probably having to undergo (re)training. He also believed that generic products will begin to wane slightly as customisation “begins to take the field“. Technology will be the great enabler, transcending both big and small clients alike.
Mr Leman notes, however, that in certain ways deciding to pull that trigger yourself and “asking to express track” could eliminate opportunities to participate in liquidity events that can sometimes occur when one defers to their broker. In his view, this is a “trade-off” in the minds of individuals, yet it also centres on how the customer sees their own role in the market place.
Michel Debiche, president and chief executive officer of Quantia Capital maintains that in relation to the question of disintermediation, it is not a case that there will no longer be a role anymore for brokers, as algorithmic trading and machines taking over.
