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Appetite for risk has never been lower and liquidity has never been tougher to identify. The downstream effect is impacting every part of the electronic trading business and culture. Quod Financial's Ali Pichvai examines where he sees the sea change in trading skills and style.

We are at the midst of a structural, and subsequently cultural, change in the capital markets. Firms’ appetite for risk is shifting and counterparty risk is now high on the agenda. This trickles to each function and aspect of investment and execution; from investment decision making, to risk management, and the mechanics of the electronic trading. In addition, liquidity is increasingly fragmented across a multitude of pools and is affecting how electronic markets are evolving. So how does this landscape impact how firms will trade?

Changes on the buy-side and how the future will look are still uncertain. The hedge fund industry, the great innovator investor class, has in large part been discredited and its model will need to drastically change. The quasi-demise of this large segment will leave a void that needs to be filled. It seems that the future lies in more transparent, better risk-managed, low-cost listed products, which respond to the appetite of global multi-asset investment and execution strategy of the investors. Furthermore it is now clear that liquidity and solvency are intimately linked, and evaporating or volatile liquidity creates systemic risk on solvency. This will, without doubt, have a large impact on future capital market structures.

The buy-side transformation will inevitably accelerate the pace of the current secular trends of more electronic trading on centrally cleared liquidity venues and competing global or regional multi-asset liquidity venues. NYSE Euronext, as a global multi-asset liquidity venue, seems to be the role model for all other market participants. The liquidity fragmentation, as observed today, will certainly be greater and more complex going forward. It also seems we have entered a second age of liquidity fragmentation, with three phenomena which have appeared, or been reinforced, in the current turmoil.

Liquidity is becoming ever more dynamic. As competition increases price wars are becoming more frequent, and pricing models are being altered to attract more and more liquidity. For instance, the rebate model for passive orders (i.e. by resting a passive order, you can receive a fee) has often been used as an effective marketing tool for new alternative trading systems. Clients are therefore moving their execution on a realtime basis from venue to venue, as pricing evolves within a competitive landscape, making liquidity ever more dynamic.

Liquidity is decreasing transparency. As new dark pools and brokers internalisation profligate, with the US equities having achieved 17% of execution in these dark venues, the level of transparency is decreasing. This creates a massive trading challenge. Transparent liquidity is important since it creates an efficient price discovery model, which then disappears into a non-transparent execution model.As transparency decreases, in addition to market data sourced from the different displayed prices, there is a need to move to real-time post-trade analysis, to rebuild a more intelligent picture of liquidity.

Volatility increases fragmentation and increases execution risk. The current intraday volatility, and an even lower period volatility, is much greater than at any other time, and bigger than the impact of incurred costs. As seeking liquidity becomes more important, fragmentation will increase. The result is a new type of risk which needs to be mitigated; the execution risk. This means that the investment case can be fully redundant if the execution in a highly volatile market is not properly performed. This risk evolves from the inability to execute down to execution too far away from the investment decision. Another obvious effect is that the widespread algorithmic trading engines, which were built to limit for low volatility markets, have become obsolete. Nowadays, in an averagely volatile day, it is not uncommon to have 300 basis points of volatility, which dwarfs a single digit basis point cost impact. That means that the next cycle of investment in algorithmic trading needs to be redirected towards liquidity seeking algorithmic trading (also called smart order routing - arguably a misnomer, since it is simply routing rather than delivering a real-time decision making process).

Exchanges are modernizing, market participants are investing heavily in technology and electronic trading is on the rise. The end result? Firms today face a challenging new market environment, one that is fractured, extremely competitive, and constantly evolving. Portware's Damian Bierman explains why bringing in the experts could be the best investment you'll ever make.

Today’s global trading landscape is vastly different than it was twenty years ago. Structural, economic and regulatory forces, combined with major advancements in trading technology, have ushered in a new era of automated trading. In the United States and Europe, numerous electronic market centers – exchanges, alternative trading systems (ATSs), electronic communication networks (ECNs), and crossing networks – compete for client order flow, offering superior execution speeds, reduced market impact, anonymity, or a combination of the three. New regulations in the US (RegNMS) and Europe (MiFID) have hastened the pace of structural and technological change. As for Asia and other emerging markets, they are not far behind.

At the same time, all market participants – buy-side firms in particular – are under increased pressure to reduce trading costs and rationalize their IT budgets. This is not a new trend. While the recent economic downturn is partly to blame, the goal of bringing increased efficiencies to the trading desk predates the global credit crisis. For firms in all global markets, the challenge is twofold: deploy advanced trading technology that will allow you to navigate – and exploit – today’s complex marketplace, but do so with an eye towards long term value and scalability.

New requirements for a complex market
What constitutes “advanced trading technology,” and what do firms really need to compete effectively in today’s market? To answer that question, consider the challenges posed by today’s market:

  • Access to fragmented liquidity. Firms today face an increasingly electronic global marketplace, and one that offers a wide choice of execution destinations. However, with increased choice comes increased responsibility for execution quality. In such an environment it is incumbent on market participants to take greater control of their order flow. From a trading standpoint, this means the ability to access all available sources of liquidity – including broker execution algorithms, crossing networks, exchanges, ECN’s and other pools of non-displayed liquidity – from a single trading environment.
  • Advanced trading tools and analytics. Given the complexity of the market, traders must have access to integrated toolsets with which they can make informed decisions. Pre-trade transaction cost analysis (TCA), real-time benchmarking and performance measurement, portfolio-level analytics and post-trade TCA – all of these help traders to efficiently gauge trading costs and route orders accordingly. Consolidating and integrating these toolsets into the trading process is critical. Not only does this drive efficiency, it allows for the analysis of orders at any point during the trade workflow cycle, helping firms gauge traders’ decision making processes (and overall performance).
  • Performance. For many firms, the recent spike in volatility has been a painful experience. Soaring trade volumes and related message traffic have crippled legacy trading systems. Unfortunately, these kinds of volumes are fast becoming the rule, not the exception. Technology that can withstand this kind of message traffic is no longer a luxury, but an absolute necessity.
  • True multi-asset support. The ability to trade multiple assets on a single platform offers numerous advantages to firms today. First, connecting data feeds and workflow applications to a single platform reduces integration costs and operational overhead. Second, multi asset systems can support advanced strategies such as auto hedging and multi-asset arbitrage, both of which are becoming increasingly popular.
  • Flexibility and ease of integration. Given the web of interconnected workflow applications, data feeds, and other third party and proprietary systems that firms have deployed, having a system that can easily interface with the rest of a firm’s technology infrastructure is another key requirement. The alternative – closed systems based on rigid technology architectures and proprietary languages – are difficult and prohibitively expensive to deploy. While the short term costs associated with deploying closed systems are considerable, the long-term costs can be enormous. The more difficult an application is to integrate, the harder it will be to upgrade it or customize it in the future. Eventually, such systems become part of a firm legacy infrastructure: out of date and costly to maintain, but too expensive to replace.


China’s insurance sector has experienced robust growth over the past decade, with total asset size and fund balance increasing more than ten-fold since 2000. But the industry is not without its challenges, especially on the technology side, which has struggled to keep pace with demand from the market. Gao Shong, Head of IT for PICC Asset Management offers FIXGlobal his assessment of the technology issues that must be resolved for the industry to move ahead effectively.

With the rapid development of the insurance business, the scale of asset management in China’s insurance industry is also growing at high speed. The latest available numbers (Oct 2008) show a ten-fold leap in assets managed and fund balance in less than 10 years, to RMB 3.19 trillion and RMB 2.89 trillion, respectively.

Beginning in the 1990s, Chinese insurance companies, such as China PICC, China Life, Ping An and Taikang, have all set up specialised asset management units, and since 2003 the same firms have gradually launched insurance asset management companies, based on the external trustee model (trust and managed funds, and independent trust) seen internationally.

At present, there are nine Chinese-funded (China PICC, China Life, Ping An, Central Reinsurance, Pacific Insurance, New China Life, Taikang, Huatai, Taiping) and only one foreign-funded (AIA Insurance Fund Operation Center) companies. Together these asset management companies are responsible for nearly 90% of the assets of China’s insurance industry.

Broad range of financial products on offer
For these firms, insurance investment covers not only fixed-income operations, such as treasury bonds, financial bonds, corporate bonds and subordinated debts, but also equity operations such as stocks, funds and equities. In addition, the firms are actively exploring infrastructure investment, foreign investment and derivatives, such as ABS, MBS, REITS, bond futures and stock index futures.

In terms of insurance asset allocation, there are four characteristics: diversified asset structure, diversified sources of earnings, innovative investment instruments and international market scope.

In the meantime, as the Mainland regulatory body gradually relaxes restrictions on insurance asset management in operations such as third-party business, corporate annuity, investment and investmentlinked insurance, the number of investment portfolios managed by insurance asset management companies is growing rapidly.

Learning from the international model
The result is an industry that has progressed rapidly in both professionalism and accountability, often taking the lead from the internal management processes of the foreign asset management model.

Internal and external pressures
From the first-level asset allocation to the second-level professional fund allocation and the subsequent order placement, transaction settlement and final portfolio analysis –
including cash flow, risk indicators, internal performance attribution – each process involves strict risk control and monitoring. With the scale and scope of insurance investment expanding, internal analysis and management processes are increasingly complex. Away from the internal processes, the requirements of the regulator and client with regard to transparency, timeliness and research data is also increasingly stringent.

Front, middle and back-office architecture
Together these internal and external pressures are pushing the industry to examine and integrate their core business systems. Presently, the architecture in most domestic firms comprises front, middle and backoffice components. Front office includes the investment trading system, with the main functions being portfolio management and execution of on-market, offmarket and foreign transactions. “Middle-office” refers to the risk management and performance attribution system, covering asset analysis, risk management, portfolio management and performance valuation. It can also perform VAR calculations, performance attribution analysis and subsequent portfolio analysis. “Back-office” covers the accounting system, including the daily accounting and generation of valuation and business reports.

Selecting the right system
To date, the overriding approach has been to source a system consistent with best market practice. As such, a handful of suppliers dominate. These include Hundsun Technologies and Shanghai Jie Software Technology for front-office investment trading systems, and Hangzhou xQuant and Sungard for middle-office risk control and performance management systems. The main back-office suppliers of valuation and accounting systems are Ysstech, Hundsun Technologies and Neusoft.

In the past, the IT departments of insurance asset management companies lacked international experience in system architecture management, and had limited knowledge of the investment process and financial instruments. Their role was often limited to carrying our basic orders and maintenance work. The outcome was that business units often took control of IT decisions including the development of core systems.