By Vincent Burzynski, Executive Vice President, Electronic Trading at FIS and Jonas Lindqvist, Business Expert, Product Management, Front Arena at FIS
Several forces are inducing investment firms and brokerages to conflate their securities trading functions. The convergence is taking place not only through their adoption of multi-asset trading platforms, but also with a broadening of the skills-set expected of their staff.
The primary impetus comes from the buy-side. Institutional investors are promoting multi-asset portfolios, offering clients greater diversification and often the ability to combine incremental yield in a low interest environment with earnings growth potential. Easy access to analytical tools, research data and performance measurement techniques facilitate the decision and allocation processes.
At the same time, money managers face escalating costs to meet regulatory requirements, which include documenting audit-trails and performing other administrative tasks for each sell-side and vendor relationship. Hence, there is an incentive to reduce the number of market counterparties and consolidate dealing platforms into as few as possible without raising operational risks.
This demand puts pressure on the selected sell-side firms to provide more services, which in turn encourages them to consolidate trade functions within a centralised hub. In many cases, it is also consistent with a shift already underway among brokerages and investment banks.
The sell-side is struggling with its own cost pressures caused by lower share trading volumes and dealing margins as well as from compliance implementation. Equity turnover has fallen well below pre-2008 global financial crisis levels (as much as 45% less) while G4 government bond issuance is six times higher.
Liquidity in both asset classes has declined, as tighter capital requirements and restrictions on proprietary positions constrain market makers from holding shares or bonds on their books for any lengthy period. The effect is to reduce their ability to act as all-weather liquidity providers in addition to their role as intermediaries.
Shifting bond trading practices
At the same time, MiFID II is pushing for greater transparency in over-the-counter (OTC) trading, the usual method for fixed income instruments. The sell-side is responding by creating systems and deploying tools that replicate or are similar to those used in their equity business, while retaining workflows needed for their asset classes. In addition, there is regulatory pressure to trade bonds on formal trading venues, so the rationale for conflating asset trading platforms, especially if the buy-side promotes more multi-asset funds, is becoming even more compelling. The sell-side achieves economies of scale and a more streamlined (and perhaps more manageable) operational model. On the other hand, risk monitoring can be more complex because previously discrete risk silos for different asset classes are aggregated at one source.
For example, the Singapore Exchange recently announced an initiative to trade bonds on its AsiaEx bond platform. The Monetary Authority of Singapore (MAS) is planning to introduce the 5% Rule, which imposes limits on what can be traded by retail investors and that they must have at least five percent of the value of outstanding stocks as collateral with the broker at the end of the day. So before trading any asset, it is necessary for the broker to assess and calculate, in real time, what a customer owns across its entire portfolio. Valuing (and then reassessing its risk profile post-trade) a portfolio containing a mixture of asset classes (bonds, equities, derivatives, alternatives and so on) is significantly more complicated than a fund containing only bonds.
In fact, multi-asset investing has gained traction quite rapidly in Asia. The institutional fund management industry and also the retail investor base is younger than in Europe and North America, so it is less bound by a legacy of siloed trading. Moreover, the private banking or wealth management sector is comparatively more prominent in Asia, and its affluent clients have tended to take a multi-asset approach.
So, it is important to remember that regulatory requirements are not in themselves the driver towards multi-asset trading. Instead, they make it advantageous for an increasing number of market participants to adopt common platforms for different asset classes in order to reduce costs and streamline operations – as the technology becomes available.
Generalist and specialist functions
Other imperatives follow the adoption of multi-asset platform. Both buy- and sell-sides need to construct single multi-asset order management systems (OMS) to accommodate the process through from pre-trade to execution to post-trade across asset classes at any time. Yet, the mechanics of trading a bond or a stock, for example, are different so the idiosyncrasies must be built into the systems. In effect, a unified whole must contain specialised parts.
Particularly at sell-side firms, a similar structure is needed for its professional staff composition. Salespeople are increasingly required to service their buy-side clients on diverse asset classes, but those clients might also value the expertise of a specialist, whether in a security-type, a sector or a country. A multi-asset trader might need to approach a specialist market maker directly to ensure best execution, rather than just place the order through an automated channel.
However, the generalist salesperson is the first and most important point of contact and might be expected to direct or execute trade orders in a multitude of different asset classes and jurisdictions. This subjects them to greater strain and closer scrutiny: keeping on top of so much data and so many markets is challenging and the risk of errors is amplified. Rigorous systems should be in place to maximise the ability of the generalist to provide best service while minimising errors.
Clearly, lower trading volumes and reduced dealing margins are forcing brokerages and other sellside financial firms to focus on cost-savings. The biggest expense for most is their headcount.
Yet, staff cuts are taking place at the same time as the buy-side, whose margins are also being squeezed, is demanding more sophisticated services, better value for money and a level of automation that is compatible with their own trading styles.
Paradoxically, of course, it is the adoption of greater automation and multi-asset dealing (and OMS) systems that provides hope for both sell- and buysides. The application of technologies can obviate high staffing levels, cut costs and help restore margins. It is also likely that standard rules and conventions, similar to the FIX Protocols that formalised earlier electronic trading practices, will evolve for multi-asset trading.
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