A Multitude of Risks – Multiple primes, multiple systems … is integrated technology the only solution?


The way we trade has never been more complex. The current environment is overloaded with the demands of multi-asset, multi-broker, multi-exchange, multi-market and multi-national strategies. FTEN’s Ted Myerson rakes through the coals of the current financial turmoil and offers his perspective on the best model for success.
Sponsored access comes with a multitude of parts and complexities that all have their consequential risks. Inherent to this type of business are multiple prime broker relationships, various trading systems, competing liquidity destinations and different asset classes traded across diverse global markets. The constantly evolving financial environment, amplified by the viral instability of financial institutions, changes in regulations, and the globalization of trading, just seems to proliferate more of it— more relationships, more systems, more markets, more regulations and oversight requirements.
This environment has become fundamentally more chaotic and consequently a lot more riskier. The sum of all of these components can lead to compartmentalization and blind-spots without the proper tools in place to aggregate all of the pieces. This threat of organizational disorder presents significant risks for both the buy-side and sell-side.
Technology that aggregates and consolidates all of these disparate components can mitigate the friction and chaos, providing a singular view into all of this activity. Because of the different interests of these distinctive, and sometimes competitive, components technology is truly the only way to control the multitude of risks associated with sponsored access in this multi-faceted environment.
The Multi-Prime Brokerage Model
The market turmoil, over the last year, has accelerated the demise of the single prime brokerage model. Hedge funds – big and small – are increasingly moving towards establishing multiple custodial relationships in an effort to avoid the fallout from a bank failure.
The need for hedge funds to spread their assets over multiple prime brokers, juxtaposed with the multiple accounts and trading strategies involved in their businesses, results in a myriad of complexities. Without the proper infrastructure, hedge funds can experience a “silo” view of realized and unrealized profit and loss, overall position, and exposure.
This presents a new set of risk management challenges for buy-side clients.
At the foundation of this issue is the need to collect disparate position and transaction data across multiple prime relationships. Broker neutral, agnostic technology that processes drop copies from all trading destinations and prime brokers and rolls them up into one dashboard, can help alleviate the disjointed view. Since hedge fund administrators typically only view data after the market close, this roll-up must occur in real-time and throughout the trading day for there to be complete electronic control over position and exposure.
Mulitple Trading Systems
As buy-side clients spread their assets and risk over multiple prime brokers, the number of trading systems also increases, compounding the disparate sources of data and the threat of creating silos and blind spots. Consequently, the risks of these blind spots are compounded by all of the staff and resource cutting measures currently affecting the financial services industry. There are simply not enough screens or people to watch them in today’s market. This trend is expected to continue into the near future.
Trading desks need an agnostic platform to consolidate the total exposure of committed capital across clients and accounts into one real-time, intra-day dashboard view.
Multiple Asset Classes in Multiple Markets
Further complexities arise as electronic trading strategies begin to embrace global securities, options and futures. Since this is a significant and growing trend, consideration must be given to different currencies, time zones, regulations and taxes when considering risk exposure and overall positions.
Technology that can aggregate the impact of these inter-market issues and calculate their net effect on portfolio is tantamount to risk management in firms that include multiple assets and geographical markets in their trading strategies.
Consolidation At The Exchanges
Until recently, traders used to trade equities and options on separate platforms. There were separate traders with separate desks using separate strategies. Increasingly, electronic trading strategies now include both equities and options to offset risk on both sides for more stable hedges. Because of this, we’ve seen electronic exchanges like ARCA and NASDAQ merge their equities and options offerings. BATS is expected to follow suit.
Buy-side clients seem keen to take advantage of this multi-asset offering, because diversifying across liquidity and volatility drives their trading strategies. This requires low-latency, cross-asset awareness that captures the increase in message volumes and aggregates the overall risk exposure to the organization.
Also, with the increasing emergence of new exchanges, MTFs and ECNs around the globe, quoting symbology, for the most part, lacks a cohesive logic from one liquidity destination to the next. With the ability to trade the same stock at multiple exchanges, the lack of a uniform language makes it difficult to map symbols. This can negatively impact the algorithms and strategies of trading organizations.
In Europe, things look set to change. Exchanges such as BATS Europe, Chi-X and NASDAQ OMX are working together to create a uniform symbology across their liquidity destinations. The idea is that creating a uniform code will make smart-order routing more efficient and make consolidated tape offerings more effective. The overall impact would result in better market data and smarter trades, cutting down on systemic risks traditionally caused by bad data in the market.
However, in many cases, many exchanges will hold on to their own distinct symbologies and other exchanges, ECNs and MTFs will still pop up. It is imperative that exchange-agnostic technology be available to support this dynamic environment.
Risk Management: Relationships and Technology
Relationships are still important, but the volatility in the market coupled with the uncertain future of some of the biggest financial institutions, and the recent of scandals that have plagued Wall Street naturally make relationships more risky. Consider KYC (Know Your Client). This is an old school term that just doesn’t cut it for risk managers anymore. As we learned from the Madoff scandal, seemingly strong relationships don’t necessarily translate into sound risk avoidance strategies. While technology is not perfect, it intrinsically lacks self-interest and cannot be influenced by greed. When properly used, it is truly the best tool for managing the chaos and the risks.
It is technology that can scale and adjust to accommodate the multitude of issues and changes that continue to impact the financial markets. It is a consistent and reliable tool but it is imperative that nothing be hard-coded or static. The best tools for consolidating all of these disparities inherent to this business come from agnostic platforms that can integrate with any broker, trading platform or exchange to provide the most comprehensive, real-time and intra-day view. This is essential for controlling risk across an organization, and ultimately, the market as a whole.