Future Proofing Trade Execution Systems


A GlobalTrading Roundtable Discussion.

Regulation, technology advances and behavioural changes mean that trade automation will increase, and systems and their providers need to be flexible, agree speakers at a GlobalTrading roundtable. But, the degree of standardisation and the merits of outsourcing are controversial.

The technology and business functions within buy- and sell-side firms can no longer be siloed; they are interdependent. A trading desk can only be successful if it incorporates and prioritises technology that, if applied properly, will ensure a firm’s survival, agreed speakers at a GlobalTrading thought-leadership roundtable sponsored by Itiviti and hosted by the LSE on 22 November 2017.

Regulatory headwinds are an important catalyst for technology improvements that are creating new data sets and the opportunities to use them. The proliferation and fragmentation of liquidity and how to use it is a key issue for dealing desks.

For instance, the restrictions on dark pools imposed by the Markets in Financial Instruments Directive (MiFID) II will propel the automation of block trading to find alternative sources of liquidity and firms will need a cost-effective way to do this – which means making technology core to their businesses. Without the adoption of technology in a central role, firms will struggle to compete.

Furthermore, there is a danger that firms might re-invent the wheel for different asset classes, so it makes sense to move towards multi-asset platforms and integrated operations. Avoiding duplication reduces costs.

But, too often in the past, technology has been applied like sticky plaster, patching up gaps in systems and salving deficiencies. Instead, future proofing technology needs a clear sighted integration of the business strategy with the technology architecture. It might be expensive for smaller firms to implement, and consolidation within the industry might be an inevitable consequence. Clearly, those firms that have already invested in technology as a key component of their business strategies are at an advantage.

Most topically, if a firm implements MiFID II correctly, then it should be well-positioned to adjust to new technologies and future regulations. This means applying the requirements of the legislation diligently across asset classes to ensure accurate transaction cost analysis and best execution. As data is fundamental to achieving best execution, greater automation is inevitable in order to tap into new sources of information and optimise processing. The scalability of data collection is essential.

Some asset managers have already unequivocally embraced an automated trading process. This includes integrating platforms and aligning data processing facilities in a systematic way with the objective of enhancing access to liquidity and maximising operational efficiency. The result, within just a few years, will be almost no human involvement in the process which instead will be managed by artificial intelligence and machine learning, according to a speaker.

However, even if this were an established trend, inertia would likely prevent its unanimous adoption within the industry, noted another speaker.

Of course, there is a danger that the perspectives of business strategists and technical experts gets lost in translation. Their disciplines have different languages, so perfect integration and mutual-understanding is perhaps an ideal benchmark rather than an attainable target.

Standardisation and customisation
Some speakers argued that firms should build internally the systems that give them a competitive advantage, such as data analytics, trade algorithms and content distribution, but buy – or more accurately rent – systems for their more basic activities. Another way of expressing the model is “to customise round the edges but install a core provided by vendor”. Basically, the firm has a standardised workflow system surrounded by smart algorithms.

However, the distinction between what should be proprietary and what is generic is not always clear. For example, some firms, especially if they are large and complex, might build their order management system in-house, others might conclude that it can be standardised.  Vendors need to make various predictions about the direction of automation, and there can be logistical and cost problems trying to align those bets.

A significant insight that arose from the discussion about the buy/build or hybrid models was recognition that the “buy” option is now more often a “rent” option. Firms increasingly hire systems rather than own them, which allows them to be more flexible to advances in technology and the imposition of future, unknown regulation. This characteristic is likely to predominate among the younger generation entering the financial industry, who are more comfortable with the concept of renting and sharing, but still causes nervousness among veteran industry participants uncomfortable without fixed, secure data centres and copyright-protected trading systems.

Their concerns are legitimate to some degree. For instance, the increasing use of cloud technology raises issues of jurisdiction, the requirement for audit trails implies specific responsibility, and future proofing systems competitively suggests ownership rights and licensing agreements.

Indeed, liability and risk containment is a major factor for future proofing trade technology. If under pressure, then brokerages and asset managers tend to choose in-house solutions for their technology needs, because they have more confidence in their success. It is a natural tendency to manage risks internally.

Arguably, vendors will soon be more tightly regulated – and perhaps some should be already – as their role gains more importance, especially if they create and install standardised systems. It would be ideal, buy- and sell-side speakers agreed, if they could outsource to a vendor and have confidence that it will automatically upgrade to comply with any new regulatory changes. Nevertheless, some systems are especially sticky, so renting could turn out, in practice, to be a purchase for life.

Hence, the momentum towards standardisation can often be checked by the necessity of a market place that offers purchasers with alternative, flexible systems. Besides, too much standardisation can stifle innovation.

Although technology is automating market convention, standardisation requires collaboration to ensure legitimacy and authority, and there is a continuing conversation within the FIX industry about standardisation of systems that confers the former, and a dialogue with regulators that bolsters the latter. The merits include easier compliance, lower costs and increased revenues.

New world challenges
Re-skilling is a major aspect of the financial industry. For example, visualisation techniques are being imported from gaming, while research and development departments are recruiting more and more staff from non-financial backgrounds. Everyone has to think more laterally about the expertise they can deploy – in fact one speaker pointed out that their firm had recently hired a molecular biologist to calibrate data from a different perspective to a traditional financial quant, and another said that their best technical analyst was an environmental scientist.

In fact, quantitative analysts in all their many forms increasingly “own” the trading process. In a sense, outsourcing is taking place within a firm.

It can be difficult for both vendors and in-house technology teams to recalibrate their systems quickly to changes in regulation. That is not because they are not flexible or agile – quite the opposite; rather, large firms have to spend time checking the adjustments and back-testing their efficacy in order to satisfy the regulators. In future, perhaps artificial intelligence can bridge the time interval.

Technology is transforming from a product into a service. Meanwhile, the behavioural revolution underway led by the younger generation means that the financial industry requires much more investment in technology that can maintain orderly markets and ensure security.

In addition, the longer-term macro-outlook indicates an escalating demand among defined contribution pensions scheme for equities that earn growing returns. This trend will need significant investment in technology frameworks, especially if asset classes and their individual securities are rationalised and consolidated.

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