Liquidity? Cost? Speed? What’s driving automation?
By Chris Sims, Bradley Duke
Taken from the buy or sell-side the answers can be very different …While there is no turning back the technology clock, the rate of development and adoption across the investment services community has not always been consistent. However, bucking the gloomy financial markets, 2008 and 2009 have seen a strong rise in automation. FIXGlobal discussed the issue with two leading industry professionals from the buy and sell-sides, to see what was driving this growth in automation on their respective sides of the business.
View from the Buy-side
The increase in automation that we’re experiencing is a natural progression in our industry. We’re a client facing business and we feel that technology is helping us to bring additional services and benefits. As to the main drivers, I would identify a number of aspects that are affecting the pace and depth of automation. Firstly, you need to look at accessing liquidity. This would have to come close to the top of our list. Automation gives our people the latest tools to perform at the highest level. It’s a risk management tool, both when markets are choppy and when we need to use all the networks and order routing tools to tap into multiple exchanges and dark pools.
Getting it right is more important than doing it fast
Secondly, I’d point to an area which I feel is actually not driving automation to greater heights. Latency. In my view, there is too much focus on speed. Overwhelmingl your investors are more focused on ensuring the investment decision is made in a thorough and considered way, and similarly, the trade executed efficiently. That it might take a few micro-seconds longer is not the key issue.
More colour, better audit trail, less counterparty risk
A third area that’s driving, or is at least a by-product of greater automation, is transparency. If you’re looking at creating an auditable trail, or need greater colour, taking the electronic route is clearly preferable. It’s easier to manage. Every order is raised, executed and sent to compliance electronically. Verbal orders simply don’t have the same transparency or level of detail.
This automation also keeps us in line with the requirements of the industry regulators. For a few years now, we’ve been working with increased regulation and given the current economic situation, it’s understandable that we’ll see even more. With electronic trades, the more logs in the audit trail, the easier it is to efficiently satisfy the regulator. In particular, the traditional institutional buy-side firms that are also involved in using hedge funds, for example, are in a much stronger position to remain in line with regulators.
But the opportunity of automation and resulting audit trails provides the buy-side with more. The ability to capture, monitor and analyse the way that trades are initiated and consequently executed allows you to better gauge your counterparty risk. If you’re working electronically and you want to describe the deal, it provides the opportunity for you to talk more efficiently to your counterparty. You can travel back and check the costs and underlying exposure.
Cost ? Less of a factor than you think
Finally, we often talk about the costs of trading. But the options are rarely black and white. Automation allows you to access the services that give you the best implementation, the option you choose might not always be the cheapest but might deliver the desired end result on a more regular basis. It might be cheaper to run a direct link to the latest MTF, but use of a broker algorithm with access to the same MTF might deliver a cheaper overall implementation. Clearly though you still need an experienced trader deciding on the correct approach for each individual investment decision.
View from the Sell-side
The key driver for increased automation, in my mind, is the complexity of the markets today. With fragmented, global markets overlaid with a complex range of financial instruments available, it’s almost impossible to trade unassisted. It’s essential to have some form of support from tools such as algorithms and smart order routing solutions. It really comes down to a question of efficiency. When you’re looking for liquidity, not all of it is public. There is a lot of dark liquidity in the US and Europe – and each pool tends to have its own rules and protocols – so it can be incredibly demanding for the individual traders. To achieve your investment objectives and to trade in a timely manner, greater automation is a must-have support service.
Computers still can’t do it alone
But, if you think computers and algos are going to replace humans, you’d be wrong. I don’t see computers and smart programming replacing people. It’s not about fewer traders, it’s about greater efficiency. Behind each machine there will always be the investment strategy. Developing this strategy is a process developed by financial professionals that understand the investment needs of their clients. It is unlikely that in the foreseeable future computers will be able to understand trading objectives. The human elements of experience and skill that traders and programmers bring to the equation are still essential in the process.
Transparency? Depends where you are in the trade
I don’t personally see a direct correlation between increased automation and the need for greater transparency. Certainly clarity is improved with electronic trading in terms of the audit trail, but transparency is not driving the technology. I fully appreciate that a high level of transparency is desirable post-trade, but while you’re holding the order, it could be a dis-service to the client. Keeping market impact to a minimum, while maintaining anonymity is crucial.
Trading efficiency – not necessarily cost-efficiency
I’m often asked whether cost and the desire for greater efficiencies is driving automation, and I feel that it really depends where you’re trading. In the US, where you have multiple exchanges but a single settlement structure, it is reducing costs. However, this is still not the case in Europe. In Europe, it gives you trading efficiency, but not necessarily cost efficiency as there is limited intra-operability between CCPs.
Cost may squeeze the smaller players – or create niche players
The required capital and on-going upgrade costs of improving your electronic trading capability can certainly be high, resulting in the increased risk of squeezing out some of the smaller players. I certainly see an irony in the fact that MiFID, which was introduced to improve the competitive landscape, has brought with it, some high cost considerations in meeting the regulatory requirements laid out in the Directive.
We’ve certainly already seen a lot of the smaller brokers consolidate, be bought up, or simply drop out of the market. The smart ones are realising that they can no longer be full service brokers, so they focus on the niche areas in the business. It’s an interesting development of both MiFID and the increase in automation across the industry, and it is most likely going to continue for some time to come.