ONE YEAR: FIVE CHANGES Adapting to the new trading environment in the EMEA region
The Oxford English Dictionary defines ‘challenge’ as the “move from one system or situation to another”. It is a word Toby Corballis, CEO of Rapid Addition, believes, all too easily describes the financial turmoil of the past six months. With a particular focus on EMEA, Corballis examines these challenges and the associate risks facing firms and software vendors across the financial marketplace over the coming 12 months.
Given the continuing volatility of global markets, large-scale movement of people, data and systems, challenge looks set to be the order of the day. Or, in the words of Robert Zimmerman, ‘The Times They Are A-Changing‘, in the world of electronic trading, like many others, ‘movement begets change and change begets risks’. Over the following year, the industry looks set to face a series of challenges, change and risk.
Change #1: Consolidation of software
With apologies to any egg-sucking grannies, once upon a time, to attract order flow, the sell-side gave away various software packages to the buy-side. It was the same kind of logic applied by proponents of the ubiquitous loyalty card, and buy-side firms saved money, as they didn’t have to pay for their software upfront. Actually, costs were partially hidden in sell-side fees and partially realised through the inconvenience of having to use a multitude of different solutions that did more-or-less the same thing but connected to different counterparties.
This may seem trivial, but it represents a seismic shift in the way systems make it to market. Money for these systems will no-longer flow from the sell-side to the software vendors. The relationship is now owned by the buy-side. No one wants to pay for something that used to be free, so it’s unsurprising that there are mutterings in the corridors. Expect this crescendo to peak as many existing ‘free’ contracts expire, creating a drive to consolidate on as few solutions as possible. This consolidation carries a number of risks to all sides of the financial Rubik cube.
Buying software requires an understanding of the software procurement process, a process that is itself currently the subject of change. Questions like, “how long has the vendor been trading?” are likely to matter less than “who is the ultimate parent?” and “how solvent are they?”. Ownership is likely to say much about the chances of software being able to support your requirements later on. Where safety in numbers was once seen as good (vendors had more clients so less chance of going under), it doesn’t work so well if you’re in a long queue of creditors to a failed business.
Knowing who the ultimate parent of a company is gives other insights. Do the company’s principals really understand my industry (they need to if you want some assurance that your system will change to keep up with the times)? Do they have a reputation for innovation? What is their commitment to Research & Development?
Change #2: Increased regulation as a by-product of political oratory
Politicians love to claim credit, deflect blame, and be perceived as tough guys. A quick scan of the local media is enough to see that the current political culture is very much one of blame. Fallout from political rhetoric tends to materialise in legislation which almost always beats the drum for “greater transparency and accountability”. What is actually meant, of course, is greater auditability, or the ability to recreate a moment in time so as to prove that the course of action taken was fair and in the best interest of the client. This is all good and there are many ways to achieve it, however it would be hard to argue that computer records were anything other than the most accessible of these.
Imagine trying to model all of the Credit Default Swaps (CDS) contracts into which Lehman’s entered. One problem is that a CDS could be created in so many ways: phone, instant messenger, and so on. Finding and recreating all of these would be a nightmare. That there is an appetite by the regulators for things to be more auditable is evident in recent speeches by Charlie McCreevy, the European Commissioner, who has been looking to introduce legislation to create more on-exchange trading of CDS trades.
If more assets are traded on-exchange that implies that more software connections are required to connect venues with participants. That, in turn, implies more trading platforms and more capacity to handle increased transactional volumes by the participants.
Change #3: Fragmentation of liquidity.
Recent times have seen an increase in the number of trading venues, with Mutual Trading Facilities (MTF’s) like Chi-X, Turquoise, and BATS entering the scene. Later this year the London Stock Exchange plans to launch Baikal, a pan-European dark liquidity trading venue.
I’m not going to argue whether fragmentation is a good thing or a bad thing, but it does provide several challenges. The first is in being able to find liquidity fragmented across multiple platforms, some of which are hidden. The second is being able to connect to, and speak the language of, many venues at once. Fragmentation in the financial marketplace is reflected in vendor routes to market. Increasingly, the connectivity method du jour is FIX. The London Stock Exchange recently announced that it will FIX-enable TradElect using FIX5.0, and Chi-X already uses FIX. This makes a great deal of sense as it lowers barriers to connecting with additional counterparties and leverages more than 17 years of a protocol that has had extensive industry peer review. The trick is to find a FIX engine that meets your needs.
Change #4: Aught for naught, and a penny change. Total cost of ownership.
Everyone likes something for free and when budgets are constrained there is a natural tendency towards cutting costs. There is, as we all know, no such thing as a free lunch. There is a distinct risk that people view open source software as exactly that. Whilst licences are free, the downstream costs of open source software are often overlooked when calculating the total cost of ownership.
Manuals, if they exist at all, are often a paid-for extra. Help with installation is an add-on and can be upwards of $2,000 per day. Maintenance? Another extra, and firms often need to employ their own technical staff. Updates cannot be guaranteed (a quick look at the website for one of the most popular open source FIX engines suggests it hasn’t been updated to support the most recent three versions of FIX), so this cost is often borne by the licensee. The ownership structure is sometimes not clear, adding the potential for future licensing issues.
Finally, there is no concept of liability with open source products, unless you specifically buy liability insurance, which these days is not cheap.
De-risking the cost of ownership requires that those making the purchasing decisions understand the costs upfront and can clearly see a return on investment within a reasonable time frame.
Change #5: Natural selection. The ISV landscape.
Software vendors will need to be flexible, in order to survive. That means being agile enough to adapt offerings quickly and bespoke solutions to their clients’ needs. We’ve all heard of large software providers refusing to make changes to software until they encounter the same request multiple times from multiple clients. That sort of behaviour is unlikely to survive the changing software landscape.
A lot of this behaviour occurred because making changes to software was time-consuming and costly. It required that developers open up the software, make changes, go through iterations of testing, and deploy to a large client base. Advances in software and associated methodologies mean that much of the logic can be defined outside the code. Business rules engines embrace this concept, as do data-driven FIX engines that can read in the FIX repository (or a derivative thereof) and instantly understand the logic for each transaction, as well as maintaining an edge on performance.
Change #5: The rise of social networks.
The appeal of Facebook and My Space is that they connect friends with each other across the globe. This has practical applications, of course, in connecting people with a common interest, but is very horizontally focused. However, more and more social networking sites aimed at specific verticals are starting to spring up. An example of one of these is Hedgehogs. net, a social website aimed at the Investment community. Sites like these incorporate vendor plug-ins (widgets) that offer users useful tools but the software vendor has to recognise the value of the platform, its viral marketing potential, and have software capable of seamless integration.
Many of the challenges faced in EMEA are, undoubtedly, global in nature. To ensure survival, companies need to look at the value of their IT investments, whilst vendors will need to offer flexibility at appropriate prices. It’s a big small world out there but the biggest risk, as always, is in doing nothing.