A recent survey by CutterAssociates indicates that market leading buy-side firms are transforming their trading practices and technology to enhance performance, lower costs, reduce risk and meet regulatory requirements. Survey findings indicate that the number one IT priority for many firms is to provide traders with enhanced trading and analytic tools, connectivity to liquidity sources, and integration capabilities.
The Impact of Regulations
The four major securities industry regulatory bodies – the Ontario Securities Commission in Canada, Financial Services Authority in the UK, the European Union, and the Securities and Exchange Commission in the US – have all issued or are expected to issue regulations that will have a profound affect on the buy-side trading desk. While the methods of regulation may differ – for example, either direct prohibition of soft dollar payments for certain services or disclosure to clients of all soft dollar payments – the goals of each regulatory body are the same: managers must provide their clients with best execution and commissions can be used only for execution and services that are for the benefit of the client, not the manager.
These new directives will place the burden of proof for the manager’s compliance on the manager, unlike the traditional approach where the regulator was responsible for proving if the manager were non-compliant.
While most of the new regulations are aimed primarily at the equity markets, we expect increased regulatory scrutiny of the fixed income and derivative markets as well.
Traders will bear the brunt of the impact of the regulations. Those traders who have not already done so will have to morph from “order takers” to executors who insure best execution and compliance with regulations. The job of head trader will entail less trading, more regulation-oriented administration, and more management.
Buy-Side Power, Sell-Side Decline
Buy-side firms have taken responsibility for execution from the sell side and now execute 70% of trades away from full-service brokers. Technology-savvy agency brokers and DMA providers, such as ITG and Wave Securities, will continue to expand their rosters of services to offer buy-side traders more analytic and execution venue choices. The buy-side will still look to the sell-side for commitment of capital, research, market color, and execution of special orders, but declines in commission rates will put pressure on full-service brokers to change existing business models and explore new ways to generate profits.
Because the buy side has taken increased responsibility for trading, traders will need increasingly sophisticated technologies to do their jobs. Market-leading firms are rethinking and reworking trading practices and deploying new systems to accommodate changes.
The Trading Desk Will Be Buoyed (or Swamped) By a Flood of Technology
Firms will be adding a host of new systems throughout the order workflow to support the trading desk’s evolution into a consistent alpha contributor.
· Order generation will include portfolio manufacturing-like decision support tools to keep portfolios in compliance.
· Trade analytic tools will provide for real-time transaction cost estimation, real-time risk management, and systems to suggest appropriate trading strategies.
· Hand-off to trading capabilities will allow selection of orders that can be sent directly to an exchange, systems to display order and market data tailored to the specific order and market conditions, and enhanced communications capabilities between trader and portfolio manager concerning the goals of the order and current markets.
· Order and execution management will identify potential basket trades, simulators to assist in selection of trading algorithms, real-time “shadowing” of the chosen algorithm using other algorithms, decision support systems for selecting a trading venue and method, systems for real-time monitoring of the status of all orders and automated exception reporting, real-time compliance and risk management systems, and visualization tools that allow the trader to absorb a great deal of information in a short period of time.
· Post-execution processing will provide real-time settlement exception processing and next-day transaction cost analysis.
The Challenge
The OMS vendors may be able to provide some of the functions, but most investment firms will have to rely on other systems providers and their own development teams. Advanced trading technologies create daunting integration and development challenges to IT because of the sheer number of systems involved, the computer power required (real-time risk management, compliance, and TCA), and the need for true, real-time interfaces. Despite the complexity and difficulty, those firms that can successfully deploy systems that fully automate trading and provide the full range of analytics will achieve an enormous competitive advantage.
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