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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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