Prime clearing and execution brokers serving buy-sides that have internal trading or dealing desks (e.g., large institutions, hedge funds, CTAs, pension funds, proprietary trading firms, etc.) are increasingly commoditised and up against fierce competition. They must both attract new and retain existing clients and order flow. So it’s crucial that they have a clear understanding of what today’s buy-sides are looking for, to ensure that innovations address legitimate concerns and provide clear differentiation.
In the latter half of 2013, Object Trading conducted extensive research into how sell-sides can simplify complexity in their market access infrastructure in order to remove the limitations to innovation and growth. In the course of that research, a number of common themes emerged around how sell-sides may better serve their buy-side clients.
#1 The buy-side wants a simpler integration process
In the past, sell-sides differentiated themselves by offering an increasingly diverse portfolio of trading technologies and venues. Many still do. Buy-sides demanded diversity as part of the overall service offering. But costs pressure the sell side to reduce choice; likewise the buy-side are now under similar pressures to limit the diversity they had chosen to accept. Most buy-sides with dealing desks manage their technology internally. So any sell-side system must integrate with the buy-side’s front office, risk management and post trade processes. If the broker has multiple technology stacks across asset classes, integration requires substantial time and effort. So to reduce integration and compliance burdens, and the number of execution and order management systems, buy-sides have begun take matters into their own hands.
For example, a major hedge fund that began integrating to each of its clearing and prime broker platforms found the process inefficient and endless. So the fund adopted a standardised market access platform to normalise pricing feeds, order execution and trade management functions, and pre-trade risk constraints. Using the FIX protocol would have been beneficial yet insufficient. Though an industry standard, the variety of custom deployments at counterparties limits the efficiencies. Thus the fund further adopted the market access platform’s single API (application programming interface) for access across all markets. Now the fund requires its executing and clearing brokers to integrate with this API, standardising the approach to execution, trade management and risk functions, regardless of the variety in counterparty engagement rules. This has helped the fund gain quick, efficient, precisely controlled execution to all marketplaces. It has also removed post-trade limitations, dramatically simplifying the integration work.
This fund’s approach is being mirrored by other buy-sides that will no longer devote resources integrating to the sell-sides’ platforms with dated proprietary technology. They need a single, normalised architecture to spend less time on technical integration and achieve a single point from which to manage trade execution, view aggregated risk, and perform compliance. Resources can then focus on trading strategy development. If sell-sides can decouple order generation from market access infrastructure, they can simplify trading for clients, and enable value-added services.
In contrast, some sell-sides say that proprietary technology will make their services more “sticky” with customers. They assume that if customers are willing to adopt the sell-side’s platforms, build the needed interfaces and tightly integrate with their back office systems, they’ll be less willing to leave. However, locking customers into proprietary ecosystems only works when no viable alternatives exist. Given the increasing choice of clearing and prime brokerage options, this approach won’t succeed much longer.
#2 The buy-side wants better capital efficiency
Efficiency in allocation and management of margin and of overall capital was previously a secondary consideration to transaction cost efficiencies, particularly in the clearing process. But increased competition for alpha, coupled with the new global regulatory environment brings focus upon intra-day collateral management processes as well as generally increased levels of capital requirement. This new reality compels market participants to find innovative ways to maximise capital efficiency and manage intra-day margin consumption; so capital efficiency has now become an integral part of an effective trading strategy.
If buy-side firms are unable to manage the allocation of their capital and have to fragment their margin to comply with regulations, they will be forced to reduce trading volumes, potentially stifling liquidity. Sell-side firms that were once focused on reducing costs in order to attract customers are realising that helping clients allocate and manage capital efficiently is a compelling value proposition.
Below are three areas where we see sell-sides addressing the capital efficiency problem.
· Silo-ed technology platforms are the low-hanging fruit. Most sell-sides have different technology platforms across asset classes, using distinct order generation and market access infrastructure, with distinct risk controls. If risk information isn’t shared amongst platforms, capital cannot be re-allocated dynamically during a trading session. So a trading strategy that leverages one system more heavily than the other might use up the margin allocated to that system, while the allocation in the other system lies idle.
To maximise capital available to be dynamically deployed towards trading strategies and minimise margin consumption, firms must achieve a real-time, aggregated view of the risk accrued across technology siloes. This view enables dynamic, efficient margin offsets, ensuring the firm realises the full potential of its increasingly scarce capital resources.
· Firms also offer margin efficiencies across derivatives and listed products by leveraging recent product developments by exchanges and clearinghouses. Providing efficiency opportunities for customers has been a key driver in exchange mergers such as the ICE acquisition of NYSE. On May 31 2013, NLX launched to enable the trading of short-term interest rate (STIRs) and long-term interest rate (LTIRs) listed derivative products on a single exchange, providing participants with unique cross-margining capabilities to reduce the total cost of trading.
· Prime/clearing brokers further develop their own cross-margined products and innovative risk management methods, for example by facilitating better pre-trade margin efficiency. Some firms will offset a client’s positions based on their understanding of the exposure and correlation between products and the current prices at which they could liquidate.
This is allowing buy-sides to efficiently allocate their available capital without increasing risk or consuming redundant margin. To offer clients this kind of pre-trade margin efficiency, sell-sides must have a real-time, aggregated view of the risk accrued across asset classes. This view could enable dynamic, capital efficient margin offsets.
#3 The buy-side wants a flexible, on-demand platform
Buy-side clients are increasingly nimble and capricious. They want to follow movements in liquidity, entering and exiting pools and products faster. Unfortunately, client-side technologists in many sell-sides operate within a web of disparate exchange connectivity technologies, making timely response to demand challenging. These brokers’ Client Technology groups have trouble supporting existing destinations, while clients are always asking for more. As the entire sell-side faces this difficulty, therein lies the opportunity for those that can break free. The fundamental way for sell-sides to dramatically increase business is to make it easier for buy-sides to buy, rather than make it harder for them to leave.
The first step is to improve the early customer experience. Using a normalised gateway API, buy-sides integrate their systems once. Once they’re certified against one venue, it’s faster to authorise them to additional venues using the same normalised interface. This approach allows sell-sides to remove redundancies, simplify access to markets, and reduce significant overhead in compliance for and maintenance of numerous in-house and vendor gateways.
The next steps ensure retention of the buy-sides already onboarded. Again, standardising the APIs for accessing markets allows both parties to enhance the relationship. Both sell and buy side can see a single point of execution, trade management, pricing and risk. And the sell side has a platform for developing services that the buy-side simply can’t get elsewhere.
This enhanced experience benefits both the sell- and buy-side by removing costs and friction. Sell-sides capture more order flow. Buy-sides are more nimble, taking advantage of new trading opportunities with lowered technical investment.
An action plan for sell-side success
Buy-sides are looking for sell-side partners that offer them a low-grief interaction, specialised services, and extensive market access. They don’t want to be locked into “monolithic” sell-side technology. They would however benefit from an on-demand architecture that allows them to access clearing and prime brokerage services and capture fleeting trading opportunities.
Whilst buy-sides are increasingly knowledgeable about competing with technology, they do not have unlimited technology budgets. They desire simplicity and sophistication in their execution platforms, demanding more with less internal staff. To meet these pressures, sell-sides need to reevaluate their service offerings to simplify interactions for their customers. Today’s investors have more options than ever when selecting suitable execution and clearing brokerage partners. Sell-sides need to focus on delivering innovative services. Flexible, simplified technology will help them meet buy-sides’ desires.
For more information on how simplifying technology can help sell-sides better compete in the marketplace, join our Webinar: Getting Ahead in Fragmented Markets.