By Will Winzor-Saile, electronic execution product specialist at Fidessa
The electronic execution landscape has undergone a steady transformation. The underlying infrastructure provides essential functionality, but few brokers see it as a means of gaining competitive advantage. Today’s differentiators are found higher up the chain: sophisticated algos, execution consulting capabilities and other innovations. However execution is something that brokers have to get right, and getting it right has become a lot more difficult.
The costs associated with execution have ballooned during a period when brokers’ margins are already under tremendous pressure. The execution landscape has become far more complex too. Electronic trading has spread into new regions and new asset classes, each with their own regulatory dimensions. The increasing need to be everywhere and support everything, but do this in a controlled and consistent manner, will define the battle for supremacy between global and super-regional brokers.
The last decade has seen a staggering proliferation of new venues around the world, all of which come replete with their own subtleties and idiosyncrasies. Additionally, each venue typically makes one or two mandatory upgrades a year – that alone means brokers are running pretty hard just to stand still.
A new regulatory consensus with a focus on transparency is compounding the issue. The regulators' belief that lit markets are good and over-the-counter bad means trading is being pushed onto the former. This will put further pressure on margins and accelerate the spread of electronic trading to new asset classes.
In the US the plans to move OTC derivatives trading onto exchanges has resulted in the creation of more than 20 SEFs (Swap Execution Facilities) since 2013. At this stage brokers have no way of knowing for sure which will make the cut, so they need the flexibility to switch in and out of new markets with speed and ease, and the ability to test the waters with minimal risk.
With a number of European reforms underway, such as Mifid II, execution quality has been placed firmly in the spotlight. Brokers will need to make major changes to their execution infrastructure in order to support new monitoring, control and transparency requirements.
Because this shift has been gradual, many brokers’ electronic execution capabilities evolved in a patchwork manner. Market access infrastructure has been bolted together piecemeal as firms have expanded their capabilities. The upshot is a multitude of systems underpinned by different technologies, duplicating routes to market in some areas, and failing to provide any route in others.
This approach simply no longer suits the vastly different trading environment that brokers now find themselves in – it’s time for a new approach.
Time for a rethink
So what should lie at the heart of this new approach? Brokers need to provide their buy-side clients with globally consistent trading behaviour. At the same time they need to be able to deliver their unique selling points through this client experience. Performance, reliability and cost are all part of the mix too.
In today’s marketplace, the pursuit of consistency is key. This means creating a single, unified execution layer across the business that insulates the trading function from everything underneath it. No matter the geography or jurisdiction, clients should enjoy a uniform trading experience.
This requires a system that understands the regional nuances as well as the specifics of the market. For example, it needs the ability to create synthetic order types on exchanges where an order type is not supported.
Achieving consistency on a global scale with reliable performance is harder still. Historically, firms have tended to view performance in one dimension – like a 100m sprint – chasing faster speeds, sometimes at the expense of other factors. But as execution has become commoditised, other factors have come to the fore.
Firms are realising that execution is in fact a multi-discipline event, more akin to a decathlon. Yes, speed is important: you’re not going to win unless you can run fast, but a successful decathlete needs to be much more rounded, able to outperform in a number of different disciplines.
Brokers are starting to treat execution performance in a similarly multi-dimensional way. The ability to be on time every time is far more important than the ability to be fastest on the field under time-trial conditions. If some orders take tens of microseconds and others take thousands, then it is impossible to define a reliable execution strategy. Latency needs to be consistent, regardless of throughput.
Latency measures must also take into account the entire process. For instance an order can't go to the market without undergoing risk checks. A market gateway that takes a couple of microseconds is of little use if the risk checks in front of it amount to several milliseconds.
Reliability is part of the puzzle. Brokers need to be able to rely on their infrastructure day-in, day-out. A patchwork of electronic trading infrastructures seriously increases this type of risk.
Cost is another dimension to consistency. It becomes very hard to control cost when it's spread across multiple vendors. Whether or not these silos remain at the organisational level, there's huge scope for reducing fixed costs by collapsing them at the technology level.
And control is crucial. Historically, many brokers have wished to deploy their own competitive differentiation around their electronic execution desks. Unfortunately the proprietary nature of these services has led firms into either having to build out their own execution layers or build multiple connection points into third-party systems. This calls for the ability to plug these services into a single control surface so that their competitive differential is maintained without the exorbitant cost of managing the market access complexity.
A new foundation
Many brokers – scale players in particular – will soon find themselves struggling if they fail to act. Those that don’t adapt will be smothered by a perfect storm of cost, regulation and inefficiency.
While the commoditisation of the execution layer means that it is the innovation on top that affords the real competitive advantage, failing to get execution right will render this impotent. Commodity or not, powerful, comprehensive, reliable, smart and consistent execution will remain a crucial ingredient for those firms that truly want to compete on a regional or global scale.