Buy-side opportunities and sell-

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					                                                                                   SPONSORED ARTICLE           l   COGNOTEC

       Sponsored by

         Kieran Fitzpatrick
         Director of Strategic Solutions,

         ClientKnowledge’s recent
                                            and sell-side
         report1 on the outlook for
         the foreign exchange
         market, and the
         technology which drives it,
                                            ClientKnowledge overwhelmingly found             Technology is at the heart of all these
         predicted massive rises in
                                            that the foreign exchange market is          developments, a point recognised in a
         both the size of the
                                            experiencing huge expansion. According       recent report issued by the Foreign
         market and its
                                            to its recent report, banks’ technology      Exchange Committee2 on the market
         participants’ technology
                                            spend of around $400 million annually        impact and best practice
                                            on ecommerce components will almost          recommendations around automated
                                            double by 2010. In addition, while the       foreign exchange dealing.
                                            proportion of client volumes traded              The challenge for banks can be
                                            electronically is currently around 50%,      summarised under three broad areas:
                                            this is set to increase to around 75% by     1. The need to support the projected
                                            2010 when the foreign exchange market            rise of electronic transactions whilst
                                            is expected to see volumes of $3 trillion        driving down the institution’s human
                                            a day (up from $2 trillion at present).          and processing costs.
                                                                                         2. The need to improve and protect
                                            Behind the headlines                             the institution’s net trading revenue
                                            Lurking behind these big numbers are             from competition in the marketplace
                                            the many investment choices banks will           in the form of new services and
                                            have to make in order to remain                  reduced margins
                                            profitable participants in the ever-         3. The need to improve and protect the
                                            changing foreign exchange marketplace.           institution’s own trading position from
                                            The need to adapt and respond to clients         predatory market participants
                                            who are becoming more sophisticated
                                            and more demanding of their banking          While achieving these aims, banks have
                                            partners, the growth in cross-border         to ensure that their technology spend
                                            trading and the trading of foreign           represents the best return on investment
                                            exchange as a discrete asset class which     and accurately targets the needs of the
                                            has introduced a new breed of trader         organisation. This is best expressed in
                                            into the marketplace all serve to increase   terms of striking a balance between
                                            the pressure.                                building business share versus protecting                                                                                  JUNE 2006            FX&MM      l   29
SPONSORED ARTICLE                   l    COGNOTEC

         the organisation from competitive            Executable Streaming Rates                          Banks who have been slow to
         elements, as well as having an eye to the    major driver                                    update their pricing engines have
         continuously evolving technological          As can be seen from these two lists, in         experienced pain in the open market –
         landscape. As ClientKnowledge puts it:       order for the sell-side to meet the             either resulting from the distribution of
         “The challenges implied by the venues        requirements of the buy-side there is a         ‘off-market’ prices, which have cost them
         and modes of trading and distribution        need for institutions to invest in their core   dear in terms of aggressive hostile
         required of banks to achieve and             technology infrastructure to facilitate fast,   trading, or because they have been slow
         maintain profitability oblige wide-scale     accurate and also scalable solutions. In        in comparison to true streaming rates
         revision of the infrastructure already in    addition, extended functionality such as        and have lost out on business. On top of
         place at most firms and a limited life-      margin trading capabilities, advanced           this, banks have found that the cost of
         cycle of any solution implemented.”          portfolio analysis, and the capability to       dealing with its own customers has
                                                      revalue all trades and exposures across a       increased in line with the increase in the
         Buy-side opportunities                       bank’s order book to enhance risk               number of price distribution channels.
         For the buy-side this is a period of         management and minimise the creation                The answer to this conundrum
         opportunity and increased choice. Multi-     of arbitrage opportunities, will be             has been the development of true
         bank portals have opened up bi-lateral       essential in order to protect the               streaming models which distribute
         trading relationships to competition while   organisations’ own activities.                  live, executable prices from the
         giving clients the choice of how and             If it were necessary to isolate a single    beginning of the trading process. As well
         where they wish to trade. Whether this is    factor which will prompt banks to invest        as enabling one-click, guaranteed prices
         via the bank’s e-commerce-enabled            in their technology infrastructure going        to end-users, for the dealing desk, the
         online trading system or portal, more        forward, it is the introduction of              true depth of the market can be
         efficient price distribution and discovery   executable streaming rates. Though it was       observed, while safety features such as
         has meant that labour-intensive manual       around ten years ago that telephone-            hit protection mechanisms can be
         processes are fast disappearing on both      based dealing was widely replaced by            employed automatically. Further, changes
         sides of the transaction. The                online trading, automation of the banks’        in market conditions are reflected in the
         opportunities for the buy-side can be        front end usually wasn’t matched by an          prices distributed by every one of the
         summarised as follows:                       upgrade in the automation of price              bank’s dealing channels – with next to
         1. Executable streaming rates will           discovery. In most businesses, both             zero latency.
             enable one-click dealing with            systems tend to have been based on                  In this model, both the buy and sell-
             guaranteed prices available at           Request for Quote (RFQ) technology              side benefit from true STP – with
             multiple locations                       where a price is generated on a demand          transaction details automatically fed back
         2. Growth in algorithmic or ‘black box’      basis, and then held for a period time          into the bank’s order book and the
             trading: new generation pricing          before a new price is generated in              client’s back office. Therefore, while the
             engines allow proprietary desks or       response to a customer enquiry.                 responsiveness of the bank’s dealing
             hedge funds to input historical price        The advent of online portals such as        desk is significantly enhanced, the cost of
             information and formulate new            FXall created the need for banks to             dealing can be reduced in line with
             trading models                           provide streaming prices. However, most         efficiency savings, a benefit which can
         3. Trades will be completed with near-       banks responded to this by creating what        also be shared with the client.
             to-zero latency and transaction          appeared to be a stream from the dealer
             information reported via straight-       side based on RFQ information. Thus the         Bang per buck
             through processing (STP), reducing       front-end appears to deliver streaming          In the near future, while the buy-side will
             risk and increasing efficiency           prices, but is actually driven by outdated      have an increased range of services from
         4. All this will be provided in an           processes. In doing this, RFQ price             which to pick and choose, the sell-side
             enhanced environment with access         engines have become stretched beyond            will have important investment decisions
             to news, research and charts             the task for which they were intended.          to make. Banks will need to ensure that

30   l   FX&MM       JUNE 2006
                                                                                            SPONSORED ARTICLE             l   COGNOTEC

       their investment in technology delivers to     one or a range of bank partners via a
       the speed of distribution, accuracy of         white label arrangement, thus further
       pricing, integration strategies and can        enabling efficiency benefits while allowing
       meet the needs of new and emerging             the bank to focus on its core currencies.
       market participants, while allowing the            Thirdly, investing now will allow banks
       dealing desk to defend itself from hostile     to develop new platforms to target new
       market participants. Of course, these may      client groups of whom they may have
       be two sides of the same coin. Hedge           little direct experience, but for whom they
       funds for instance offer banks attractive      are already making markets via online
       high-ticket trading business, however they     portals. The ability to offer advanced
       may employ black box trading models            trading functionality such as ‘click and
       which enable them to take advantage of         deal’, margin trading, charting, research
       a bank’s ‘off market’ prices in seconds.       and analytics enhances such offerings.
           In such a complex environment, the         This ability to cost-effectively offer an        Kieran Fitzpatrick
                                                                                                       Director of Strategic Solutions,
       old choice of ‘build or buy’ no longer         appropriate solution to each client
       applies for banks who are determined to        segment (and one which offers the
       carve out their niche in the competitive       ability to manage the appropriate spreads       ‘‘In the near future, while
       landscape. Banks who select a                  and risk management for each client               the buy-side will have
       technology partner to develop a resilient,     group) may well be the way forward for            an increased range of
       scalable, high performance technology          a number of financial institutions.               services from which to
       platform with the benefit of open                  Appropriate technology will make or           pick and choose, the
       architecture as a starting point, enable       break the sell-side in the foreign                sell-side will have
       them to respond rapidly and deliver to         exchange markets going forward.                   important investment
       the marketplace their own core FX              Whereas for the buy-side the landscape            decisions to make.’’
       competencies and to focus on identifying       is one of opportunity and reduced costs
       the most efficient way to meet the             of participation, for the banks it is one of
       challenges ahead.                              opportunity tempered by competitive
           This approach has several                  risks. It is investment in the right tools to
       advantages. First the bank gets tailored       manage these risks while exploiting the
       advice which allows it in turn to tailor its   considerable opportunities in the market
       range of services to specific client groups,   that will give those institutions with
       moving away from a ‘one size fits all’         foresight a key competitive advantage
       approach. Second, there is less waste, as      going forward. ■
       the bank can buy-in only the technology
       it needs and still build or integrate its
       own elements into the technology mix if
       necessary. For instance, intellectual
       property can be safeguarded because
       proprietary information such as historical
       trading information can be fed directly
       into the price engine, allowing the bank       1. ClientKnowledge – ‘FX Market and
       to retain its specific area of trading             Technology Report: The Outlook’ - June
       expertise. In addition, the bank can slim      2. Foreign Exchange Committee (sponsored by
                                                          Federal Reserve Bank, New York) -
       down the range of currencies in which it
                                                          ‘Autodealing: Market Impact and Best
       makes a market, while taking prices from           Practice Recommendations’ – May 2006                                                                                            JUNE 2006             FX&MM      l   31