The speed and volume of financial information is exceeding all forecasts. Investment institutions are facing the need to significantly invest in their trading and processing infrastructures with ever dwindling budgets. Firms will not only need to find the right speed, size, and price fit to remain financially viable, but they will need innovative solutions that add more value to each trade. We ask the experts their POV on the necessary steps for gaining that crucial competitive advantage.
Robert Hegarty, Managing Director, Securities & Investments Group, TowerGroup
Rob, what is the smart strategy for 2006 into 2007?
There is no question that firms are frantically rebuilding and re-architecting their underlying technology (infrastructure, feeds, data distribution platforms) to increase capacity, reduce latency, and improve reliability. Throughout the contraction that began in 2000 and lasted several years, most firms neglected their technology foundations, instead cutting costs and making only cosmetic improvements to their systems. This strategy has now come home to roost in the form of weakened foundations upon which many of their systems – particularly trading systems – have been maintained.
What is the biggest trap investment firms fall into when seeking to
rebuild their underlying infrastructure to accommodate new speed and
size demands?
When investment firms attempt to cut corners to either save costs or compress the time to market. Because the infrastructure rebuilds have little tangible benefits to the average business user, they tend to misunderstand the business value they provide, leading firms to shorten the projects and become more tactically focused. Infrastructure rebuilds are strategic in objective and need to be managed as such, including by the business lines.
Speed, size, or price? Pick one.
Speed has to come first. If a firm is not in the game, it must get in the game fast. It may cost a few bucks more but when costs are cut, well, consider my answer to the previous question. And size is irrelevant. If a firm has the fattest pipe on the block but it runs inefficiently, it is still behind the curve.
What advice would you give investment firms on adding value to each
trade?
Remember that we are in the middle of the tipping point for the movement to electronic trading. If your firm is time-dependent on trading, you have no choice but to invest in speeding up your infrastructure. The time value of money has never been more apparent than in today's electronic trading arena. And if you decide to not invest now, there is a hedge fund right around the corner waiting for you to hit the market with a slow trading system.
Jeffrey Wecker, Chief Executive Officer, Townsend Analytics, Ltd.
Jeff, what would you say is the winning strategy?
The accelerating increase in the amount of market data, news, and analytic content, as well as the demand for its delivery is without precedent. Recent growth in options volumes and automated trading, plus looming NMS and MiFID, suggest that the trend will continue. The ability to deliver timely information in the face of asset class and liquidity silo proliferation is the minimal price of entry. To compete, investment institutions will need to choose the right partners and invest in high-capacity market data delivery and trading infrastructure, as only the strongest and largest firms will survive.
What do you see as the biggest trap for investment firms?
The biggest trap is trying to do everything in-house and not outsourcing to ‘best of breed’ partners: those who have the expertise, technology, and scale to allow investment firms to focus on servicing their clients and adding value without having to worry about infrastructure.
Can you answer the speed, size, or price question?
As a technology provider we measure ourselves by how well we provide our clients with the fastest possible connections, offer access to destinations and tools to get the best price, and offer functionality to optimize size. Our customers span the gamut and each employ differing strategies. What we do is provide products and services that allow total flexibility.
What about adding value to each trade?
There are some phenomenal electronic tools worth looking at in the marketplace. Investment firms should explore the latest technology, which can do some amazing things. If you are not investigating electronic trading tools and analytical services, now is the time to do it!
Jeff Hudson, Chief Executive Officer, Vhayu Technologies
Let’s go to Jeff from Vhayu. What's your view on strategy?
In order to keep pace with trade volumes that are predicted to double annually through 2008, investment firms will need to deploy event processing data solutions, which rely on an in-memory database that simultaneously can analyze and store massive amounts of ticks. Regulatory mandates such as Reg NMS and MiFID will cause market structure shifts that will further drive down trade sizes as orders become increasingly fragmented across liquidity centers. The rise in algorithms is another factor that is expected to drive trade and quote volumes through the roof. Relational databases are too slow and not scalable enough to accommodate gigabytes of intraday data effectively to maintain a competitive advantage.
What is the mistake you often see investment firms make when trying to accommodate new speed and size demands?
Proprietary systems already exist within many institutions that attempt to capture, store, and analyze tick data. Most were built on top of relational databases and require a large amount of additional hardware to scale. In-house development efforts are costly, time-consuming, and require significant intellectual and technical resources. Vendor solutions are plentiful and most can outperform legacy homegrown solutions. A number of institutional brokers offering algorithmic trading are replacing proprietary analytics engines in an effort to reduce latency in this time-sensitive market.
And your view on speed, size, and price?
It differs by the type of order a trader is working. Large complex orders require more manual intervention with emphasis usually placed on size. Algorithmic trades have different strategies, but the most prevalent is still VWAP, which relies on price. Many of our brokerage customers are taking VWAP to the next level by calculating on a tick-by-tick basis and capturing the VWAP only during the time the order is being worked for a more precise result. In effect, it is a way to achieve real-time transaction cost research.
What do you recommend for adding value to each trade?
A powerful differentiating tool for brokers looking to add value for their customers is the ability to capture every tick of data – including full depth of book data across market centers – and store the data efficiently. This is especially true now that execution costs are being decoupled from research. Brokers who can deliver time interval VWAP reports, calculate real-time TCA, and create best-execution snapshots against every market center's top of book will have a stronghold on order flow.
John T. Powers, Chief Executive Officer, Digipede Technologies
Hi John, what would you say is the smart strategy for '06 into '07?
Invest in your comparative advantage; buy, automate, or outsource the rest. Too many development shops are recreating the wheel. This industry has a huge ‘not invented here’ issue based on each company’s belief that it has to be smarter at everything than its competitors. No company is smarter at everything. Find your comparative advantage, and then be smart enough to find good partners for the rest.
What about the biggest trap?
By far the biggest trap is companies trying to build pieces of their own systems that they could easily buy and integrate instead. Five or 10 years ago it might have made sense to build distributed computing software in-house; today, that makes no more sense than to design and manufacture your own CPUs. But at least one big bank I spoke with is putting valuable internal development resources on a project to build a new grid-computing platform from scratch. We’ll see how that works out for them next year! On the other hand, another CIO identified at least four application-specific grid initiatives in his company. He called a halt to all of them and standardized on a commercial solution that could support them all. Now his developers are working on finance, not infrastructure.
Which one: speed, size, or price?
Speed. Size without speed means you lose a little on every deal, and make it up in volume. Price without speed or size means you save on your purchase, and your competitors out-trade you. You can lose more on a single trade than you save on your entire infrastructure. But with speed, you out-analyze, out-price, and out-trade your competitor.
What would you say is the best way to add value to each trade?
Better trading analytics add value like nothing else. If you can put computing horsepower to work on trading analytics, you can identify new trading opportunities, increase liquidity, and reduce the cost of trading by improving the efficiency of order fulfillment. One big fund manager, for example, by moving its entire trading platform onto a grid, was able to use sophisticated analytics to identify trading opportunities – especially opportunities to segment large trades into smaller ones quickly, avoiding big price impacts.
Greg Johnson, Chief Executive Officer, Xenomorph Software Ltd
Greg, the winning strategy?
Those systems that can effectively combine high-performance analysis of both real-time and historical data are going to be the winners. In other words, instead of real-time data management, investment firms should be considering ‘all-time, all-data management.’ Algorithms are moving on from simple price/volume analysis such as VWAP to algorithms that combine real-time and historical data, statistical analysis, complex data such as surfaces and curves, pricing models, and static terms and conditions data across all asset classes. All of these aspects must be brought together with high performance and ease of use.
What is the biggest trap investment firms fall into?
Investment firms still attempt to use pure relational database technology to accommodate both the query and storage needs of real-time data management. Usually it takes firms about six to 12 months of internal development effort to discover that this type of technology is not appropriate, and then they have to rethink their ideas.
Speed, size, or price?
Speed. There are a number of different ways in which institutions should measure speed. Firstly, the most obvious dimension is the technical performance aspects of speed such as the rate at which data can be saved in real-time and retrieved, queried, and used to trigger notifications and actions. Secondly is the speed with which real-time data management infrastructure can be installed and configured to be useable by the trading and quant staff. Installing real-time database software is not the same thing as delivering a real-time data management infrastructure that adds value to your business: it may take many months and sometimes years before the end consumer is able to use the system functionality and before money can be made. Finally, the speed with which new ideas can continually be tested and implemented is vital given the pace of innovation in the market. If your quant and trading staff cannot quickly change the algorithms and analysis involved then they may waste time in endless discussions with technology experts. Wasted time means a less profitable and competitive business.
What is your advice on adding value to each trade?
The biggest initiative we hear from clients and prospects is to go cross-asset when developing new trading strategies. Developments in the market such as credit derivatives are producing new relationships across all asset types. As a result these profit motives are breaking down some of traditional business, operational, and technical barriers to having a single data analysis infrastructure for all assets and all data types. So my advice would be to choose your technology for cross-asset trading carefully, as it is too easy for both internal development and vendors to state, ‘We support all asset classes.’ The business reality is often disappointingly different from both the marketing hype and the sales promises!
Kenny McBride, Managing Director, Securities & Capital Markets, Microsoft Corporation
What's your view on a winning strategy Kenny?
Ease of use. The software industry is rapidly progressing from a software licensing business model into ‘software as a service.’ The key issue for all firms – buy side, sell side, and utilities – is making access to services and products easier. Acquisition and deployment have traditionally been cost prohibitive, with technical deployment and integration the largest roadblock to achieving the ROI now demanded in this technology-dependent industry. Anything that improves the experience for the customer, employee, and operations is the smart strategy.
The biggest trap?
The biggest trap is not embracing change quickly enough. In the front office, the mantra among traders is ‘the first cut is the cheapest.’ When your position is wrong or you have made an incorrect investment decision, get out as quickly as possible and regroup. In the world of IT, too many firms look at previous investments and attempt to incorporate previous technology investments into tomorrow’s solution. The complexity and cost of integrating legacy environments into a vision to address the industry’s needs of today and tomorrow is a rat hole that far too many IT executives embrace. Software bias and emotional ‘religious’ debates often cloud real business necessities when radical change is needed. Software is now a core business of any financial institution and should be treated as such. IT is no longer a support function. Every IT department has to survive on its own merits and not expect the business units to address the budget or monetary shortfalls that arise through mismanagement or blinkered IT selection.
Speed, size, or price?
Size is irrelevant. Institutional firms rely on transparency, the basis of which is speed and price. Speed and price affect every aspect in the financial markets of the modern world. Through physics and engineering, we will continually address the speed and latency problems, which in turn create further dependency. Today, algorithmic trading has become something of a self-fulfilling prophecy. The more Wall Street adopts algorithmic trading tools, the more it depends on them to cope with their consequences. Speed and price is also reflected in IT and software development. The ability of any firm to create and produce the next application/product/service quickly and at a price that is competitive is more important than ever as the market continues down the path of commoditization.
What advice would you give investment firms on adding value to each trade?
The experience economy is fully with us. Front, middle, back, and IT office strategies must embrace and reflect this change. The customer is becoming more powerful as a result of technological capabilities and the transparency the Internet provides. Firms must be adaptable to customer demands but produce solutions in anticipation of needs rather than demand.
Steve Semenzato, Chief Executive Officer, ClusterSeven
And let’s go to Steve. What’s your advice on strategy?
Smart system strategies will unite rapid product development and market testing environments with cost-effective volume processing for risk and settlement. All new products start life as potentially high-value opportunities. Some will peak early and then fade away, some will become mainstream with high volumes but lower margins, and others will never become commercially successful. The architecture of trading systems must address this ‘Darwinian’ process of evolution and extinction rather than plan for the status quo. Spreadsheets play a critical role in the early stages of this process because of the speed and efficiency with which innovators can structure new products. This role is often overlooked because it can be difficult to admit how much value a low-cost desktop software product is creating for the business. Smart strategies will, therefore, promote the use of spreadsheets as strategic business infrastructure – provided that they are controlled and integrated into standardized business processes.
The biggest trap for investment firms?
The temptation in any new investment firm is to create an infrastructure that can address all current and predicted needs and eliminate many of the informal or less-controlled information environments, with spreadsheets being a primary target. In practice, the ability to adapt to future developments is a far more valuable capability than trying to predict and accommodate future requirements. Spreadsheets are one of the most adaptable tools in financial software. The trap, therefore, is the desire to eliminate the spreadsheet. Instead, its strengths should be exploited and its weaknesses mitigated. Solutions now exist that provide an operational risk management environment with the ability to integrate this auditable, validated data directly into central systems.
Speed, size, or price?
Speed is definitely the most important. To maintain their competitive edge, investment institutions need to be quick, nimble, and flexible in order to get their new product in the market first. Again, this is where spreadsheets become essential as they enable the traders to experiment with the more complex trades and produce results fast.
On adding value?
Added value comes from the innovation and drive residing in the top-tier minds of the organization. The challenge is removing the obstacles that prevent the use of this mental horsepower while applying sufficient controls to prevent abuse. Too often the control processes force value to be lost before the ideas can reach the market. The use of controlled, integrated, and strategic spreadsheets maximizes the value-add that can reach the market and generate profit.
Jeff Shoreman, Chief Operating Officer, Eze Castle Software
Jeff, what’s the best strategy for this year and next?
To compete in the marketplace, investment firms will need enterprise architectures that are both flexible and scalable. This is becoming increasingly true with the growing complexity of investment strategies through globalization and asset class coverage; the speed and volume of financial data; and the increased need to tightly integrate disparate systems along the lifecycle of a trade.
The biggest mistake investment firms make?
Investment firms often underestimate the depth and breadth of the changes that are needed to modernize their infrastructure. To avoid this pitfall, firms must clearly define and maintain their enterprise architecture and then apply the right technology and resources to it. Instead of simply reacting to market demand, today it is imperative that investment firms balance their core competencies (research, portfolio analysis, trading) with the challenges of real-time technology (functionality, scalability, integration). Strategic partnerships with key financial technology providers will emerge as an important strategy as investment institutions build out their enterprise architectures.
Speed, size, or price?
All of the above. The optimization of speed, size, and price really depends on the particular investment strategy, but all three are critical. To support these added speed, size, and price requirements, more transparent statistics and analytics are needed. This requires architecture with the scale and flexibility to handle the expected explosion in data.
What about on adding value to each trade?
Adding value to each trade requires that the right information be available at the right time along the entire life cycle of the trade: pre-trade, during execution, and post-trade. The flexibility and ease of integration afforded by service-oriented architecture-based infrastructures allows for dynamic, real-time updates of data across multiple systems, both third-party and proprietary. For the first time, all of the information about an order can be condensed into a single blotter view for both analysis and action.