Human and Machine-Rise of the Cyborg: The Cycle of Voice Trading

Celent has explored voice trading in Human & Machine-Rise of the Cyborg: The Cycle of Voice Trading, published yesterday. In this piece, we look at the power of voice trading as well as the business drivers, challenges and forces that are driving change in voice communication, collaboration and voice market engagement.

Celent believes that voice is a key channel that will remain relevant and will work more seamlessly with electronic and data channels in the coming years. A move toward unified communication approach and advances in technologies, combined with a challenging business environment, are reshaping the modern trading desk. Cost cutting, front office effectiveness, gleaning better insight into customer behaviour combined with digital automation are pushing this frontier forward. Voice trading remains the major channel for transferring risk, across asset classes, yet remains a challenge due to the difficulties in leveraging this unstructured data set.

Advances in both preparing and leveraging data for advanced analytics are creating a demand for business insights-the demand for better data is ever growing. Firms are beginning to leverage advanced data tools for not only risk mitigation and regulatory requirements, but are creating front office opportunities for better counterparty engagement and communication.

Fintech continues to advance in the capital markets and the implications are profound for incumbent players. Firms that effectively leverage the full spectrum of innovation available are becoming more streamlined and more effective. The overarching need for business model evolution and the importance of technology in the markets continues to ramp up. As one example,last week alternative dealer Citadel Securities hired Microsoft COO to be the new CEO of it electronic market making business.

We are surrounded by advances in voice technology for interacting with machines in our life in general. We are getting comfortable with Apple’s Siri on mobile, and Amazon's Echo in our homes. Similar technologies have advanced in areas outside the capital markets, but leading firms are trying to leverage voice data for better insight, engagement, and automation. While we are nowhere near Robotic Stingray Powered by Heart Cells from Rats published in last week’s WSJ, in merging machine and biological elements we are heading more into an era of the cyborg-where capital market participants will increase their direct engagement with machines via voice interaction.

Intra-IDB part II: The ICAP to eCAP deal

Where there is smoke there is fire and the proposed outline for a deal which I discussed in my blog this weekend was announced today.  Long time rivals  in the inter dealer broker (IDB) space Tullett Prebon and ICAP are coming together with Tullett buying ICAP in an all-stock deal. Tullett will now be the 800 lb. gorilla of voice brokering, with about 1500 ICAP brokers  going to Tullett as part of the deal as well as another 1000 employees. The deal will also include certain electronic assets like  ICAP’s 40.2% ownership in iSwap (IRS) , certain JVs and as well as the not clearly defined information services revenue. The details of the deal terms, economics and structuring are discussed in the press release and the analyst presentation. I will focus on certain key points of the deal looking at the ICAP side. ICAP has followed a strategy of acquiring growth and putting together an impressive portfolio of front to back  technology assets. Historically, its main challenge in maintaining the voice business was not only the lower margins, and slowing environment for many of the products traded  but the internal competition between its voice and electronic channels. The electronic businesses have not grown as they should, had this internal friction not been present. This is the case across asset classes. But, as they say, better late than never, and ICAP is on the road to becoming a different company. The new ICAP (let’s call it eCAP) will include: • FX venue EBS and the related EBS businesses • Treasury exchange BrokerTec • Post-trade and processing companies TriOptima and Traiana which serve across asset classes with a focus on FX, rates and credit • FinTech incubator Euclid which has been active in making strategic bets for the firm • Tullett will have the right to the ICAP name What is not entirely clear at this point is what “information services” will remain with eCAP. Given the importance of market data, a detailed understanding of the  value of  eCAP will be a function of whether certain market data assets like data from EBS and BrokerTec will remain with eCAP. Furthermore, it will be interesting to see if the eCAP has the right to compete in interest rate swaps, or what its plans will be to develop an electronic platform for IRS given the loss of iSwap. I would imagine, given the importance of interest rate swaps in the rate world that the new firm will want to have a robust offering in this area. In sum,  eCAP will be a lean technology, execution, venue, tools, pricing, and analytics company. Of course, eCAP will still have a vested interested in the voice business as it will hold about 20% of the newly issued Tullett stock.      

MiFID II on the minds of fixed income leaders

I am getting excited about participating and speaking at the Fixed Income Leaders Summit in Barcelona, Spain this week.  The timing could not be better; the fixed income world is grappling  with the challenges of an evolving market structure, innovation and technology, all within the context of a recently delivered regulatory MiFID II/MiFIR proposal. I am looking forward to hashing out the most pressing challenges facing the market, with the best and brightest leaders from all corners of the fixed income world. In advance of the conference, the European Fixed Income Industry Benchmarking Survey 2015, surveyed 50 senior buy side leaders to get a sense of their focus. The primary challenges  identified, include: the evolving center of gravity in the relationship between the buy side and sell side; digesting and understanding the regulatory framework and MiFID II guidelines: and, engaging with the changing landscape of sourcing data and electronic trading. Celent is very focused on the evolution of the fixed income business within the context of evolving market models, data aggregation/analysis and regulation.  We continue to discuss these topics in our ongoing research. I am especially eager to participate in discussions  around requirements for quoting and new reporting requirements that will impact the buy side. I will also be discussing the evolution of trading tools and electronic trading-looking at the landscape of trading platforms, new analytical tools for accessing liquidity access, and creating a holistic approach with engaging with the market across products. I look forward to catching up on all these topics. Please come by and see my session on market structure and electronic trading tools at 11:45 on Thursday in lovely Barcelona.

MiFID II and you – here before you know it

A brief review indicates that ESMA has given more clarity on its view of fixed income trading in the post-MiFID II world. We are now one step closer to a new world of secondary trading in European bonds. In the context of the heated debate around liquidity in fixed income recently ESMA has moved to an approach that looks at each bond to determine the liquidity thresholds and hence the exact nature of the required pre- and post-trading transparency. ESMA will be looking at 100,000 Euro thresholds with at least two trades occurring daily in at least 80% of trading sessions. Hence, a certain proportion of European bonds will become subject to a wholly new regime of trading-scheduled for January 2017 if there are not additional delays to the start of MiFID II. Bringing a new level of transparency to the pre- and post-trading of fixed income products, in conjunction with the myriad other touch points of MiFID II, will stretch the resources of most financial market participants. While firms have been preparing for some time, there are different degrees of readiness.  For most firms,  the next year will be huge effort, to get ready for this new trading regime.

The future is here

The pressures are well known in banking and the capital markets. Each month there are front page articles of scaling back, overhauling, reorganizing, or closing major bank lines. A continued reworking, a forging of a new business is occurring. Old models are shrinking and being replaced by new business models or being cast aside. Since the 2008 crisis, wave after wave of pressure has made this perfectly clear. Capital constraints, on-going regulatory pressures, and an ultra-low interest rate environment have all struck hard at the existing banking & broker/dealer system. Nearly all players-big and small- are rethinking the very core of their businesses. And this is a multi-threaded problem across all businesses: equities, FX, fixed income, and derivatives. Banks and broker/dealers are trying to balance their existing franchises against the pressures they are facing to create a lean profitable business that supports their clients. There are no easy answers, given the strong interdependence between the wealth, asset management, and capital markets businesses across all products. Many of the solutions are moving from efficiency, or cost-cutting to effectiveness. Costs are being cut-there are improvements in risk, compliance, processing. The cost side is getting better but the challenge remains on the revenue side. This drive for effectiveness is driving business models that support internal and external clients from a compliance, transparency, regulatory, fairness and cost perspective are driving more automation and electronic trading solutions. Celent will be discussing the evolving landscape of innovation in automation and technology at two upcoming roundtables. On September 15th in London we will be looking at changes in the US and European fixed income markets and how new technologies are driving change. Then on September 22nd in Zurich, we will be looking at wealth management and the capital markets and the many changes that are occurring in Swiss banking.

Billions, trillions-actually it’s quadrillions

I am going to start today’s blog post with a short quote from Blythe Masters who was presenting last week at a conference on digital currencies, where she was reported as saying, “It should be fairly obvious that the addressable market for this technology is absolutely gigantic. We’re talking markets that are measured in the trillions, not the billions.” Actually, the dollar value of securities transactions processed each year is measured in the quadrillions. That is the first time I have used the word “quadrillion” in writing but I think I will be using it a lot more in the coming months. The market sizes for possible disruption in capital markets by distributed ledgers/ blockchain technology are absolutely staggering as is the breadth of impact on lowering costs, freeing up capital, reducing counterparty risk, introducing new financial services players, and managing the systemic risk of our financial system. As mentioned in an earlier blog post, we are starting to see different approaches to distributed ledger/ blockchain technology emerge and, frankly, there remain a number of challenges to implementing the right architecture for this technology. However, when you are talking about markets measured in the quadrillions then the financial incentive to innovate and navigate these challenges is arguably larger than any financial incentive in history. Incumbent financial institutions have got to be on the front foot when it comes to understanding the potential impact on themselves and the ecosystem they’re a part of.

Lessons of Bondcube

We have been following the development of Bondcube since early 2013 after its foundation in 2012. Founded by CEO Paul Reynolds and CTO Mark Germain, Bondcube had a unique vision to support trader workflow in fixed income to support greater liquidity in the market. While many FinTech start-ups focus on B2C and the client experience, Bondcube was squarely focused on B2B and workflow support for traders. While Bondcube leveraged new Web 2.0 capabilities such as chat and tracking, it was essentially a new tool for an existing audience with the vision created from former industry insiders trying to create something new. The central idea was that Bondcube could revive large order execution, minimize the market impact of search, and be disruptive to existing marketplaces like MarketAxess, Bloomberg and Tradeweb. It planned to optimize trading via chat and by leveraging historical inquiries. We understand it was marketed at zero cost to buyside and (relatively) cheap connectivity for dealers. Bondcube decided to focus on both the Europe and the US, like existing competitors. An investment by Deutsche Boerse AG suggested that Bondcube might have some legs to build traction, but today’s news on liquidation suggests that further funding was needed and the shareholders declined to do so. Brad Bailey is compiling an updated report on the platforms in the market today, but this is clearly a sign that the market is still sorting through the various ideas and that incumbency (and inertia?) still has great value. Also, sometimes the market asks for change but then does not actually adopt the change it’s clamoring for. All too often the buy side says “Yes! Yes!” but does not adopt new options rapidly, but only after long trials and testing. Capital (and patience) can disappear before the testing and optimization process is complete.

Hedge funds/ asset managers continue to find opportunity in capital markets and shadow banking

Citadel announcing this week that they will become a dealer of US treasuries becomes another proof point that hedge funds continue to take on sell-side market making activities filling a growing liquidity void in credit and loan products. Although Citadel has no desire to become a primary dealer at this point, it will hold substantial dealer inventory to meet client demands. Citadel’s broker dealer arm will handle this business as it already does with equities and FX. This continues the trend that as Western banks both in the US and Europe are required by regulators to reduce their balance sheets, hedge funds, asset managers will continue to full fill the supply side of this demand vacuum. We already see this as an increasing number of hedge funds are building portfolios of syndicated loans, private equity and real estate. Also a few hedge funds have started the securitization of mortgages and loans even to the point of securitizing and packaging “peer-to-peer” debt. The main point is as bank balance sheets shed high demanding RWC products, hedge funds and asset managers will move into supplying these products. Increased liquidity will be provided and an increase of revenues for hedge funds and performance returns for asset managers. But at the same time regulators will increasingly focus on these “shadow banking” activities, demanding hedge funds and asset managers to up their game managing market, credit and operational risk. This is all good but also means hedge funds and asset managers will need to continue to upgrade operations and systems in order to satisfy client and regulatory transparency demands. As one business shrinks another’s grows. For more on shrinking balance sheets see Oliver Wyman’s The Wholesale and Investment Banking Report.

All MiFID, All The Time

I just spent a week speaking to many of Celent’s UK based clients.  I was surprised by how high MiFID II was on everyone’s agenda.  Whenever I posed the question—what are you most interested in discussing? The answer was firmly-MiFID II.  The response was typical for the entire client spectrum: buyside to sellside; venue to infrastructure provider; vendor to regulator. It was most apparent regarding anything fixed income, given the potential magnitude of change coming to those markets. It is interesting to note the divergence, from a fixed income perspective between the US and Europe. On the US side, we have been discussing the evolution of fixed income markets-the gradual pace that occurs as a function of a naturally changing environment. Generally, change is slow, but sudden shifts to the established environment can occur. In a similar vein, think of the Cretaceous period-80 million years with incremental natural selection occurring over vast time frames but ruled by dinosaurs.  Of course, during those long periods of time stresses occurred that accelerated the process of change. In the US fixed income market, those stresses come from dealer decreasing balance sheet, transition to alternative liquidity, buyside flexibility, rise of new venues, QE, and, ever restrictive capital/regulatory regimes. By contrast Europe, where under MiFID II, slated for implementation in the next 18 months, market participants are looking at a major shift in the climate. Implemented as currently written, MiFID II will be a radical remapping of trading across the universe of FI products-an asteroid, plummeting into the Gulf of Mexico-ending the cretaceous period with a “bang”, and life/trading as we know it.  Of course, we know how that story plays out – the dinosaur die off made way for those nimble, tiny creatures to find their way and-well, become the established order.

Lack of liquidity in corporate bonds – (un)intended consequence of low rate policy

I was at the Fixed Income Trading & Investing Summit conference earlier this week listening to many perspectives on the fixed income market, particularly corporates. The themes of market structure, liquidity (or lack thereof), regulation, electronification, and new entrants in the space pervaded all conversations, formal and informal. Reflecting on the state of the US corporate bond market, it is difficult to reconcile record new issuance, and record levels of bonds outstanding, with the drop in major dealer inventory by 80% from pre-crisis levels to present. This lack of dealer inventory was recently discussed by SEC Commissioner Daniel Gallagher. In March, Gallagher said that the drop in dealer liquidity could cause “systemic risk”.  The SEC is bringing to attention the possibility of a liquidity crisis, perhaps sparked by an eventual rate rise. However, one of the main reasons that dealer inventory is so low, is the evolving regulatory and capital regime make it much more expensive to maintain risk assets on balance sheet. In a sense, an unintended consequence of the low rate policy is potential dysfunction in secondary bond liquidity. Arguably, certain policy makers might have intended to move secondary trading of corporates away from major dealers, as part of general strategy of de-risking the financial system, or at least, as a means of transferring assets from dealers to the buyside. The SEC is now looking carefully at how to deal with the liquidity issue; they seem to desire that the industry offer innovative solutions for providing secondary trading. This liquidity can come from traditional dealers and alternative liquidity sources such as the buyside, or other types of dealers and expanded electronic resources.  We are at a juncture in the evolving market structure of corporate bonds. The goal should be for the industry to find the right level of incentives for the dealers to make markets, engage the buyside and their needs, and leverage innovative technology to fill the gaps.