New Year New Tech New Research

New Year New Tech New Research
In your new year resolutions, did you pledge to understand more the technology that scares you? Or at least the one that some people (aka analysts like me) claim will replace you? If the answer is “No” and you are working in the field of Investment Research, whether producing, consuming or distributing it, then you may want to read our latest report Start Coding Investment Research: How to Implement MiFID II with Robots and AI.

I get paid to write research on fintech so theoretically I am not the tech scared type though I am the first one to control screen time at home. I know we have more and more competition from free research you can all find at your fingertips on the internet, and from cheaper research that leverages outsourced resources crunching a lot of data, but so far we are keeping up probably because our clients think we provide insight that those competitors do not provide yet.

I know however that we have competitors that have technological platforms that distribute their technology in a more user-friendly way with podcasts and fancy databases, that write their research in a more automated way and that you can consume easily because you pull the information with selective search technology that knows what you want and how much you can pay for it.

So before the holiday season, to make sure we were all going to start this new year with the right information in hand, I did look into what artificial intelligence and robotic process automation tools will be doing to research; not exactly my kind of markets fintech research, but more specifically to Investment Research, those written recommendations about equity or bonds or macroeconomic environments to help the buy side make investments.

The result is very honestly scary and exciting at the same time. These new  technologies are maturing at a time of big regulatory change in Europe, MiFID2 is finally kicking in and that means the unbundling of investment research cost from the execution costs the brokers and banks charge their buy side clients. Some buy side will keep using them and be happy to pay that fee, some clearly will start looking at other solutions that will have to propose a different business model provided by banks or by new market players, based on technology.

In our recent report we do look exactly at that: new business models and live case studies that have already been implemented in investment research production, distribution and consumption. Enjoy.

Proof of artificial intelligence exponentiality

Proof of artificial intelligence exponentiality

I have been studying Artificial Intelligence (AI) for Capital Markets for ten months now and I am shocked everyday by the speed of evolution of this technology. When I started researching this last year I was looking for the Holy Grail trading tools and could not find them, hence I settled for other parts of the trade lifecycle where AI solutions already existed.

Yesterday, as I was preparing for a speech on AI at a conference, one of my colleagues in Tokyo forwarded me an Asian newswire mentioning that Nomura securities, after two years of research, would be launching an AI enabled HFT equity tool for its brokerage institutional clients in May –  here it is: the Holy Grail exists, and not only at Nomura. Other brokers have been shyly speaking about their customizable smart brokerage, e.g. how to use technology so that tier5 clients feel they are being served like a tier1. Some IBs are working on that, they just don’t publicly talk about it.

Talking to Eurekahedge last week I realized that they are tracking 15 funds that use AI in their strategy, I would argue there are even more than that because none of those were based in Japan (or Korea where apparently Fintech is exploding as we speak).

All this to reiterate that AI is an exponential technology, ten months ago there were no HFT trading solutions using AI, and we thought they were a few years away but no, here they are NOW. And the same with sentiment analysis, ten months ago they were just a marketing tool, now they are working on millions of documents every day at GSAM. Did I forget to mention smart TCA that’s coming to an EMS near you soon?

Stay tuned for more in my upcoming buy side AI tools report.

Invesco buys Jemstep: why asset managers are driving robo consolidation

Invesco buys Jemstep: why asset managers are driving robo consolidation
First BlackRock buys FutureAdvisor, now Invesco snaps up Jemstep. Consolidation of the robo advisor space is heating up, with asset managers leading the way. Why asset managers? Simply put, they are keen on improving distribution and reversing the erosion of pricing power caused by:
  • Their distance from the end consumer of their product (i.e. the retail investor), which has given them limited pricing leverage as well as something of a tin ear for investor needs
  • Brutal price competition in the ETF space itself
Note that this deal, as with the BlackRock purchase, is first and foremost a B2B play. Invesco wants to secure distribution for its flagship PowerShares product by harnessing Jemstep’s robust  onboarding and aggregation capabilities. These capabilities have been a differentiator for Jemstep in the robo space since it first targeted RIAs and brokerages via the launch of its AdvisorPro platform in 2014. Time to Cash Out? Jemstep’s motivations are more obvious. Despite some success in the RIA space (in part due to its partnership with portfolio reporting system provider Orion Advisor Services), the firm has been burning cash and under pressure. Furthermore, all the hype around the B2B model (as opposed to the B2C model with its high costs of customer acquisition) cannot disguise the fact that the use of digital distribution by real life advisors is a model still untested. Fundamental questions remain at play: Should robo function as a feeder system (i.e. a means of serving younger and less affluent clients? How does one integrate automated distribution with a value proposition centered on access to a real life advisor? Also, what happens when the client ages and accrues enough assets to merit face to face consultation. Is he likely to forswear digital channels and “graduate” to the (more expensive) real life advisor? It will be interesting to see what Invesco paid for Jemstep. I’m guessing in the $100 million range, but it could well be less. Schwab was able to launch its own robo advisor, and Fidelity, Merrill Lynch and others plan to do the same. Invesco may have decided to buy, but momentum is on the side of “build”. That’s among the reasons why Personal Capital hasn’t found takers for its $400 million asking price.

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

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.

Smaller buy side firms and regulation

Smaller buy side firms and regulation
Increased regulation has become a way of life in the financial markets. Buy side firms are also devoting a lot of time and energy to meeting regulatory requirements. The share of expenditure for regulation and compliance has also risen accordingly. Firms are often building their IT strategies around the various requirements arising from Dodd-Frank, MiFID II, FATCA, Basel III, EMIR and so on. In this environment, smaller buy side firms are possibly in a tougher position than some of their larger asset management and hedge fund counterparts. The reason is that they do not have the same financial and technological capability and hence have to often adopt a more piecemeal approach to regulation and compliance. Their IT systems and platforms are also not geared fully to meet these needs, and streamlining the same is often beyond the capacity of many such small firms. An interesting development that has resulted from the spate of regulations post-financial crisis is the reduced participation or even effective withdrawal of the banks from different types of risk-taking activities. This has been accompanied by the effort by buy side firms to fill some of these needs. While this is an important area of opportunity for buy side firms, it is also something they should be cautious about. The reason is that the increase in buy side activity has to some extent moved the sell side risk to the buy side. This is accompanied by some liquidity problems due to the declining sell side activity. While smaller buy side firms are probably affected less by this issue than some of the largest asset managers, nevertheless they need to ensure their risk management systems are capable of bearing any new and additional stresses that the larger systemic role of the buy side might bring. Celent is currently conducting a lot of research looking at the various requirements of buy side firms, and I am about to publish a report that discusses the specific needs of smaller buy side firms when it comes to regulation. This research would also look at some of the ways in which these firms can cope with their pressing demands, and discusses how it is important for them to stand back and take a more holistic approach to regulation.

Buy side insight for Fixed Income platforms

Buy side insight for Fixed Income platforms
Time keeps becoming scarcer and we all become more selective on what conference we will attend or speak at. But yesterday, as I was by chance in Paris, I dropped by one of the potentially nth conference on fixed income, and was presently surprised by the value of its content. Congrats to Trading Screen for pulling it off. Let me share with you a few takeaways, mainly from a great buy side panel: 1) One of the buy sides (whom we all know are the ones calling the shots nowadays) summarized his selection process for choosing a new trading platform as follows: i) Who owns the platform? A bank (negative points) or a vendor (positive points if strong balance sheet). I would add exchanges (they are neutral) and interdealer brokers (for whom it is one of the only options to remain in business) to that list, but the latter will have a challenge at connecting all the buy side. I have an open question here: why wouldn’t the big buy side invest together in a platform they believe in with Equity so that they can reap the benefits of the success they will bring to it as the banks did with Tradeweb?Aren’t they in the business of investing? ii) Buy side is not an option: if the buy side doesn’t all connect together in an automated way, the success rate of the platform will be low. (c.f. who’s calling the shots). iii) The need for an independent clearing agent from ownership and/or for the functionality to choose one’s own clearing agent. Here I actually pushed the question further as a big custodian is currently rumored to be the clearing agent of a MD2C platform’s new product: should custodians be involved, should they become agent brokers since they have the assets of the AMs (and a clean balance sheet, may I add?), or be a platform? Some people in the audience laughed at that one, pretty sad considering what some of the big global custodians have in pipe, let’s assume these were brokers who have never taken the time to understand what happens “post” trade… thankfully at least two of the big buy sides in the panel actually got my point: there could be room for some innovative matching engine to team up with custodians (Algomi?). See last year’s Celent report: Innovation in Focus: The Analytics Powering Fixed Income Matching for a comparison of the functionalities of the new matching vendors. iv) Flexibility of interactivity: the buy side has to be able to choose to interact only with each other, to exclude toxic flow, to include some banks, etc. Everyday potentially in different ways. So just a switch functionality for the other side of the trade. Some new platforms thankfully already have that in their rule book/functionalities such as Bondcube or TradeCross (Trading Screen’s 2.0 version of Galaxy). In our report we actually had mentioned the “selective multicast” capability of Baymarkets for banks to select what prices to send to what client in cascades; this is an interesting adaptation for the buy side to select who to send what interest or order or request for quote to whom in cascade or not. 2) Another point that was made was that there is no first mover advantage, this is taking time to pick up as AMs are adapting to change and regulations on transparency is not final: I could not agree more as we have been having these discussions for the past 3-4 years non-stop, and the number of professionals buy and sell side interested keeps increasing. Still, at some point the big AMs will have to jump on one ship as the cost of illiquidity is becoming too expensive for their funds’ performance (nice presentation on that from an AM quant). 3) Last but not least is the cost of connectivity to all of these platforms‎, apart from the time spent to connect to them (and to convince senior management to connect to them?). This has to be corroborated also by the lack of screen space available for new entrants, the need to come in via other or incumbent screens maybe? Or via a web browser? 4) Last interesting point which is an idea we have been pushing out at Celent for a while: the buy-side could go directly to the issuers: yes, and they already do actually, for big infrastructure projects or issues whereby they already have a relationship with the issue. A platform with both and no brokers, banks to build the book and syndicate and sustain the price? CSDs and iCSDs have a role to play here: such a platform could work with Dutch auctions or even normal auction process, but it would work more in the interest of the smaller buy side than the big ones obviously, creating a level playing field… hence hard to make it pick up… SMEs and small institutions could meet on P2P lending platforms through aggregators of interest such as Orchard though. More in an upcoming report on these… As for TradeCross‎, I still need to get a demo but we already know that it will be All-to-All (but in the flexible way mentioned above, not our old definition with CLOB and level playing field), anonymous, an MTF, trading with all-in price (commission), interest and orders, multiple trading models (did they mean protocols?), spread or price or yield trading and with a web browser if need be. No go live date as of yet.

Beyond HFT

Beyond HFT
I recently attended the Tokyo Financial Information Summit, put on by Interactive Media. The event was interesting from a number of perspectives. This event focuses on the capital markets; attendees are usually domestic sell side and buy side firms and vendors, including global firms active in Japan. This year there was good representation from around Asia ex-Japan as well; possibly attracted by the new volatility in Japan’s stock market. The new activity in the market was set off by the government’s Abenomics policies aimed at reinvigorating the Japanese economy. But I suspect the fact that Japan’s stock market is traded on an increasingly low latency and fragmented market structure gives some extra juice to the engine. Speaking of high frequency trading, Celent’s presentation at the event pointed out that HFT volumes have fallen from their peak (at the time of the financial crisis) and that HFT revenues have fallen drastically from this peak. In response to this trend, as well as the severe cost pressures in the post-GFC period, cutting-edge firms seeking to maintain profitable trading operations are removing themselves from the low latency arms race. Instead, firms are seeking to maximize the potential of their existing low-latency infrastructures by investing in real-time analytics and other new capabilities to support smarter trading. HFT is not dead, but firms are moving beyond pure horsepower to more nuanced strategies. Interestingly, this theme was echoed by the buy and sell side participants in a panel at the event moderated by my colleague, Celent Senior Analyst Eiichiro Yanagawa. Even though HFT levels in Japan, at around 25 – 35% of trading, have probably not reached their peak, firms are already pulling out of the ultra-low latency arms race–or deciding not to enter it in the first place. The message was that for many firms it is not advisable to enter a race where they are already outgunned. Instead they should focus on smarter trading that may leverage the exchanges’ low latency environment, but rely on the specific capabilities and strategies of a firm and its traders. Looking at this discussion in a global context, it seems interesting and not a little ironic that just as regulators are preparing to strike against HFT, the industry has in some sense already started to move beyond it.

Back Office Outsourcing by Buy Side Firms

Back Office Outsourcing by Buy Side Firms
In the last few years buy side firms have had to make lot of changes in their mid and back offices. There are primarily two drivers that have forced firms to make these changes. Leading up to 2007, the economic climate was favorable, and profits were rising, which meant technology budgets were also on the rise. Many firms made technology investments on an ad-hoc, or as per need, basis. Since the front office trading departments are primary revenue generators in trading firms, the technology decisions were largely determined by front office staff based on their immediate needs for certain asset class or execution methods. The mid and back office activities were largely ignored and continued to be run by legacy systems. The crisis of 2008 changed firms’ priorities dramatically. Revenues dwindled and margins were hit. In tumultuous economic climate managing costs became an utmost priority. While downsizing enabled cost cutting in the short run, firms had to consider long term cost savings opportunities by improving operational efficiency and making strategic technology decisions. Against this backdrop the mid-back office was ripe for attention. Many institutions still use legacy systems. Most of them are based on simple excels, offline communication, and handled manually without much automation. There is little integration in the mid-back office of the disparate platforms used in the front office. These create huge operational inefficiencies, and if not addressed adequately, can diminish or even nullify the efficiency gains achieved in the execution of trades. In the aftermath of the financial crisis, the regulatory environment has undergone rapid changes and is still evolving. This has created additional obligations for mid-back office processes in the areas of risk management, reporting and regulatory compliance. It has become essential that firms address the complete trade cycle in a much more holistic way, and are on top of their processes almost on a real time basis to be able to adequately address regulatory and business needs. These two drivers are often conflicting with each other. In the short term, firms have to prioritize technology investments to address regulatory and compliance related issues. Large numbers of impending regulations and a finite technology budget have meant most of the spending is being made to meet regulatory issues, which leaves little room to invest in projects on efficiency and process improvement. Some firms have mentioned to us as much as 60% to 80% of their change management budget is being spent on regulatory and compliance related issues. In this backdrop, outsourcing of mid-back office processes by buy-side institutions is becoming popular. Since almost all of them have to make same, or similar, arrangements to adhere to regulators’ demands, there is good potential for the development of shared utility services whereby firms can outsource some or all of their back office functions to a third party service provider. While the trend of outsourcing in back office function is not new to the industry, this practice is gaining greater traction as buy-side firms realize the complexities of reconciling higher volumes of more complex trades – this is increasing the strain on staff and IT. At the same time, service providers have improved their capabilities and now offer a wide variety of choice for their buy-side clients. Custodian banks are seeing a surge of interest in their outsourcing services from buy-side firms. Increasingly custodians are finding that clients are asking for solutions specifically to deal with the new derivatives regulations. The concentration of flow driven by outsourcing is likely to accelerate within derivatives operations. However, we expect the trend will eventually affect cash securities operations as buy-side look to rationalize their back office functions. Through outsourcing services, investment manager will move fixed cost into variable ones and decrease the complexity of their back office operations. This evolution will be particularly acute in derivatives operations due to the complexity of dealing with the new regulatory regime, DFA and EMIR. Prime brokers will be able to leverage their back office capabilities to insource additional flow, especially around derivatives operations. While there are similarities in the mid-back office functions and processes at global institutions, large banks also need significant customization to manage firm specific needs. The challenge in developing a utility based service model is to design a common platform that will still have room for addressing custom needs. Many providers are considering of coming up with such an offering. There is a race to accomplish this at the earliest as they understand that the first one to offer it would have a big advantage over others.

Tokyo Roundtable 2013: The Capital Markets Revolution in Japan and Asia

Tokyo Roundtable 2013: The Capital Markets Revolution in Japan and Asia
Tokyo, home to Asia’s largest capital markets, is also wonderful in May, and was a perfect location for two recent Celent roundtables. The first was Exchange Panel: Drivers of Innovation and a Market in Transition. We invited Executives from five major global exchanges; CME Group, JPX Group, Korea Exchange, NYSE Euronext, and Singapore Exchange Limited. Representatives from both Asian and global exchanges discussed changing equities derivatives market structures, business models, challenges, and opportunities in Japan’s and Asia’s capital markets. Though similar at first glance, the exchanges from the East and West presented a marked contrast. Asian exchanges insisted that competition, diversity, and deregulation are the keys to growth. Exchanges based in Europe and the United States said they found the diversity and competition excessive; they would prefer order and market discipline. All exchanges stressed the importance of innovation and collaboration, and all agreed the distinction between investment and speculation is important. Such differences between East and West reflect the history of the global exchange business. Differences in time and distance are shrinking as networks grow, but, ironically, the advent of global capital markets has led investors to recognize the importance of individual trading venues. For the second roundtable, The Capital Markets Revolution in Japan and Asia, we invited the top players. From online securities companies, Monex, Inc., from buy-side, Nissay Asset Management Corporation, and from sell-side, Nomura Securities Co., Ltd. This session focused on the emerging low latency landscape and the opportunities and challenges in the region’s equities and derivatives markets. In Japan and Asia, since the introduction of arrowhead, the latency has been lowered enough and the attention has shifted to its execution quality. Technologies such as Big Data and transaction cost analysis are the focus of their challenges. Finally, in response to questions from audience of the venue, we asked the panelist to comment on high frequency trading. There were two comments; one was “the opportunity to get everyone used to HFT is here”, and another “HFT is welcome in Japan”. The market environment has changed drastically. Conversion of monetary policy, “Abenomics,” and the “three arrows” were a volcanic combination. Magma flowed, but all indicators began to rise.
FIG 1:Tokyo Equities Market last six months Tokyo Roundtable 2013_Graph
Source: NIKKEI, Celent  
These discussions will continue in New York in June. Celent will continue to explore the market trends of tomorrow. We are looking forward to meeting you soon. http://www.celent.com/news-and-events/events/sifma-tech-2013 http://www.regonline.com/builder/site/Default.aspx?EventID=1228293 http://www.regonline.com/builder/site/Default.aspx?EventID=1236023