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.

Citadel Securities and the changing market microstructure

The recent purchase by Citadel Securities of the assets of Citigroup's Automated Trading Desk business has further cemented Citadel's position as a leading market-maker. It follows closely on the heels of Citadel's acquisition of KCG Holdings' designated market maker business at the NYSE. Citadel has also been performing strongly in the swap markets in the US, specifically the swap execution facilities (SEF). It has built a reputation for reliability in difficult market conditions, at a time when broker-dealers are finding it difficult to maintain their market presence.

While the success of Citadel is noteworthy, it represents significant industry and regulatory undercurrents. Investment banks have labored under tougher market conditions and stronger regulatory restrictions. Firms such as Citadel have benefitted as they are not as tightly regulated as the banks. While this trend had been predicted in the years immediately after financial crisis, it is interesting to see the predictions coming to bear. The effect on the market structure has also been profound, and while many of the relevant developments have taken place in the US, other leading capital markets should also see similar changes in the near future due to similar economic and regulatory evolution. Investment banks will continue to narrow their focus in terms of their capital market presence, and we expect the leading ones to carve out specific niches instead ofmaintaining the comprehensive presence they had in the last decade.

From the buyside's point of view, while the lower presence of investment banks could indicate lower volumes and liquidity, it also represents a market in which there might be greater responsiveness to the needs of medium and smaller sized buyside firms.

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.

Market Surveillance issues

As I begin work on the last in the current series of Market Surveillance reports, there are some important points that we can reiterate from the recent research. The first is the all encompassing requirement for surveillance. The recent Deutsche Bank co-CEO resignations have shown the negative impact the benchmark manipulation related sanctions and fines had on not just this bank but the industry as a whole. Similarly, the investigation of a couple of British banks regarding the payments made in the FIFA bribery scandal also shows the need for constant vigilance on part of banking and capital market participants. Firms are embracing the need for holistic surveillance and compliance, which covers not just trading but also related areas such as best execution, cyber-security and AML. Firms that have legacy systems in place might want to continue with several systems, but for the better part, most firms would prefer to have one system that meets most of their requirements. As more advanced technology becomes available, this is becoming more of a reality. Another important aspect is the rising use of machine learning capabilities. Surveillance systems are becoming more advanced, processing both structured and unstructured data, especially through the use of cloud based processing and Big Data technologies. Machine learning takes this to the next level, as it reduces the need for human intervention, and allows for reduction in false positives and negatives. Furthermore, such advanced systems also allow firms to keep tabs with new compliance requirements more efficiently as they can anticipate problem areas based on learning from past experience. Finally, exchanges and sellside have been the main users of market surveillance technology. But increasingly regulators and buyside firms have also started acquiring these systems. For regulators, it makes sense because it allows them to monitor the market independently and reduces their dependence on the exchanges and the sellside for data and analysis. For buyside firms that are playing a more active role in the market, it is important that their trade surveillance is upto scratch, otherwise they are making themselves vulnerable to the same issues that are plaguing sellside firms at the moment.

A Magic Lamp for Bonds?

Blackrock Solutions recently announced it had set up a bond crossing network with the working title “Aladdin Trading Network”. The idea is that the buy-side would be able to anonymously cross corporate bonds, mortgage securities, or other fixed income instruments, bypassing dealers for some portion of their trading lists. The announcement has attracted a lot of US press, but market participants should understand that neither the theory nor application of the crossing concept is in any way new. Of course, buyside to buyside crossing is not a new concept- it exists in equities for example via ATSs, broker crossing networks and even exchange crossing. However, anonymous, buyside to buyside crossing of fixed income is not even new. State Street FICross has been in existence since 2008 for example. Many questions remain, such as whether dealers would be willing and interested to stream prices into Aladdin when the market already has Bloomberg, MarketAxess, Tradeweb, etc. And if the answer is no, buyside to buyside crossing is typically hamstrung by the ships passing in the night problem where firms have difficulty finding a match with another party at precisely the time when the trade needs to occur. This is not to entirely discount the idea. Blackrock has deep relationships and if they can increase crossing rates by even a small amount it could save the buyside significant money and improve performance.

Challenging times ahead for buy side OMS vendors

The buy side Order Management System (OMS) market has been going through a period of transition. It has had to cope with the aftermath of the financial crisis and the need for improved technology for multi-asset trading and also high frequency trading. While the buyside is very well aware that there would always be best-of-breed solutions for different asset classes and requirements, they are interested in having a solution that allows them to meet most of their needs and minimizes their requirement for an Execution Management System (EMS) wherever possible. Hence, it is becoming more challenging for the leading OMS vendors. There are some other challenges that are also affecting the choices of the buy-side firms for OMS products. The falling margins and rising costs due to volatility mean that clients are demanding value for money in a manner seldom seen before. The business and pricing models of the industry are changing and vendors are having to become much more flexible in their approach. While the leading vendors are still growing and acquiring new clients, the competition has become more severe. In the last few years, the acquisitions of LatentZero by Fidessa, Eze Castle by ConvergEx and Macgregor by ITG, while often taking advantage of the synergies between OMS and EMS, not to mention sell-side and buy-side OMS, have created a more compact market where the continuous innovation has become the key. Importantly, there has been a stagnation in demand for OMS in leading markets in the US and Europe. Due to the economic uncertainty, we believe that this is expected to continue for the next couple of years. There will be a growth in demand from Asia that will partly compensate for it, but the Asia-Pacific market will take time to mature and would also require the OMS vendors to set up their offices in the region from both a business development and customer service point of view.