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Trading in the Age of Capital Market Disruption

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Disruption is occurring everywhere in capital markets. Over the past 12 years, the economics of how major institutions operate their FICC (fixed income, currencies and commodities) trading divisions has undergone a tectonic shift. The organizational and architectural choices that firms make in the next 12-24 months will decide who succeeds and who risks falling to the back of the pack.

As we’ve seen throughout the last 20+ years in the capital markets, firms can be slow to make the necessary shifts when faced with changing markets, often waiting until regulatory deadlines loom. However, the pace of disruption in FICC trading is such that banks have to act now.

For starters, there are new client demands. Buy-side firms are asking their dealers for access to complex electronic flows and the newest assets, and better cross-asset trading support. They want a full suite of services from their relationship partners. Banks, jostling for a competitive edge in increasingly tight markets, are looking to improve the way they price trades for clients, while limiting the risk on their books.

In addition, innovation is accelerating. Data analytics is revealing new competitive edges in all aspects of trading. AI and machine learning are permeating order execution and management. Experiments with blockchain technology are beginning to bear fruit. Banks that adapt will gain an advantage, while institutions who lack the flexibility to couple emerging technologies with existing platforms risk being left behind.

On top of this, there are fiscal pressures. It’s estimated that 75% of bank IT spending is directed towards maintaining existing technologies. Building new trading platforms in-house would break these budgets. This puts banks between a rock and a hard place. They have to evolve fast, but with even tighter budgets.

The path forward will be challenging, but certainly worthwhile – BCG Research estimates that investments in FICC technology will offer three times the return than similar investments in equities. What does this path look like for banks?

Invest in your edge: Sell-side institutions should focus their energy on areas that offer the greatest potential to gain advantages and maximize revenues. This means strengthening customer relationships, especially where the client is highly dependent on the institution for various services; improving pricing on trades, without taking on additional risk; developing uncorrelated flows; enhancing internalization; improving cross-asset offerings and strengthening support of those electronic workflows and asset classes where they truly have an edge.

These pivots will naturally lead some institutions towards partnerships in non-critical areas of trading. For regional institutions, such as those in the Nordics or Asia-Pacific, who are primary-market makers in their home currencies, the greatest returns will be achieved by investing in business areas that leverage their unique insight into local markets. Providing 24/7 coverage for assets outside of their region will be far less lucrative, but nonetheless necessary to serve corporate clients. In this case, it makes sense to partner with bulge bracket firms to deliver that support, at less cost.

Trusting in technology partnerships: New partnerships won’t be limited to the business side of things. Banks are realizing that building a relentless focus toward highly-profitable business areas is not easy when they’re bogged down with the burden of maintaining legacy technology infrastructure.

In light of this, institutions are increasingly outsourcing core trading and business activities to trusted technology partners who are better equipped to handle them in an efficient manner.

Why are banks embracing technology partners, after decades of building in-house? Institutions are finding themselves able to work more collaboratively with trusted partners, who have the flexibility to handle exactly the technological elements that the client wants them to. The ‘build or buy’ question has fallen away, giving rise to a new model: ‘build, buy, and host’. Banks build their proprietary applications, algos and workflows on top of the foundation that the trusted partner provides. The partner hosts, and handles elements like connectivity, algo support, and order management.

Rebooting technology: Just as attitudes towards partnerships will have to open, the technology platforms that underlie trading systems will need to open up as well. The flexibility to work fluidly with other technologies is essential, especially as banks continue to build their own applications and workflows on top.

An open, modular enterprise platform gives banks the agility to withstand disruption and achieve growth. This platform promotes an open data model, enabling firms to collate and extract the most from their information.

In this model, rules engines allow banks to create workflows and permissions across areas like algos, hedging, internalization and e-commerce, without need for an extensive build. To phrase it differently, banks can customize and automate trading processes to make them unique.

Ultimately, the flexibility to employ an ecosystem of interoperating applications, both in-house and third party, is the key to future success. Connecting the various elements of a FICC trading architecture enables banks to expand to new areas rapidly, squeeze value from existing tech components and adjust as market conditions dictate.

Banks that have begun to speed ahead of their peers in terms of FICC trading growth have adopted many elements of the above. We’ve seen firms shift towards a more collaborative approach to technology, with the aim of creating a consolidated FICC desk. This has involved the reshaping of the trading architecture to integrate various platforms and applications and create an infrastructure that is adaptable, not beholden to one particular technology.

The banks at the front of this shift have been able to move quickly into new areas of FICC trading, such as credit portfolios and repos, which are proving to be quite profitable, while achieving significant efficiencies in their operations. We’ve seen 10-15% increases in market share year over year after employing the strong disruption strategies we’ve outlined above.

Powerful forces are clearly at play as the capital markets landscape continues to evolve. Banks need to develop and implement a forward-looking strategy that takes into consideration current industry trends because disruption isn’t coming – it’s already here.