What does it mean to modernize?
In Order to Modernize
Before proceeding any further, let’s pause to consider what core system modernization signifies to a brokerage firm. Celent surveys have found that to brokers modernization means agility in operations and reductions in IT costs.
This prompts the question of how to make modernization a reality. Celent focuses on two jumping off points or angles from which to approach this: One is trading lifecycle optimization (TLO), the second is improving risk management, that is to say, realizing of a dynamic risk-adjusted investment cycle.
Trading Lifecycle Optimization (TLO)
The digital advances in trading environments have spurred the proliferation of algorithmic trading and high-frequency trading (HFT), developments that have reduced the number of traders needed. At the same time, Asia has witnessed increasing fragmentation that is particular to the regional market, spurring the spread of smart order routing (SOR).
Social media and big data are increasingly being used as market data and exerting greater influence on the market at the same time that high touch sales by sell-side firms remains. In addition, increasing diversification is evident with significant variation in the degree of digitization across asset classes and markets, and in terms of liquidity and trade type (bulk, block order, small orders, etc.).
Against this backdrop, a new electronic “hybrid” trading that fuses traditional high-touch trading with HFT and algorithmic trading has emerged in modern capital markets and trading environments. This has extended technology application beyond traditional areas of focus such as trade execution management and portfolio management. Indeed, the role and importance of technology is only growing, particularly in these areas: linking pre-trade compliance in order management, post-trade compliance in the middle office, and the various financial intermediaries (account keepers, transfer agents, administrators, prime brokers) that work across the front, middle, and back offices.
Celent has advocated the concept of trading life cycle optimization (TLO).
TLO has come under scrutiny due to market environment changes that traders face in addition to factors including disparate or unevenly distributed trading technologies as well as trading risks (time, location, asset class, trader).
Hybrid trading environments combining traditional high-touch trading with HFT or algorithmic electronic trading, could clearly serve to benefit from TLO. Spanning the trading process—before, during, and after trading—it is vital to integrate across administration, monitoring, and auditing metrics for governance, risk, and cost (GRC). This makes extremely important to harness market data, which can serve as criteria for TLO.
Areas targeted for optimization by trading technology block (types of technology used) can be broken down into the following four: infrastructure, operation, trade execution, and allocation.
These technology blocks are very important such as when it comes to audit requirements, sponsor descriptions, trader performance reviews, and identifying automated and discrete ranges. At the same time, these are also seen as crucial functional requirements for the front, middle, and back office systems in next-generation trading.
Celent believes that trading technology modernization should mean for both the sell side and buy side a focus on amending disparity and gaps in this technology.
Innovation in Focus | The Age of Trade Lifecycle Optimization in Securities Trading
Market Data in Asia-Pacific and Japan, Part 2: Innovation Opportunities and Scenarios to Succeed in Growth Markets
Enhanced Risk Management: Realizing a Dynamic Risk-adjusted Investment Cycle
One element that is consistent across capital markets in any age is a fervent desire to pursue alpha couched in efforts to optimize risk, all of which finds a point of equilibrium as determined by the market. Today all market players pursuing modernization are doing so in an environment that is subject to the below common factors.
- Diversification of trading product (asset class) and trading method (execution method)
- Deployment of new frameworks for securities settlement and margin trading
- Volatility in cash, leverage, and particularly liquidity
- Continuous strengthening of capital requirements
As regulatory scrutiny intensifies and investor expectations for investment alpha rise, buy side financial institutions are being pushed to modernize their management functions in ways that accommodate their investment strategies with advanced levels of diversification, defensiveness, and risk transparency.
Looked at from the perspective of investors, it is clear that in addition to the deployment of advanced operational methods and superior investment strategies, that to execute these new ideas it is imperative that firms develop the capabilities needed for robust operation and risk management. Indeed, these investor expectations are likely a more daunting prospect than the stress tests and other regulatory requirements.
To perform well in today’s capital markets, Celent has advocated the need for excellence in business operations—in other words, the establishment of effective risk management and control. Toward this end, it is imperative that companies destroy institutional barriers and silo-riddled organizational structures, understand regulations and risks in the context of the market, products, and trading, and seek to strengthen their organizations with an eye to securing greater transparency.
Until now, finance (funds management or capital management) has been carried out in silos, spawning competing control and management initiatives. This is proving increasingly untenable and driving the need to better integrate finance with governance, risk management, and compliance—what Celent refers to as GRC. In the meantime, the costs only continue to surge both in terms of time and money stemming from confusion related to information transmission and the value chain.
What is the best path forward?
To accurately gauge the magnitude of this issue requires a firm awareness and comprehension of the facts, but today the management of risk and finance, processes, data, and technology are fragmented. This spaghetti-like situation and disparate nature of data routes and management systems slows business processes and obscures the reality of the issue itself. Action is urgently needed to establish data flows that cut across risk and finance as well as to create agile front office control and strive for enhanced portfolio optimization.
In addition to bringing together the three elements of data—establishing a set degree of data freshness, data quality, and data routes—it is similarly imperative to integrate seamlessly front office trading systems (OMS), portfolio management (PMS), risk management, and capital management mechanisms.
The approaches taken demonstrate the limits of long-implemented stop-gag measures implemented to meet regulatory requirements. Put another way, to heighten effectiveness, there is a need to overhaul both business and technology architecture.
Celent helps buy side organizations in the market today modernize their risk management—which is to say, implement initiatives to improve the effectiveness of their risk management. Celent does this in part by using the below six items as a conceptual framework to get a handle on the situation, research available solutions, and then offer advice on implementation.
- Understanding regulation and risk that accommodate the market, products, and trading: What is the backdrop or context and what changes are on the horizon?
- Integrating regulation and risk management with control functions: What targets should be integrated?
- Unifying risk data and risk value chain objectives: Which data and processes should be redefined?
- Selecting architecture and components aligned with objectives: Which solutions should be chosen?
- Securing mobility and flexibility in data management and platform strategies: How should the solution build be implemented?
- Rethinking business processes to achieve consistency with risk management: Where are the ancien régime legacy elements that hamstring business modernization?
Legacy Modernization in the Japanese Securities Industry, Part 1
Legacy Modernization in the Japanese Securities Industry, Part 2
Back to the Future in Risk Management: Realizing the Promise of True Risk/Reward Decisions