HCLT Whitepaper: Future of the Trading Platform


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http://www.hcltech.com/financial-services/overview~ More on Financial Services

The stage is set for some major changes in trading in the years to come. One glimpse at the trading scenario will give you enough proof that algorithmic trading volumes have gone through the roof. Regulations like MIFID, implemented in November 2007, are threatening to change the way in which banks trade. And the changes are happening fast. The trading community firmly believes that this trend is here to stay. On the other hand, the rapid changes of excessive peaks, troughs and volatility in the recent market fall outs have been blamed on the black box trading techniques.

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HCLT Whitepaper: Future of the Trading Platform

  1. 1. Future of the Trading PlatformAssociate General Manager – Capital Market Services Narayanan VIntroductionThe stage is set for some major changes in trading in the years to come.One glimpse at the trading scenario will give you enough proof thatalgorithmic trading volumes have gone through the roof. Regulations likeMIFID, implemented in November 2007, are threatening to change theway in which banks trade. And the changes are happening fast. Thetrading community firmly believes that this trend is here to stay.On the other hand, the rapid changes of excessive peaks, troughs andvolatility in the recent market fall outs have been blamed on the black boxtrading techniques.If you look from the telecom industry’s perspective that caters to theneeds of the trading industry, there are major changes that are sweepingin with customers asking for more bandwidth, storage and data centreservices. In the last 18 months alone, several trading houses upgradedmost of their exchange connections by 500% to handle the increasedmarket data and trading volumes.
  2. 2. Algorithmic Trading ChallengesThe impact of algorithmic trading has been With these challenges of algorithmic trading, industry playersdiscussed time and time again. The idea of are also facing other challenges – that of co-location, attentionbeing able to automatically build into algo black to detail and catering to the ever-changing needs of the client.box trading strategies - a switch to the trading One of the services that major exchanges are offering is calledblocks that is based on automatic updates co location. This is an attempt to work around “the speed ofcoming from news tickers - means building light” by allowing people to put very resource hungrytowards an automatic market place that applications very close to the exchange’s trading enginesswitches, routes and smarts the orders around rather than having that tiny extra latency of sending largethe market without any human involvement with quantities of messages from the bank’s trading engine to theintegrated trading strategies. exchange’s trading engine.But when we talk about algorithmic trading,issues around security and end to end When it comes to attention to detail, the industry needs to payauthentication are not far behind. Another key attention not just in terms of capturing business requirementsissue is the constant need to upgrade the to code them but also a keen eye for the application of the lawsinfrastructure. This calls for a huge investment of physics.into hardware, software, communications and Along with attention to detail goes constant attention to thecapacity. Constant upgrades to infrastructure changing needs of the clients. The clients’ needs have alwayscosts money, in addition to the end to end cost of been and will continue to be very heterogeneous. The clientstrading. are always going to be heterogeneous and the challenge forThis cost is double-fold with investment banks bankers and investment bankers is to find ways of meetingpaying huge sums to external vendors for those needs efficiently.providing the infrastructure to keep the The success of an industry where trading really occurs, be italgorithmic trading going and the second set of an exchange or a trading venue or, ECN will depend on how itcosts are costs about which the investment responds to these five issues.banks would dearly love to do more but theycannot, which is the cost of complexity - the cost Latencyof a broken Europe, the cost of the absence of a The importance of dealing with the latency issues can neversingle approach to regulation, market be overstressed. Latency means different things to differentmicrostructure issues, conduct of business. people and its definitions are many. But from a common man’sThe potential for a significant win in that area, as point of view let’s say you enter an order to buy or sella result of the Financial Services action plan, is whatever it might be and till you get the response, you do notstill in the “yet-to-be-delivered-box” as far as the know what has happened to that order. So if you say: “Buy meindustry is concerned. 100” and if the response you get is “Bought 50, 50 in the book”, we are talking about serious latency issues here. And this is one key area that has to be addressed. Since exchanges have brought down considerably the time they take to accept, process and confirm an order, traders too have responded similarly.
  3. 3. Resolving latency issues and quicker execution Overcrowding and Risk Managementtimes is definitely high on the priority list and the The general trend is that trading venues don’t want to have aplayers too are aware of this and the race to do large footprint on members or participants, whether it isthis is heating up. The key differentiators in this exchanges or ECNs, just to bring down the cost. This, tospace are network speed and location. Clients ensure that there can be consolidation on the service front orcall even just a five millisecond delay as an technical infrastructure front.outage. The other very important issue, of which we will hear quite a lotLet’s look at it at a global level. The bulk of the in the future, is risk management. Today, if you look at thecapacity and trading that exists today around the investment decisions being taken by machines with extremelyworld tends to go west; it goes via the US. It high speed and the order rates coming in at hundreds pertakes a 240 millisecond link to go from London second, the value at risk is extremely high on very low timeround to Tokyo via the US. If you go via Russia it scales. From that perspective, it is quite clear that there will beis 60 milliseconds. So are we going to see all of drastic changes since it can’t be just the trading side which canthe trades going that way and what about the speed things up but also clearing and risk managementsecurity implications of having all the tradesrunning via Russia? The Derivatives Exchange’s Stand From a derivatives exchange point of view, the aboveConsistency mentioned success criteria are all different investmentIt is not just enough to resolve latency, because strategies. Not everybody needs this ultra-low latency and thewhat the huge volumes with respect to number other attributes. We have strategic investors who want to buyof trades and values that we are seeing in the 5% or 3% of a company, maybe have a certain influence onmarket during peak periods need high certain decisions at that company, who are thinking about aconsistency. So in such a situations when there much longer time scale. And they are not doing statisticalis too much of trading happening, the traders arbitrage.except the same behavior from all IT So we have different groups of investors and this is anotherinfrastructures; be it outside providers, generalistic thing we will see in the future - that there is moreexchanges or ECNs. Here in lies the challenge. diversification with respect to technology as well.High-speed Market Data But there are some who want to be in this high-speed game,So it’s not only just knowing what your order has which obviously, comes at a cost. So as a result, we will have abeen doing, whether it has been matched or strong segmentation of the market.you’re in the book, but also knowing where the Another interesting trend that the market is witnessing today ismarket is. All this, of course, consistently with that of formation of electronic pits. Earlier, you used to havelow latency. Hence the need for high-speed the pits with the traders, but today it is all service moving closemarket data. to the exchanges, around the globe. We will see this happening not just on the trading front but also on the clearing front. This calls for real-time risk management since the risk of all these guys sending their orders at very high frequency is only going to further burden the market.
  4. 4. Dealers: Are They Here to Stay? In the long-term, in the area of say more straight forward, plainWith all this automation catching up like never vanilla, high liquid products we will see less human interaction.before, a section of the trading industry believes Only those who know how the automation machines work willthat dealers will disappear. But there are others find a place here. But on the other hand, products like complexwho believe that they will simply find new ways derivatives pricing, where you don’t want to fully rely on aof doing business, more intelligently and with machine and where innovation is extremely important, themore sophistication. But the debate rages on intervention of human beings is vital. Such kind of complexityand the questions keep coming: deserves rational decision-making, which the machines lack. Will algorithmic trading push the dealers ? What’s In Store? out of the dealing room or will social More products will enter the foray ? networking combined with low cost high In the coming years, we will see that more products will come band (inaudible) change the whole nature on exchange or on large trading venues, which are at the of trading and dealing? moment OTC, essentially to bring down the total cost of the Will markets operate locally, nationally, ? process by means of standardization. internationally or globally? Derivatives will boom ? ? the implications for market credit What are The derivatives will continue to grow at enormous rates in the operation and, most importantly, systemic future and eventually, we will see some global geographical risks as a result? clustering of exchanges. What technologies will drive the evolution ? If latency is really very important then it might lead to all the of trading? services of the exchange or trading venues -- for example theA recent IBM report on algorithmic trading and US’ equity market has lots of trading venues. New York is alatency revealed that nine out of ten dealers natural centre for equities trading in the US.would be out of their jobs by 2015. From a For the plain vanilla, high-liquid trading - which will be highlytrading house point of view, this might be automatic in the future and already is to some extent - industrydifferent for everyone and it depends on their will need people who have sound IT background and goodtechnology as well as how much the industry will understanding of the laws of physics.move away from the human touch in investment ? Products and Skill Sets Complexmarket. On the other hand, there will be a lot of complex products andIf you look at the automation story – it is a story the skill set that was good 10 years ago or 15 years ago to getwhich is fundamentally about simplification. If a job in the financial industry will still hold good. Theyou look at the Ford’s insight into the production demographics of who gets employed by investment banksline, automation of production, and the have changed dramatically and more so in trading comparedprefabrication of buildings, we see a pattern to pure investment banking. There are enough indications tohere that of - deskilling jobs, making jobs believe that this will continue. The definition of a trader issimpler, making jobs easily replicable & changing and the question is how many people are going to beexportable. But however, this doesn’t employed by operations that do trading because it is all aboutnecessarily mean that the results of automation building systems, designing systems and using systems.will satisfactorily suit the changing needs of theclient.
  5. 5. CRP – Consolidation, Rationalization and? Proliferation - We are clearly on the cusp of some very Proliferation dramatic changes in the trading landscape, the proliferation ofConsolidation - This is an extraordinarily trading venues. When there are multiple liquidity buckets youdifficult, expensive business to be in, not just for inevitably get fragmentation. This happens immediately uponthe sell-side but even the buy-side, who have the creation of these alternative liquidity sources but the factinvested very heavily in their trading operations that the orders get smaller. So there will be an exponentialover the last few years. It’s entirely reasonable growth in data because they’re probably the only realto expect that there will be something like the old beneficiaries of this. Digital news driving investment decisionsworld where people on the buy-side looked to will lead to a whole new type of investment strategy and therebrokers to provide the science and technology will be more black boxes and they’ll do more insidious thingsbehind trading and we get into an environment when the markets get rocky. It’s all about incredible complexity and the requirement, of course, for more people towhere people are competing on the objective design and build systems to deal with it.quality of what they’re doing because thesethings, after all, measurable, are getting more Finally, let’s talk about black boxes, which made headlinesmeasurable. With dark pools and all the when things started to go bad. People took notice and turneddifferent things that people have to navigate off the black boxes and people decided when to turn themthrough to do a best execution job, it’s entirely back on again. So it’s not just all robotic or automation.reasonable to imagine a world where there are BATSonly five or ten providers of such a service. It will The Better Alternative Trading System (BATS) in the US camebe, in any event, extremely complex and people up with an aggressive pricing model and in just about a couplewill have obligations to demonstrate that they of months had 20% market share. The New York Stockhave done as well as the pre-eminent providers Exchange market share is plummeting. The critical thing toof these services. note about BATS is that it has something like 30 employeesRationalization – It is extremely important to and the LSE has a lot of employees. It makes good businesslook around and see what’s happening and to sense to start thinking about how industry is going to diversifyremember what exchanges were built for in the if a major competitor is undercutting from a price point of viewfirst place. This evolves a system of and doing it all on the basis of technology. Let’s face it - theyinterconnected pools of liquidity that are don’t have fancy marble columns in their façade. It’s just aeffectively a playground for arbitrageurs and completely different model and if that is who their newpeople who are not really fundamentally about competitor is they better be thinking about what’s nextinvesting in assets that they care about. If that is including potential barriers due to the local exchangethe way things have been and if that continues, it regulatory bodies or governing bodies.will be difficult to understand exactly why we all On the volumes front, every exchange is continuing tohave to invest so much. So there’s not some evil increase its capacity with clients. Banks are trading more thanmachine out there that’s lurking, waiting to gain they did before with multiple exchanges and need more datathe system or pick up the footprint of an quickly. As a result, there is huge uptake in the requirements toinstitutional order to trade against. This last telecom providers, not just for connectivity but for data centersphase, it’s imminently reasonable to expect that space. This includes co location which is providing somemarket participants, either in concert or not, look interesting challenges to the industry because theat the market and say, “We’ve got to rationalize requirements are growing fast with regulatory requirementsthis” and look at crossing tools to reintroduce like SOX, Basel II and OCC.some order to the trading world.