Clare Flynn Levy, chief executive of Essentia Analytics, said active fund managers are recognising that behavioural data analytics is an essential tool for adding incremental returns to their portfolios.

Flynn Levy told Markets Media: “It’s just a matter of managers gaining awareness of it, of how it can be used, and why it is nothing to fear. We have helped clients uncover an average of 94 basis points of excess return per annum that had previously been lost to behavioural biases.”

Essentia calls this behavioural alpha – the added value that a fund manager can bring to a portfolio by mitigating their own biases. “In a world where alpha is scarce, it’s an opportunity that’s hard to ignore,” Flynn Levy added.

She explained that  “nudges” are the key to overcoming bias. Portfolio managers receive custom notifications to remind them of their investment process just when their most detrimental behavioural patterns come to the fore.

“It’s the manager who is improving alpha, though, by making more deliberate decisions at key moments – the technology is just there to assist them,” Flynn Levy added.

One of Essentia’s case studies involves a global equity fund within a $300bn investment manager who unlocked 68 basis points of behavioural alpha each year.

Three years of the manager’s trade, portfolio and benchmark data was imported into Essentia’s analytics engine which revealed a tendency to hold on to losers for too long and to exit positions too slowly.

Two nudges were designed – one for when a position underperformed by a certain amount within a given timeframe and another to track the evolution and execution of each investment idea on an ongoing basis. In three years outperformance against the benchmark increased from 25 to 93 basis points, resulting in an added $108m for investors.

Improving returns has become critical for active managers as passive funds have been gaining market share.

“Behavioural analytics gives active managers a far better understanding of what’s working and what isn’t, about their “activeness”, so that they can continuously improve,” said Flynn Levy. “Without that, they are essentially flying blind.”

Essentia believes that a data-driven feedback loop on investment decision-making is fundamental to the “fitness” of any fund manager who wants to survive.

"Behavioral analytics become mainstream for investment management" – one of @AiteGroup's top ten trends in institutional securities & investments for 2020. We're inclined to agree. https://t.co/UxpxDqK6PS #BehavioralAlpha pic.twitter.com/SR3WACnPZX

— Essentia Analytics (@Essentia_AI) January 16, 2020

Essentia’s white paper, The Half-Full Glass, said active fund managers could preserve more than 1.2% of outperformance per year versus passive index funds, net of fees, by paying more attention to the lifecycle of alpha in their portfolios.

Launching Essentia  Analytics

Flynn Levy founded Essentia Analytics in 2013 after spending a decade as  a fund manager. Her previous experience included running more than $1bn of pension funds for Deutsche Asset Management and as founder and chief executive officer of Avocet Capital Management, a specialist technology hedge fund manager.

She said that when raising finance, many venture capitalists tried to tell her they knew more about the active fund management industry and focused on asking questions about the downside, rather than upside.

Essentia's Philip Maymin, PhD., explores whether judging people to be irrational in their reactions to the coronavirus is itself the manifestation of a new kind of bias. #BehavioralAlpha https://t.co/RreYTqLMIA

— Clare Flynn Levy (@cflynnlevy) March 20, 2020

“When Essentia finally took on venture capital money, it was from a firm where the investors involved are women,” Flynn Levy added. “That wasn’t on purpose, but they gave me the sense that they supported me in growing as the entrepreneur I want to be – far more than any male VC I had ever met.”

She believes that more funding will go to female founders when more venture capital firms promote women within their own organisations.

Fund manager career

Flynn Levy said she grew up in a town full of stockbrokers in the “greed is good” days of 1980s Wall Street.

“My father, who worked for a very large public company, used to joke that if his share price didn’t go up, he wouldn’t be able to pay my private school tuition,” she added. “So I started subscribing to the Wall Street Journal and Forbes, first to keep tabs on his share price, and later to come up with my own trading ideas.”

In college, she worked for Mario Gabelli and the late Liz Bramwell at Gabelli Funds, and decided to become a fund manager.

“I was consistently underestimated, that’s for sure,” she added. “No matter how senior I became, men who had never met me before generally assumed I was only there to pour coffee or take notes. But I thoroughly enjoyed surprising those people – especially in Britain, where I knew their mortification was especially well-felt!”

In the UK she began to work for Morgan Grenfell Asset Management in 1995 when the business was led by Nicola Horlick.

“I figured that a company that had a female boss would be one where I had a chance of succeeding – and I was right,” she said. “Although I experienced plenty of behaviour during those years that would be considered gross misconduct in this day and age, my colleagues weren’t typically the aggressors.”

Flynn Levy  began to think about leaving fund management after 9/11.

“I had a great performance run, for a few years, and didn’t ask myself a lot of questions,” she added. “Then I hit a sustained period, post 9/11, where I was having to run very hard just to stay in one place, performance-wise.”

On the Essentia Blog: Seven top investment coaches share their thoughts on how to make good portfolio decisions in a disruptive and turbulent environment. https://t.co/3e6oE2V7rP @DeniseKShull #BehavioralAlpha pic.twitter.com/EWzadxGCxE

— Essentia Analytics (@Essentia_AI) April 7, 2020

She wanted data that could tell her what she should be doing differently but that was not easy to find.

“The more I thought about it, the more convinced I became that if I couldn’t actually prove my competitive advantage, as a fund manager, to myself, it wasn’t a good investment of my energy – I should be doing something where I could,” she said.

Before launching Essentia, Flynn Levy  went to work for Beauchamp Financial Technology, now part of Linedata Services.

“I learned a lot through that experience that has served me well in founding and growing Essentia,” she added.

We're proud to share that Essentia CEO Clare Flynn Levy has been named a "Senior Leader" on @InnFin's 2019 Women in FinTech Powerlist! @cflynnlevy #WIFPowerlist2019 #BehavioralAlpha https://t.co/k42VXlANN4

— Essentia Analytics (@Essentia_AI) March 5, 2020

In 2018 The Investment Association chose Essentia Analytics as part of the first cohort to launch Velocity, the UK trade body’s specialist fintech accelerator.

Flynn Levy continued that Essentia is at the point now where there is no question over whether “it works” and increasingly signing up very large fund managers as clients.

What is your current situation and how are you running business operations for your company?

Since the initial coronavirus outbreak in China we have seen record surges in the use of our platform, first across our customers in APAC, then in Europe and now in the United States. For example, in the first three months of the year, we saw a 40+% increase in daily active users versus 10% over that same time period in 2019. Similarly, we have seen an increase of 280% in average daily volume of messages being sent, which is 12 times last year’s increase.

Our customers – financial services professionals, who operate in one the most regulated industries in the world – have sent those employees who can work remotely home, and for groups like traders, who for compliance and infrastructure reasons must work on-site, they have implemented what is called “split operations,” whereby they divide and distribute teams across a number of secondary locations outside of financial centers. These new measures have of course dramatically increased activity on our platform, as firms use Symphony to stay in touch with each other, as well as their larger business ecosystem, including external firms and suppliers. In fact, we are considered to be a critical vendor. Many of our customers have asked to see our business continuity plan as the technology we provide is a key element in their own operations and business continuity plans.

By design, we are built for over-capacity, so we were able to quickly scale to meet this new demand seamlessly – which is crucial, as we see usage on the platform surge everyday. In terms of our internal operations, all of our employees are working remotely. During this time the health and well-being of our staff is of the greatest importance.

What are the key implications of the current situation for capital markets firms in terms of trading & technology?

As the COVID-19 pandemic continues to impact the economy and businesses globally, financial services firms have implemented new BCPs to keep their employees safe. Employees who are able to work remotely are sent home, and traders – who face much greater compliance standards – are divided into teams and sent to secondary office locations. These firms have increasingly relied on collaboration technology to stay in touch as seamlessly as possible while not in the office. As we previously mentioned, we’ve seen not only an increase in the numbers of users, but also a significant increase in the volume of messages exchanged on the platform on a daily basis. We’ve also seen customers increasingly turn to other capabilities such as video calls and screen sharing to keep operations running while remote.

With Wall Street firms sending traders home, how can they maintain compliance standards?

Wall Street firms have limited options in terms of collaboration tools, as they are part of a regulated industry with high reporting standards. Symphony was actually born out of the need for a secure and compliant communication platform for the world’s financial institutions – that’s why we provide end-to-end encryption, on-premise key ownership, and enterprise-class admin control into one extensible platform.

While many financial services professionals are working virtually, most traders are working at isolated secondary office locations, as many of the other tools they use, (unlike Symphony which was designed for remote and mobile use), are not easily remoted.

What are vulnerabilities necessary WFH policies have exposed on Wall Street and across financial services?

Coronavirus and the remote work – including working from home- it has spurred have exposed vulnerabilities in Wall Street’s infrastructure, which is heavy and not easily remoted. However, like other crisis situations this industry has faced – from 9/11 to the 2008 global financial crisis – Wall Street will emerge with a keen understanding of these vulnerabilities and the opportunities to be addressed (if they haven’t already been addressed in this period). With each crisis, deeper preparation becomes imprinted into Wall Street’s DNA.

We have heard consistently from our customers that they would not have been able to manage their transition to split and remote operations without our technology. We are humbled by their feedback and proud to be supporting the world’s financial institutions through this challenging period.

After the COVID-19 pandemic is over, we should expect to see firms maintaining fully operational secondary office locations and investing in new infrastructure that would allow traders to work remotely while adhering to compliance and security standards.

What are longer-term implications of such a huge remote work experiment?

COVID-19 is jumpstarting the conversation around longer-term work-from-home policies and what the future of this could look like. What we have learned is that companies need to be prepared for situations such as these and have the technology and business continuity plans in place to enable normal business operations through remote – yet secure – work. At Symphony, we are committed and prepared to keep our customers up and running if remote work became the new normal.

Scrutiny, compliance, risk management and the mission-critical nature of the core foundations of the modern business era in the digital world are the most important pillars for running the world economy today. Across the board, there is an increased degree of awareness around this and we expect to see greater investment in this area, especially amongst capital markets firms, in order to enable stronger compliance factors.

What trends are you seeing in Asia’s business recovery and how might that impact the U.S.?

In Asia, it is clear that not everything will go back to how it was before the pandemic at least for months to come. People are trying to figure out and adjust to the “new normal” which includes not being able to have face-to-face meetings, not being able to host conferences and greater use of collaboration technology.

We are observing the activity growth on our platform as well between 100% and 500% – depending on the way we look at the data – and the trend should continue as this wave continues to impact the US and EMEA.

Exabel, which provides a simple-to-use artificial intelligence and machine learning platform to active investment managers and financial analysts, has gained clients in the UK and aims to expand into the US.

Neil Chapman, chief executive of Exabel, told Markets Media: “We help the buy side to use more data and become more quantitative. We can provide artificial intelligence and machine learning as a platform to non-technical users to allow asset managers to squeeze more value from data.”

Exabel announced that Chapman had joined as chief executive in January this year from ForgeRock, which develops develops commercial open source identity and access management products.

For the majority of active asset managers, developing an in-house AI capability is prohibitively expensive, especially as data scientists are a scarce resource. Chapman explained that there is a bewildering variety and quality of data, so asset managers need help in determining which have value for their strategies.

“Many asset managers are new to using data sources such as geolocation and satellite images,” he added. “We help them backtest and establish value which can cost them millions of dollars to do themselves.”

Oslo-based Exabel was founded in 2016 and launched a new platform in October last year.

“We ran a pilot in Nordics but have since expanded into the UK,” said Chapman. “Next, we will look to expand in New York.”

He gave the example of Exabel helping a UK hedge fund to build an AI platform in a week. “On their own it would have taken them three months and three to four staff,” Chapman said.

In addition, Exabel provides explanations to ensure that the user understands the results and has confidence in the robustness of the data models.

“We are not in the business of replacing humans,” Chapman added. “Our platform is complementary allowing the user to confirm or challenge their investment hypothesis.”

COVID-19 dashboard

Exabel has also partnered with alternative data provider 1010data to develop a dashboard to allow fund managers and the public to assess the impact of the COVID-19 pandemic on consumer spending at https://1010data.exabel.com/covid-19/

https://twitter.com/jbaksht/status/1245764072131440641

Chapman said: “We’ve got a strong response from asset managers and believe there’ll be a lot of interest in the COVID-19 Impact Dashboard, which in essence is a simplified exemplar of the kind of value asset managers can derive from Exabel.”

The dashboard uses near real-time credit card data to show spending trends across categories such as grocery, air travel and apparel retail. 1010data’s credit card and location data sets are based on large, representative panels which provide insight into changes in consumer spending across the US.

“In these chaotic times people need more information,” added Chapman. “In a few weeks or months we will need to know whether we have hit rock bottom and whether growth is returning.”

The data already shows there was a significant change in behaviour after February 25, when the US government held its first press briefing on the pandemic.

AI in capital markets

Nearly half, 44%, of capital markets professionals globally are using AI in their trading processes, according to a survey from Greenwich Associates last year. The consultancy’s report, The Future of Trading: Technology in 2024, also said that 17% planned to implement AI in trading in the next 12-24 months.

“Four out of five expect AI and/or machine learning to be fully integrated into the trading process in three to five years, and that their firm will have internal AI expertise within that timeframe,” added Greenwich.

Kevin McPartland, head of research in Greenwich Associates market structure and technology group, said in the report that one of the biggest impediments has been data availability.

“Most financial services firms are still working hard at normalizing the data they do have, are struggling to work within privacy rules surrounding customer data, and often work with such limited data sets that the output is still more art than science,” he added.

More than 60% of study participants expected AI-focused budgets to increase.

“Many buy-side institutions feel strongly that the best way to advance an emerging technology is to leave long-term development to IT providers, and then implement resulting innovations in AI and other areas to improve their businesses,” McPartland said.

Regulators are pulling back the curtain on trade order routing.

The sell side long has had limited answerability to the buy side in terms of trade handling and routing practices. Brokers have a fiduciary duty to achieve best execution on every trade, and they want to make clients happy, but providing information about the logic behind why a given trade went where it did is ultimately at the broker’s discretion.

This changes on June 1, when U.S. Securities and Exchange Commission Rule 606(b)(3) is scheduled to go into effect, reflecting a two-month delay due to the effects of Covid-19. The rule requires a broker-dealer, upon request of a customer that places not held orders, to provide specific disclosures, for the prior six months, regarding routing and execution of such orders.

The intent behind 606(b)(3) is simple: to help buy-side investment managers trade more efficiently by empowering them with more data and information about their trades.

“The analysis of routing data, not only where your order was routed to but also the execution protocol, is critical,” said Joe Wald, CEO at trading-technology provider Clearpool Group. “By understanding the way broker algorithms route orders, and being able to see data on the venue and order-type level, you get a sense of what tools, venues, order types and liquidity you can use to build a best-execution protocol that’s right for you.”

Greenwich Associates is producing a research report that assesses how the buy side intends to use 606(b)(3) order routing data on ‘child’ orders, which are offshoots of the initial ‘parent’ trader order. The report will also cover the buy side’s access to unique liquidity sources and their brokers’ capability of managing liquidity workflows.

Once 606(b)(3) is in place, regulators will first survey the sell side to make sure brokers are gathering, collating, and disseminating the appropriate data on a timely basis. After that, attention will turn to the buy side, regarding what data they are using and how they are using it.

That’s the expectation of Shane Swanson, senior analyst in market structure and technology at Greenwich. “We find the number one priority for the buy side is sourcing natural liquidity,” Swanson said. “How do you find not just natural liquidity, but how do you use technology to identify unique sources of liquidity that you might not be able to find otherwise?”

Swanson noted that the largest, most technology-centric investment managers already do 606(b)(3)-type data gathering and analysis; it’s the rest of the buy-side universe that stands to benefit from the new regulation. “For those firms that haven’t been able to make that investment or didn’t have relationship capital to be able to demand transparency on an order-by-order basis, this levels the playing field by making the data available to all.”

“The buy side will have more granular data on how their brokers execute not-held orders, especially if their broker is utilizing the execution services of another broker downstream,” said Khody Azmoon, an electronic trading consultant previously with State Street and Cowen Inc. “This will enable the buy side to better determine any potential conflicts of interest, like a broker favoring their own pool or prioritizing explicit transaction costs in the routing logic.”

On the sell side, Clearpool’s Wald expects 606(b)(3) to result in a bifurcation of brokers: those the newly revealed data flatters, and those it doesn’t.

“Brokers with the right strategy, and the right approach to venue and liquidity, will be able to demonstrate better execution quality than their peers, and that’s what this is all about,” Clearpool’s Wald said. “Things are going to get much more bespoke.”

The Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) continue to monitor the impact of the rapid spread of the coronavirus disease (Covid-19) on the global financial system.

The #BaselCommittee and @IOSCOPress defer by one year the final two implementation phases of the framework for #MarginRequirements for non-centrally cleared derivatives #coronavirus https://t.co/HIFJjkTnxp pic.twitter.com/tVBykUAUPY

— Bank for International Settlements (@BIS_org) April 3, 2020

In light of the significant challenges posed by Covid-19, including the displacement of staff and the need for firms to focus resources on managing risks associated with current market volatility, the Committee and IOSCO have agreed to extend the deadline for completing the final two implementation phases of the margin requirements for non-centrally cleared derivatives, by one year. This extension will provide additional operational capacity for firms to respond to the immediate impact of Covid-19 and at the same time, facilitate covered entities to act diligently to comply with the requirements by the revised deadline.

With this extension, the final implementation phase will take place on 1 September 2022, at which point covered entities with an aggregate average notional amount (AANA) of non-centrally cleared derivatives greater than €8 billion will be subject to the requirements. As an intermediate step, from 1 September 2021 covered entities with an AANA of non-centrally cleared derivatives greater than €50 billion will be subject to the requirements.

The Committee and IOSCO have published a revised version of the margin requirements to reflect this revision on their websites. The revised publication features no other substantive changes to the margin requirements framework.

Source: BIS

EFAMA, which represents the EU asset management industry, said:

We welcome the Basel Committee and IOSCO announcement below. This extension will help the financial industry to focus on its clients in these unprecedented times. Thank you! #efama #Covid19 #derivatives https://t.co/MQiLF8M8zJ

— EFAMA (@EFAMANews) April 3, 2020

Peter Rippon, chief executive of derivatives analytics firm OpenGamma, said in an email:

“Certain market participants behind on their UMR preparations will be applauding this move by the Basel Committee and IOSCO. Many firms are still getting to grips with the fact that they will have to post hundreds of millions in initial margin for the first time.

This extension at least provides some much needed time to put detailed plans in place in order to trade more efficiently. In the months ahead, expect to see more and more firms with uncleared swaps portfolios move away from trading bilateral uncleared derivatives, and shift towards central clearing.”

John Straley, executive director, institutional trade processing at DTCC, said in an email:

“DTCC supports the decision by the Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) to delay the implementation of the final two phases of the uncleared margin rules (UMR) for non-centrally cleared derivatives by one year as a result of the Covid-19 pandemic.

Covid-19 is an industry-wide challenge and the additional time provided by the UMR delay will be welcomed by industry participants as they focus resources on managing risks associated with current market volatility in conjunction with future regulatory requirements.”

Sean Tuffy, head of regulatory intelligence, Securities Services at Citi, summarized the actions that regulators have taken in response to the Covid-19 pandemic in his latest What Does in Mean for FinReg ? report:

The European Securities and Markets Authority has extended consultations on the MiFID transparency and third-country rules by four weeks and the US Securities and Exchange Commission has delayed any action on its proposed Derivatives Rule until 24 April.

Esma also delayed the live date of the first phase of the Securities Financing Transactions Regulation reporting requirements by three months.

Additionally, the September deadline for the fifth wave of the Initial Margin requirements for uncleared derivatives has been delayed by a year.

“Regulators have been pragmatic in their response to the COVID-19 outbreak and if it stretches on, it’s possible that they will delay implementation dates as they get closer,” he added. “Nonetheless, firms can’t bank on any delays and should continue to prepare for these regulations to go live as scheduled.”