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Investment Banks Face Headwinds

By
Shanny Basar
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Investment banks face structural headwinds with changes in customer expectation and increased competition from fintechs and big technology firms.

Analysts at German financial services group Berenberg said in a report this week that investment banks face structural headwinds that they cannot avoid.

“Many cling to the hope that higher volatility will be a silver bullet, but recent experience suggests otherwise,” added Berenberg. “Furthermore, the introduction of daily average leverage ratios will put further pressure on returns of European Union investment banks.”

The analysts said they maintained their belief that the banks face headwinds which are structural, not cyclical. They noted that a surge in volatility in the fourth quarter of last year did not translate to higher trading revenues as participants remained on the sidelines and trading revenues fell 12% year on year.

“We believe that complaints about low volatility is a cyclical excuse for a structural decline,” said the analysts. “From 2002 to 2006, volatility almost halved, but trading revenues more than doubled.”

Berenberg continued that the introduction of daily average leverage ratios will show that European investment banks are less profitable than they appear and they will be outperformed by their US peers. US investment banks have increased their share of global revenues from 51% to 61% since 2009 and the analysts expect this trend to continue.

“This will leave banks with three choices, in our view: continue the business at lower returns, reprice or exit,” said the report. “Repricing is very difficult given competition from US investment banks, while exiting business lines risks impairing the broader franchise resulting in further earnings dilution.”

McKinsey report

Chira Barua, McKinsey

Chira Barua, partner at consultancy McKinsey, agreed that banks are facing structural, rather than cyclical, challenges.

Barua told Markets Media: “They are not fighting regulation but fundamental changes in the environment.”

He was co-author of McKinsey’s global banking annual review which said that just over one third, 35%, of banks globally are sub-scale and will need to consolidate to survive a downturn.

Kausik Rajgopal, Silicon Valley-based McKinsey senior partner and report co-author, said in a statement: “The report identifies four distinct archetypes, which banks around the world would broadly associate with based on the strength of the individual franchise and the constraints of its markets or business model: ‘market leaders’, ‘resilients’, ‘followers’ and ‘the challenged’. While all banks have common actions they can take, each bank archetype has their own specific late cycle priorities to act upon.”

Barua continued that disruption is coming from consumers who have become accustomed to real-time and personalized services.

“The need to improve service and agility is not going to change,” said Barua.” Fintechs have created a new paradigm for customer service.”

The McKinsey report said that while this behavior is most acute in retail banking and asset management, the same trends are emerging in corporate banking, capital markets and investment banking.

“A classic example is a trend within transaction banking where clients increasingly demand a single window and real-time multi-currency multi-asset view of a firm’s payments positions with reduced settlement times with each passing year,” said the report.

In addition, McKinsey’s Future of Banking July 2019 Consumer Survey found that most respondents trust big tech companies to handle their financial needs, including Amazon, 65%, and Google, 58%.

“The challenge for incumbents is intensifying as the fintech landscape also matures, with new rounds of funding shifting towards larger organizations and the number of fintech unicorns globally topping 40 (worth approximately $150bn),” added McKinsey. “ Exacerbating the situation, fintechs and big tech players are attacking the highest return on tangible equity segments of banking, representing approximately 45% of the global banking revenue pool.”

Fintech investment Source: McKinsey

The study suggested that in order to compete banks should consider risk management, productivity, and revenue growth while recruiting talent to build advanced data analytics infrastructure.

“Every bank I speak to has realised the importance of data,” said Barua.  “There is a wide spread of capabilities in the market.”

He noted that McKinsey data has found that the leaders in one cycle can become the laggards in the next cycle if they do not make the correct investments.

Analytics Source: McKinsey

McKinsey said banks should also make more use of of third-party “utilities” for non-competitive and non-differentiating functions. For example, capital markets players could move trade processing volumes to multi-tenant at-scale utilities.

“Outsourcing non-differentiated activities could improve banks’ cost-to-income ratio by approximately 20%,” added the report.

Another potential area for industrialization is regulatory and compliance functions such as know your customer and anti-money laundering, which typically represent between 7% to 12% of costs.

Analysis : Equity markets in Europe : Autumn 2019

By
Ian Rycott
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LiquidMetrix analyses consolidated performance figures for equities and ETFs traded in Europe in the previous quarter.

LiquidMetrix’s unique benchmarking methodology provides accurate measurements of trends in market movements. We have seen many changes to market microstructure over the last year, and here we present statistics based on three quarters of 2019 as a guide on the current trend.

To give an overall indication of the market in 2019, we are comparing the Value Traded in Europe against the % Traded LIS. The trend from Q1 to Q2 was a steady increase in the %LIS against the general increase in value traded to its peak in June. Value Traded appears to have been on a slight decline from mid year with the downward trend continuing into the end of Q3. The % LIS, however, has remained consistent throughout the Q2/Q3 period.

One criteria to assess Venue quality is the % of times the Venue has a Best Price in the market. This is a measure of how competitive the Lit markets are, as its based upon the major index constitients of each market and includes both price ties and unique best price.

The Lit markets have altered characteristics compared against Q2, with the strength of the Primary Venues becoming a factor as there were significant decreases across all MFTs in best price ties across all markets, with the exception of Aquis solidifying its 2nd place ranking now on all markets.

The Market liquidity picture has against reversed the trend from the previous quarter, with a decrease in liquidity across all MTFs on all markets in Q3.

Some Primary markets appear to have benefited from the decline in available liquidity with increases on FTSE, DAX and OMX-s, but declines with the rest of the Venues on CAC and MIB.

The tables below give one method of how to assess performance of dark pools in Europe. For trades in each major index constituent stock we review the value traded during the period, the average trade size and the relative impact on the Lit market using as a measure the % of times there is a corresponding movement on the Lit market.

The largest change was on the DAX where Turquoise increased in traded value to overtake Chi-X.

Using the same methodology we assess performance of periodic auction venues together.

For the Periodic Auction Pools, Turquoise gained market share and ranking on DAX and OMX-S, with the ITG XPAC venue gaining on the MIB. Aquis went down in ranking on MIB and OMX-S.

With the dramatic changes in Trading landscape in July for Swiss Major stocks preventing trading on European MTFs, we take a look at how this may have affected Execution performance.

We can see from the chart below the fall off in volumes from the MTFs and the resultant increase in value traded on XSWX from July.

Spreads on appearance of by the reduction in competition as spreads were on par with those on XLON in April/May, but decreased in June prior to the regulatory changes, and continue to remain narrow. This may be due to the additional liquidity being present as a residual from the other markets.

ISS LiquidMetrix are pioneers in the measurement of European Fragmented markets, and provide research,TCA best execution and Surveillance for financial market participants and regulators – www.liquidmetrix.com

©BestExecution 2019

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MarketAxess Pushes Into Emerging Markets

By
Shanny Basar
-

MarketAxess expects further growth in the trading of emerging markets bonds as the electronic fixed income venue provider pushes onshore, provides more data and extends trading along the yield curve.

Craig McLeod, MarketAxess

Craig McLeod, co-head of emerging markets product management at MarketAxess, told Markets Media that emerging markets bond trading volume has had 30% annualised growth on the platform.

“This can continue as we push onshore and there is greater adoption of electronic trading,” he added. “Given the global regulatory landscape, there could be a similar kicker to growth as we have seen in credit in Europe in the last few years which was a function of MiFID II.”

MiFID II regulations came into force in the European Union at the start of last year and mandated best execution and reporting requirements in fixed income for the first time.

McLeod continued that MarketAxess is seeing adoption of electronic trading across emerging markets, which is being supported by regulators.

“In both Mexico and Brazil, regulators are encouraging electronic trading and Singapore is focused on best execution in foreign exchange markets which will likely spill over to fixed income,” he said.

This month MarketAxess reported that a record $131bn (€118bn) of emerging markets debt was traded on its platform, up 51% year-on-year. The number of active emerging markets participants reached a high of 1,135 firms in the past 12 months, 12% more than in the prior year.

“We are well-positioned in Asia and Latin America after putting more recent focus on building the onshore client base in those regions,” added McLeod.

MarketAxess covers 26 local emerging market currencies and aims to extend trading along the yield curve. McLeod added there is also some investor interest in frontier markets.

Asia

In its third quarter results MarketAxess highlighted that local currency trading grew strongly in Asian currencies to a record $7.4bn, up 154% on the third quarter of last year.

McLeod said: “In Asia, where regional dealers and local investors dominate their home markets, our technology is allowing them to extend their reach across the region and create new trading opportunities.”

Consultancy Greenwich Associates said in a report that there has been a clear acceleration of electronic bond trading in the region in the last three years due to uptake by regional banks.

Greenwich said regulatory and operational barriers in the region make it difficult for Asian banks to grow beyond their own borders. “Increasingly, therefore, they are looking to electronic platforms to help them build regional scale,” added the report.

The study found that global dealers continue to dominate in G3-denominated assets, but Asian banks have grown market share in both corporate and sovereign bonds from just over 3% in 2013 to more than 10% last year. However, in domestic currencies regional banks have overtaken the global dealers and now have more than 50% share in both markets.

“Across Asia, regional dealer share rose from 60% to 82% in local currency corporates, from 42% to 60% in sovereigns and overall from 47% to 66%,” said Greenwich. “Regional dealers are a powerful force in local markets.”

Ken Monahan, vice president, market structure and technology at Greenwich wrote in the study that Asia’s regional dealers are more aggressive in using electronic trading platforms that peers in other regions.

“Using the number of global dealers’ counterparties as a benchmark, regional dealers worldwide have 18% of the number of trading counterparties, while regional dealers in Asia have 31% as many,”added Monahan. “A strong local focus and aggressive use of electronic trading are part of the reason that local dealers have overtaken the global banks in local currency markets.”

All-to-all trading

McLeod continued that balance sheets in emerging market credit have shifted to regional dealers and Open Trading allows global asset managers to go straight to the bond holders. Open Trading, MarketAxess’ all-to-all trading protocol, allows multiple parties in a network to come together to trade, rather than the traditional model of only banks supplying liquidity to the buy side.

“Two years ago, Open Trading was 20% of EM hard currency activity and has grown to over 30% today,” added McLeod.

Ken Monahan, Greenwich Associates

Greenwich said MarketAxess has significant penetration into local Asian markets and Open Trading is growing rapidly. The study found that over a third of Asian regional dealers who are clients of MarketAxess Open Trading are only clients of Open Trading – and not the bilateral protocols.

“These Asian regional dealers that are Open Trading-only users account for 33% of the platform’s volume in Asia, a figure that is growing,” added the report. “As such, all-to-all trading is playing a unique role in Asia.”

McLeod agreed. He continued: “Regional banks in Asia do not have the salesforce to manage global distribution so Open Trading allows them to increase connections to many investors and clear risk more efficiently.”

Greenwich added that Bloomberg and Tradeweb also compete in Asia. “Bloomberg has a wide reach and, along with Tradeweb, has connections to Chinese markets through BondConnect,” said the report.

Block trading

In addition to the growth in all-to-all trading, MarketAxess has seen the expansion of block trading using the “Request for Market” (RFM) trading protocol in emerging markets. Investors trading emerging market local currency bonds can use an RFM inquiry and receive two-way pricing, which allows them to trade in larger size.

More than $9.3bn was traded via the RFM protocol in the third quarter of this year, up 141% from the same period last year.

McLeod said RFM for block trading has grown 150% in Asia.

“The average size of a block trade in local markets is $8m but the use of RFM has led to trades as large as $60m in Asia and $260m in Latin America,” he added. “Clients and dealers benefit from the protocol as there is no information disclosure and thus see additional liquidity and improved execution quality.”

He expects further growth in block trading and explained that another opportunity is that clients are asking for data that provides insight into the trading process to optimise execution outcomes.

“We also want to thoughtfully increase market transparency,” McLeod added. “The US has TRACE and our Trax data could provide similar data in emerging markets.”

Trax is MarketAxess’ reporting subsidiary.

Charity day

For the last 17 years, MarketAxess has hosted an Annual Emerging Markets Charity Trading Day, raising nearly $1.7m. MarketAxess will donate up to $300,000 from emerging market trading revenue from yesterday, October 23, to this cause.

IA Fintech Hub Celebrates First Anniversary

By
GlobalTrading
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The Investment Association, a trade body representing fund managers in the UK, officially launched Velocity, a fintech hub and accelerator for the buy side a year ago, and now wants to develop a taxonomy and expand internationally.

Keith Phillips, IA

Keith Phillips, membership & enterprise director at IA, told Markets Media that the launch of MiFID II, the European Union regulations that came into force at the start of last year, led to a huge uptick in fintechs and interest from asset managers.

“The IA is in a unique position next to the largest fintech hub on the planet,” said Phillips. “Asset managers are bombarded by fintechs and had a huge appetite to engage so we created a portal for the industry.”

The fintech membership program was set up to connect firms with buy-side organisations as the IA has more than 250 members who manage more than £7.7 ($9.9) trillion. The aim is to promote innovation which results in increased efficiency and better outcomes for clients.

“More than 120 fintechs have already connected and we get two to three enquires from fintechs every week,” added Phillips. “A specialist ecosystem of venture capitalists and consultancies is also emerging which we support if it helps the buy side.”

Due to the number of fintechs who have become members, the IA is going to develop a taxonomy for the firms including the asset class being covered, the position in the value chain and the underlying technology.

“The taxonomy will provide greater clarity,” said Phillips. “We will put the results on the website so it can be searched by asset managers and it will also allow us to identify trends.”

Accelerator

In October last year, the IA also unveiled the first cohort of five fintech firms who joined its fintech accelerator specifically for the asset management industry.

“We made a conscious decision not to be an incubator as the fintechs have to enterprise ready and solve an existing business problem,” added Phillips. “We are agnostic to the underlying technology but they have to make a difference to the asset management industry.”

In May this year IA unveiled the five firms which who were successful in joining the second Velocity cohort.

This month IA launched the search for the third cohort to join Velocity. Five new member firms who joined the cross-industry Velocity advisory panel, which will take part in the selection process – Citi, Columbia Threadneedle Investments, GAM, Insight Investment Management and Wesleyan.

“A big focus has been cloud-based fintechs using AI to unpack unstructured data and improve how data is utilised,” said Phillips.

He continued that one metric for Velocity’s success will be that the firms increase their market presence and gain traction with the buy side.

Birmingham

The IA is expanding its fintech program by creating Velocity Birmingham with Wesleyan. The new premises are set to open next month as a regional co-working space of 5,000 square feet in the centre of the city.

Fintechs can apply to become one of up to ten firms who will receive one year’s free co-working space and access to the IA’s expertise. The firms will be chosen by a panel led by Graham Kellen, chief digital officer of Schroders and chair of the Velocity advisory panel.

Phillips said: “We are seeing an enormous appetite for the Birmingham hub. Technology firms are finding coding and development talent in the West Midlands and also want to use Birmingham as an operating centre.”

International expansion

As well as expanding in the UK, the IA is looking to grow the fintech hub internationally.

Velocity has signed a partnership with  B-Hive, a fintech ecosystem based in Brussels, to promote pan-European collaboration. Velocity and B-Hive will share knowledge and expertise on technology trends and work together on joint events and training, and tackle common innovation challenges.

Phillips explained that Velocity is largest global fintech tub for the buy side and one fifth of its fintech members are international. Collaborations with other financial centres will be a priority next year.

He added: “There are more than 2,000 fintechs in the UK so we still have a way to go. It is an interesting time with the asset management industry at a nexus in terms of culture, ESG and technology.”

Should There Even Be a Market Data Debate?

By
Creating Digital
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Is the ongoing market data debate much ado about nothing?

Market data has become a battleground between exchanges, who generate data, and investment managers and brokers, who claim they are forced to buy proprietary data to meet a requirement to demonstrate they are getting the best deals for their customers.

Jack Miller, Baird

“It is clear that the fundamental processes of the buy side and sell side are becoming more data-driven and there is no question that the value and necessity of data is growing,” said Jack Miller, Head of Traders at Baird in New York. “But the market for such services is as much a function of the health of the consumers as it is for the value proposition of the suppliers. In this regard the exchanges have to walk a delicate balance insofar as they can leverage their value proposition without inflicting damage on a client base that is feeling the pinch on both the revenue and expense side of the equation.”

Under the current model, exchanges from the giant NYSE down to start up IEX, sell their own data products or share in the profits from the government-mandated Securities Information Processor (SIP) distribution of market data. And while the reasonableness of the revenue or profit generated from market data is in the eye of the beholder, the market framework, Miller explained, needs to achieve a balance where competitive forces can keep the prices of such services in check.

Nasdaq, which has cited its Global Information Services unit as a chief driver of growth, has weighed in on the discussion with an effort to combat misconceptions around its data business. In a bid to be more transparent, Nasdaq shared some revenue data not previously publicly disclosed in an article published in late September. The hope is that its candid disclosure will prompt other exchanges to step forward with similar transparency.

“We want to engage with stakeholders on market data, but we want to engage with the facts,” said Jeff Kimsey, Vice President and Head of Data Products for Nasdaq’s Global Information Services. “Our markets are too important to base our discussions on hyperbole or misconceptions. We took the step of disclosing meaningful revenue data in the interest of transparency and to put proper perspective on this important issue.”

Jeff Kimsey, Nasdaq

Kimsey noted that stock exchanges are one of the smallest expense factors in the financial ecosystem, as pointed out by Nasdaq Chief Economist Phil Mackintosh in his article, The Big Picture on the Data Debate. Mackintosh noted total exchange costs to the industry and investors is collectively about $1.5 billion per year, a tiny fraction compared to the $50 billion each year generated in investment advisory fees and management fees, and the $31.8 billion the top five investment banks make annually in equity trading revenues, according to a Trefis study highlighted in Forbes this summer. Overall, exchange fees amount to approximately 1.18% of total investor costs.

He added that the cost of market data fees available from Nasdaq have not risen as much as some would like to think. “For U.S. equity market data products offered by Nasdaq, the compound annual growth rate (CAGR) of revenue associated with price changes from 2009 through 2018 is 2.4%, or 1.8% when adjusted for inflation. That’s a far cry from 14% claimed by some.

Overall revenue growth (CAGR) across all of Nasdaq’s U.S. equity market data products, from 2009 through 2018 was 6.6%.”

Kimsey said equity exchange data fees paid to Nasdaq since 2009 post an average annual price change of only 2.4%. That, he noted, basically mirrors the rate of inflation during the same period.

He also sought to debunk the theory that brokers are forced to buy proprietary data products. “Our data shows the following rates of traction on the part of Nasdaq proprietary data products: Only nine percent of our clients take data from Nasdaq directly; most recipients of Nasdaq data pay an intermediary to receive it. Just one third—33%—of our U.S. equity data clients take depth-of-book data. And the percentage of our equity data clients who use colocation services in the U.S. tops out at 27%. These are hardly majorities.”

Spencer Mindlin, capital markets analyst at Aite Group, said that data fees aren’t so much of an issue as many make would like it to be but rather just a good incendiary talking point.

Spencer Mindlin, Aite Group

“The reality is market data fees is a relatively small cost to an end investor,” Mindlin began. “Generally, the debate around market data is between exchanges and their customers, with the regulators stuck in the middle. For sure, larger firms can more easily carry costs; smaller firms will feel them more. But it’s important to consider the all-in costs to transact on an exchange in order to be intellectually honest about the impact of exchange fees.”

Mindlin said exchanges could move the debate if they were to provide more justification on their overhead and what informs their price setting decisions. “The fact that exchanges, notably international exchanges, have such dramatic differences in prices is telling about how opaque the market for market data is – and it’s rarely discussed,” Mindlin said. “Many of these exchanges seem to price data arbitrarily, meaning it is unclear what actual operational overhead informs these pricing decisions.”

Jim Angel, adjunct professor at the McDonough School of Business at Georgetown University the market data issue is extremely thorny and will likely be debated for some time.

James Angel, Georgetown University

“We have been arguing over market data for over a century, and we will continue to argue over it for the next century,” Angel said. “Data is the new oil. Good data are essential for fair and orderly markets.  The problem is how we define property rights in data.  Right now, we have nationalized the top of book and last sale into Stalinist collectives known as NMS plans. We clearly need to improve the governance there.”

There is no obvious good solution, Angel said. The data business is one with very high fixed costs and very low marginal costs, and that leads to what he termed, ”weird economics.”  Furthermore, the exchanges produce what economists call “joint products.”  For example, similar to how a sheep produces both meat and wool, and exchange produces both trade matching and data.

“Any attempt at cost-based pricing quickly runs into the problem of how you allocate the high fixed costs. For the sheep, how much does it cost to produce the wool?  How much of the feed should be allocated to the wool versus the meat? For the exchanges, how much of the cost of the data centers and the software belongs to the trade matching versus the data?  There is no perfect way to determine costs,” Angel said.

FinServ Ramps Up Machine Learning

By
Shanny Basar
-

Two thirds of financial services firms currently deploy machine learning and expect to increase their use of the technology within the next three years.

The Bank of England and the UK Financial Conduct Authority conducted a joint survey this year on the current use of machine learning, a methodology where computer programmes fit a model or recognise patterns from data, without being explicitly programmed and with limited or no human intervention. This contrasts with ‘rules-based algorithms’ where the human programmer explicitly decides what decisions are being taken under which states of the world.

The study said the median firm uses live machine learning applications in two business areas and this is expected to more than double within the next three years.

The survey was sent to almost 300 firms, including banks, credit brokers, e-money institutions, financial market infrastructure firms, investment managers, insurers, non-bank lenders and principal trading firms, and received 106 responses.

Mark Carney, governor of the Bank of England, said in his annual speech at the Lord Mayor’s Banquet for Bankers and Merchants of the City of London  in June this year that a new economy is emerging which is driven by changes in technology, demographics and the environment and which requires a new finance.

Mark Carney, Bank of England
Mark Carney, Bank of England

Carney said: “With its leadership in fintech and green finance, the UK private sector is creating the new finance, but your efforts will be more effective with the right conditions in which to innovate and the level playing fields on which to compete.”

The study said firms were using machine learning in cases ranging from equity trading to optimize order-routing and deal execution to anti-money laundering where the technology is used to analyse millions of documents for ‘know-your-customer’ checks. Insurance and banking had the most live cases in the sample with the median bank having 5.5 machine learning applications.

“Larger firms may possibly be more advanced in their ML deployment due to benefits of scale, access to data, ability to attract ML talent, or greater resources,” said the study. “However, more research would be needed to shed light on the specific reasons for sectoral differences.”

The median respondent expects their number of machine learning applications to more than double over the next three years although banking expects growth to almost triple to 15.5 applications.

“This underlines growing interest in ML and the prospect of increasing use across the financial sector in coming years,” said the survey.

Use cases

The survey found that machine learning is used in sales and trading to increase speed and accuracy of processing orders; in pricing through combining a large number of market time-series to arrive at an estimate of a short-term fair value; and in execution to evaluate venue, timing and order size choices.

“Within this, ML may also be used for intermediate steps of the process; for instance, for calculating the probability of an order being filled given the available characteristics of the order,” added the study. “Firms use ML techniques to determine order routing logic, this is often contained within systems called smart order routers or broker/algo wheels.”

Data used is still largely of a traditional, structured type but some firms also use unstructured data, such as text data, to estimate prices in illiquid markets.

In asset management machine learning often plays a supporting role according to the survey. Applications are used to analyse large amounts of data from diverse sources and in different formats; to assist in establishing a fair market price for a security; support decision-making processes by linking data points and finding relationships across a large number of sources; and sift through vast amounts of news feeds to extract useful insights.

The CFA Institute said in a new report that AI and big data allow analysts to perform more thorough analysis and for portfolio managers to make better informed decisions.

Larry Cao said in a blog that, for example, analysts can estimate staffing levels at Tesla using publicly available cell-phone data.

“In fact, that’s precisely what Thasos Group did,” he wrote. “By gauging the number of cell phones present near Tesla’s plant, they independently verified that Tesla was running around the clock with three full shifts.”

He also gave the example of analysts at Goldman Sachs overlaying publicly available labor information on top of the geometric data of production sites to estimate the market power of manufacturers in aggregate.

Cao concluded that AI will transform investment management, but it will not lead to the mass extinction of human investment managers.

“Rather those investment teams that successfully adapt to the evolving landscape will persevere,” said Cao. “Those that don’t, will render themselves obsolete.”

Consultancy Greenwich Associates said in a survey this month that 44% of capital markets firms are already using artificial intelligence in their trading processes.

Almost one-fifth, 17%, of firms reported plans to implement AI in trading in the next 12 to 24 months with four out of five expect AI and/or machine learning to be fully integrated into the trading process in three to five years.

Kevin McPartland
Kevin McPartland, Greenwich Associates

Kevin McPartland, head of research in Greenwich Associates market structure and technology group, said in a statement: “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.”

Next steps

The Bank of England and the FCA said their survey is the first step towards better understanding the impact of machine learning. The Bank of England and the FCA are also establishing a public-private working group to explore some of the questions raised by the study and will consider repeating the survey next year.

TCA Q&A: Dave Cushing, Clearpool

By
Markets Media
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Clearpool Group in June appointed trading and market strategies expert and Transaction Cost Analysis pioneer Dave Cushing as Advisor. Markets Media recently caught up with Cushing to discuss the state of TCA.

Can you provide an overview of TCA, from past to present?

Dave Cushing, Clearpool

For better or for worse, I’ve been around since essentially the inception of TCA in the mid 1980s. I have seen it evolve from small-scale datasets, with not necessarily great timestamps, and with limited ability to create unique benchmarks using tick data and other data sources around that execution data. Now in our age of big data, atomic clocks, cloud, AI and everything else, there has been an explosion in the ability to do more sophisticated work.

But it’s still very difficult to do high-quality TCA, because the data is noisy, because there are many factors outside the trader’s control, and because datasets can be incomplete. So even though we have much better tools at our disposal today, in some ways the challenges that have been part of TCA since the beginning are still with us.

What’s helping TCA now is that there is a regulatory imperative to invest more in this area, and firms need to eke out every last basis point of alpha. So tools are improving, datasets are larger and cleaner, timestamps are better, and computing power is cheaper. So I think we’ll start to see the actual practice improve in quality and sophistication because of these surrounding factors.

In a way, people are the limiting factor in TCA. I’m hoping to see an industry awakening to the greater performance that a well-crafted TCA approach can bring. There is a lot more potential to be unlocked as people become more curious and more systematic about how they approach it. So as the data, the visualization, the processes, and the automation around TCA continue to improve, people will come along with it.

What are you hearing from buy-side and sell-side market participants regarding TCA?

A point of focus is having data be both accurate and rich, and then being able to conveniently access the insights contained in that data.

The state of the art is evolving here, and I think there’s going to be a lot of value placed on being able to attack this on the scale it needs to be attacked. But there’s also a counterbalancing of being accessible and being actionable. You can spend a lot of money building a repository and building analytics that sit in that repository, but then if you don’t know where and how and when to apply that information, its value will be underutilized. And by the same token, you can build analytics, but if you don’t have the data to go with it, then you have an incomplete picture.

It’s essential to have both of those things — have the underlying infrastructure be both accurate and complete, and have the right tools sitting on top of that. People approach this from a lot of different perspectives, and you want to be able to reach as broad of a swath of people as possible. So that means you have to be really thoughtful about what does the interface look like, how does it function, where does it function? How easy is it to customize? These are all really important questions, and we’re trying to find that sweet spot via Clearpool’s Venue Analysis and other trading tools.

What attracted you to the position at Clearpool?

Clearpool has a state-of-the-art infrastructure, and because they run so much volume through their platform, they have what’s needed to produce meaningful analytics at scale. Those are a couple of the things that attracted me to partnering with Clearpool as an advisor. Many places don’t have enough data, or they don’t have enough development resources or compute power for TCA. Clearpool has all of that in place, and the tools built on top of that are very visual and very intuitive. They make it easy to ask scientifically based questions about choices that traders are making, and the consequences in terms of cost or execution quality of those choices. Bringing those analytics to the point of sale is really powerful.

In my role, I want to help Clearpool shape the form, the timing, and the delivery method of those analytics to make it easier for a trader or an analyst to drill into the data. What’s needed is insight — insight into venue selection, insight into order types, insight into the settings for those order types. From there the trader or analyst can begin to improve the foundation, and then elevate those improvements to ultimately be able to match the order type to the tools in an optimal way.

What is the future of TCA?

There’s going to be a more sophisticated repository for data, and there’s going to be more control over that repository. Firms spend a lot of money to try to get data right. I think in a few years we’re going to see some robust solutions that have complete and accurate data, and in a way that the firms who generated that data don’t lose control of it. Control is going to be a big theme, as people are going to insist on having more control.

We’ll also see the sophistication of analytics improve, as well as the ability to differentiate between things that don’t matter and things that do.

If we’re looking three-plus years out, I think things like AI will play a big role, because it’s well-suited to TCA. These are huge datasets with lots of different ways to look at them, and people need all the help they can get to look at that data most productively. AI won’t necessarily give you the answers, but it will help people zero in on what data matters most.

Today it’s more of a one-way cycle, where you place the order, you get the execution, you analyze the execution and you measure the quality. But the future will be about the ability to take that output and cycle it back to the front end of the process, so you can complete that loop, and more actionable insights will come out of the data.

Profile : Charlotte Crosswell : Innovate Finance

By
Ian Rycott
-

Charlotte Crosswell, CEO, Innovate Finance explains how fintechs are reshaping the financial services landscape.

What are the challenges facing the financial services firms and how can fintechs help provide solutions? Where are the biggest problems that need to be addressed today?

The challenges depend on the vertical you are talking about, but we are seeing constant advances in fintech adoption. For example, we have seen significant advances in regtech as banks want to have more compliance solutions that use technology such as AI. I think this will continue as we see support from government and regulators such as the Financial Conduct Authority who are looking at machine readable handbooks.

Not surprisingly, data and connectivity are also huge challenges. It is not easy to connect the pipes across countries because of the different regulations across regions. For example, the UK has adopted Open Banking in addition to the European Union’s Payment Services Directive (PSD2). As for data, the industry is constantly looking at data, but the challenge is how can they retrieve and fully maximise the impact it can have. There should be more focus on analysis of behaviour and how the ecosystem is changing. Take the insurance industry. In the past, people would look to purchase cars, but now they may lease them with insurance included, so insurance companies may be disrupted with these changing trends and will need to better compete with each other and develop products that customers want.

What are some of the major trends in the fintech space – such as the move to B to B from B to C, partnerships between banks and fintechs, etc?

Fintech is not a magic bullet. Although this is often talked about as a decade of change, it is still a nascent industry and I think we are just at the beginning. That said, we have already adopted many changes. In the beginning, banks saw fintechs as disrupters and wanted to keep them at bay, but subsequently realised that they needed to become more innovative or they would risk losing out. They started out buying fintechs, or supporting innovative start-ups, in order to keep a competitive edge. However, today there is a real focus on collaboration and partnerships to solve some of the problems. They may be off a bank’s balance sheet but their solutions are being embedded within the organisations, which is a more efficient way than the banks building it themselves.

London just overtook New York for investment – what are the reasons and are there concerns that this could change if there is Brexit?

Our research showed that London overtook New York in a ranking of cities that attracted the most funding for financial technology firms. The city’s fintech sector attracted 114 deals worth a combined £1.6bn so far this year, which was ahead of New York’s 101 deals, which were worth £1.5bn. The attraction of the city is that it is a major financial centre, has a deep technology talent pool and supportive regulation.

In terms of Brexit readiness, fintech firms in the UK are getting on with business as usual and have spent time and money preparing. fintech companies are nimble and can respond quickly, although the longer it drags on it creates uncertainty, which is never good for any business. We did some analysis this summer and found that 43% of respondents believed passporting, cross-border transactions and servicing EU clients will be the most affected areas by Brexit, while 17% were considering moving to a different jurisdiction. 23% wanted additional information from government about trade. They would also like more information on how data sharing across borders would work.

What role can Innovate Finance play?

We have been in regular communication with the government and regulators over the past weeks and months, so that we can help our members navigate through this situation and provide information and education. Our role is also about promoting the UK sector internationally. I do not see any reason why fintech business should not stay in the UK. The country has embraced financial services innovation and fintech and I think it is in a unique position. Not only does it have the talent and a major financial services centre, but also importantly, government and regulatory support. We do not just have fintechs sitting around our table but also investors, regulators and government ministers.

This is not the case in other countries which only have the fintechs. There is also a greater understanding in the UK about the industry as a whole. In the US, for example, the West Coast knows about tech and investment but not necessarily about fintech, while the East Coast and Wall Street will understand the benefits of fintech.

How is your Innovate Finance Women in FinTech Powerlist helping things move forward? 

One of the problems is that fintech is a male dominated industry, often born from financial services and technology. The latest statistics show women account for 29% of total employees in the UK fintech sector, but only 17% are senior executives. Our own research has shown that female founders continue to struggle to raise capital. Only 3% of venture capital investment in the UK in 2018 went to fintech firms with a woman founder or co-founder. And this is despite the fact that female backed businesses are typically more successful than male backed ones, both in terms of revenue and return on investment. One of the problems is that many women struggle to get in front of venture capitalists, which are largely led by men. We are trying to create networks that create more warm introductions for women, and the ability to tap into a person’s personal networks.

Things are changing, but not fast enough. When the Women in FinTech Powerlist was first launched in 2015, there were only 100 applicants. Last year we were given 1,200 names. The Powerlist showcases 150 women in the industry, with 35 standout females selected by a judging panel. It aims to raise the profile of women in the industry, but making it onto the list is not just about launching a company, it’s also giving back to the community and making a real impact over and above their day-to-day role in fintech.

There is also a war for digital talent. How can the UK better develop the skillsets needed? Can you tell me more about your FinTech for Schools initiative project?

We definitely need a better skillset in the industry, whether it be coders, data engineers or scientists. Again, it is about collaboration and getting industry to work together with schools and universities in terms of how the curriculum should change. It also means talking to careers officers and teachers and explaining the careers and skills needed for jobs in these areas.

We launched the FinTech for Schools initiative earlier this year to help young people better understand how they may interact and use fintech, as well as the increasing importance of digital skills in the workplace, with a focus on making the sector more attractive to girls. We bring in founders to talk to the students about the types of jobs available in the sector, about innovation and the need for more of them to learn STEM skills. But we also focus on how digital solutions can be applied to every day financial issues and how they can use them. For example, around 16 million people in this country have less than a hundred pounds in savings and many rely on payday lenders as their only source of funds when they don’t think banking can help them. We show them how fintech companies can help solve these problems and give more businesses and consumers access to a wider set of financial products.

Biography:

Charlotte Crosswell is the CEO of Innovate Finance, the UK membership body representing the fintech industry. She has spent most of her financial services career in market infrastructure roles. Prior to joining Innovate Finance, Charlotte was Founder and CEO at two Nasdaq owned London start up exchanges in equities and fixed income, and sat on the board of LCH Ltd. She has held a number of management positions at Nasdaq and London Stock Exchange across international capital markets, equities, fixed income, OTC derivatives trading and clearing.

Crosswell also sits on the boards of government fintech advisory groups, technology companies and fintech start-ups. and has been working with technology companies throughout her career. Charlotte holds a BA (Hons) in French from Southampton University. She has been included in the list of top 100 Women in Finance over many years.

©Best Execution 2019

PAST INTERVIEWS:

Best Execution 10th Anniversary : Charlotte Crosswell

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Buyside profile : Gianluca Minieri : The liquidity paradox

By
Ian Rycott
-

Gianluca Minieri, Deputy Global Head of Trading CEO of Amundi Intermediation UK and Ireland assesses the current trading landscape and how the industry and firm are navigating their way through.

Gianluca Minieri is the Deputy Global Head of Trading and the CEO of Amundi Intermediation UK and Ireland. Before joining Amundi, he was the Global Head of Trading at Pioneer investments and the CEO of Pioneer Investments – UK. Prior to joining Pioneer Investments, Minieri was the CEO and CIO of Monte Paschi Ireland Ltd. He also worked and was responsible for proprietary trading in Banca 121, Italy, where he previously held the role of Head of Risk Management. Before this, he served as a Consultant in Arthur Andersen. Minieri holds an MBA with the SAA Business School in Turin and a specialisation in Finance through The Pace University and the Manhattan Institute of Management of New York. Gianluca holds a first-class honours degree in Economics and Banking Sciences. He is also a Certified Public Accountant.

There are a number of reports on the dearth of liquidity in the market. Has it got worse?

I agree, there have been several articles about the dearth of liquidity. In my view the situation of liquidity today is a paradox. From a macro perspective, there has been an abundance of liquidity due to the accommodative monetary policy and ultra-low interest rate environment. It is different on the micro level (financial markets) where liquidity has significantly contracted because of the structural changes in the market. In general, I would say that the liquidity is more fragile and less resilient. There is a perception that, during normal market conditions it is fine, but it vanishes when you need it the most.

What are the key drivers?

There have been a few key drivers. One is that of the intervention of regulations, the most recent being MiFID II, which have impacted market makers such as banks who acted as shock absorbers and important sources of liquidity. This changed because of increased capital charges and ratios. The regulations have also created a battlefield where exchanges compete on price. Each of them is trying to create its own value proposition but this has led to increased fragmentation of liquidity across different asset classes and currencies. For example, in the US, there are 13 different exchanges, in addition to alternative platforms and dark pools.

There has also been a contraction and reduced profitability in the repo markets due to this ultra-low interest rate environment. A less profitable repo market translates into less liquidity in secondary markets, given that is the place where market makers refinance their long-term positions overnight.

The other driver is changing investment trends. While we are all happy with greater automation and electronification, we have seen a proliferation in quantitative strategies and passive investing such as exchange traded products and systematic trading. The problem is that these strategies are takers of liquidity and can become forced sellers when market conditions are volatile, exacerbating ordinary market downturns.

How can buyside trading desks respond to the challenges. What tools and skills do they need?

As with many functions, you need to have a strong infrastructure and ensure that leading edge technology is at the core of the trading system. You need the tools that can find liquidity efficiently and at a competitive price. This includes an integrated order and execution management system, connectivity to electronic platforms, direct market access, smart order routers, algos, etc.

As for skills, the technology does not diminish the need for human competencies. If you are a driver of the latest racing car, you need to be an even more experienced driver behind the wheel. In the same way, these new powerful and sophisticated systems require people who can manage technological complexity. When I first started, all I needed was a phone, but today you need people who can understand the vast quantities of data for pre and post trade analysis, to make price feeds and for execution. They also need to be able to carry out market intelligence and add value to the investment process. You should also not underestimate the importance of a rare skill – common sense.

Geopolitical tensions are rising. How have they impacted trading?

Geopolitical events have always impacted financial markets, but I think they affect some countries more than others. For example, Europe and US are more mature and are impacted less than emerging markets, which are more fragile and where geopolitical tensions can more easily lead to a deterioration in liquidity. That is why nowadays you need to be able to source liquidity from all available sources. However, relationships, even in these technological times, are also very important especially in stressed situations. We believe that maintaining several long-term, trusted relationships has helped us gather reliable liquidity insight and provide market intelligence to our portfolio managers so that they can make better-informed investment decisions.

How has the prolonged low interest rate environment changed investment?

Asset managers are looking to achieve a better return at a lower cost, and if you look at the strategies that we manage today, they are more sophisticated and encompass different asset classes and currencies. I think cost will continue to be a main motivator and we will continue to see more assets gather around passive products.

In general, how has the role of the fixed income buyside trader changed over the years? How has your role changed?

As a result of the trends mentioned, we are hiring more people on the desk that have a quantitative background, who understand algos but can also evaluate financial markets with a more fundamental approach. From my point of view, our role has completely changed because of the increased competition and sophisticated investment strategies. Liquidity has become a key factor when building the investment process and this has meant that our role is not just about pure execution but also advisory. They need people who can provide support, manage the pre and post trade analysis and understand the role that liquidity plays in the investment process.

What impact has MiFID II had on trading?

I think one of the consequences is that it has made principal trading more expensive for banks and as a result has reduced the ability for markets to absorb shocks. We have also seen traditional market makers being replaced by high frequency traders. I am one of their fiercest opponents because I see them as opportunistic. In my view, they might have the advantage in terms of market data but there is a gap in their fundamental analysis. This means when there is a fundamental shift in the market, their machines do not know what is going on and they pull out of the market which in turn reduces the level of liquidity and contributes to exacerbate market downturns.

Data has become a hot topic for every asset class. What role is it playing in fixed income and how is it contributing to better decision making?

Effectively managing data has become key. We have an entire data management division at Amundi but we are also hiring data scientists on our team in order to produce quantitative measurements that can prove the added value to the investment process, as well as execution, and our performance against benchmarks.

Looking ahead what do you see as the biggest challenges and opportunities?

Taking the challenges first, it is no surprise that we need to continue to maintain a trading infrastructure that is technologically up to speed with the requirements of today but that can also meet the complexities of the future. These are very capital intensive investments and I think small to medium sized asset managers will find it difficult to make the investments that are required. Large asset managers like us will have a competitive advantage given that we can leverage on our economies of scale and global reach.

As for the opportunities, I see the role of the larger asset manager, who has the proper technological infrastructure, changing from price taker to price maker. Asset managers in general are holders of large inventories of bonds and unlike banks do not have to re-finance their long maturity inventory every day in the overnight repo market. As a result, they are better placed to provide liquidity to each other. There are several new initiatives such as all-to-all trading protocols which will give buyside firms the confidence to trade with each other.

©Best Execution 2019

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Viewpoint : ESG Investment : Serafino Tavoletti

By
Ian Rycott
-

SUSTAINABLE, GREENER FUTURES.

Serafino Tavoletti, Market Hub Brokerage & Execution, Banca IMI

Serafino Tavoletti, Market Hub Brokerage & Execution, Banca IMI

Incorporating environmental, social and corporate governance (ESG) factors in investment strategies has become a distinct service for many providers of investment products. ESG investing is an approach that focuses on several non-financial dimensions of a stock’s performance, including the impact of the company on the environment, a social dimension and governance. This investment philosophy has been gaining momentum, not only in Europe, but across the globe, becoming the most widely used strategy by SRI investors and there is rising interest by “millennials funds”. Let’s have a look at these 3 factors.

Environmental criteria look at a company’s energy use, waste, pollution, natural resource conservation and animal treatment. They also evaluate which environmental risks might affect a company’s income and how the company is managing those risks.

Social criteria look at the company’s business relationships. In other words, it is about the impact that a company can have on their employees and on society: diversity and inclusion policies, safe and healthy working conditions, labour standards across supply chains, and good relationships with local communities.

Governance factors focus on corporate policies and how companies are governed. Responsibilities, rights, and expectations of stakeholders are considered, so that interests are met and a consensus on a company’s long-term strategy is achieved. Illegal behaviour or the use of political contributions to obtain favourable treatment are among the screening criteria.

For each of these dimensions, a lot of information on the firm’s practices is being collected and analysed. ESG investing relies on the belief that both investors and society benefit by including ESG information. This means that capital is being invested to ensure that today’s investment needs are met without endangering future generations.

It’s still early days and challenges remain over the different definitions, lack of standards and varying market structures, but the adoption of this approach is spreading rapidly and increasing amounts of money are flowing into funds that consider ESG factors in their investment process. Morningstar estimates that Ä34.4 billion flowed into European ESG funds in 2018, bringing the total assets under management to Ä684 billion at year-end.

It was just a matter of time before the ESG movement moved from the equities sphere across fixed income and listed derivatives. This is well reflected in the product range of index providers and derivatives exchanges. The most recent examples are in Europe, where two leading exchanges have launched futures on stock market indices that meet ESG standards. Nasdaq was the first exchange to move into this new sector in October 2018; the exchange launched futures on a version of the OMX Stockholm 30, the main benchmark for Swedish stocks, that excludes companies that fail to meet ESG standards. Plans are also underway for a corresponding ESG index of the OMXC25 in Denmark and the OMXH25 in Finland.

In February, Eurex introduced the Stoxx Europe 600 ESG-X Index, a version of the large-cap Stoxx Europe 600 that screens out companies with low ESG rankings and the Euro Stoxx 50 Low Carbon Index based on the Euro Stoxx 50. It also launched the Stoxx Europe Climate Impact Index, a group of roughly 260 European corporations that disclose the environmental impact of their businesses and excludes companies in industries such as coal, aiming to help market participants address the challenges and opportunities of sustainable investing. Eurex also gained CFTC approval to make these products available to US investor and is working to expand the product range to cover more regions together with the introduction of options to support market participants with efficient derivatives instruments and meet the requirement to incorporate ESG into their investment strategies.

Open interest in the Nordic exchange has been relatively stable with an average of 27,500 contracts, the equivalent of Ä415 million. Eurex on the other hand has seen a growth since its birth, showing in 7 months an average open interest of 40,000 contracts, around Ä570 million. However, it’s still too early to see consistent volumes and regular activity. Despite this variability, the books are liquid, showing decent bid /offer spread thanks to liquidity providers.

The introduction of listed derivatives has been crucial because it gives asset managers more flexibility to hedge their portfolios, create synthetic positions, manage unwanted sustainability risks and meet investment mandates in a cost-effective way, compared to capital intensive products like ETFs or structured products.

One aspect to consider though is the fact that ESG can be confusing for investors who are familiar with the classic socially responsible investing (SRI) methodology. ESG investors choose companies because of impressive environmental, social and governance attributes; conversely, a traditional SRI investor focuses on excluding certain industries (tobacco, alcohol, weapons, gambling). ESG offers more flexibility and depth of research to define a comprehensive corporate initiative and management’s patterns. Moreover, ESG is also a stakeholder-centric theory, which means how companies treat all their stakeholders will impact their long-term success or failure.

Despite the proliferation of sustainability indices and ESG agencies, there is no standard methodology for the evaluation of companies. Recent work done by the European Commission to develop a ‘taxonomy’ aims to develop a ‘universal understanding’ of what is environmentally sustainable, shared by scientists, governments and industrialists. A proposal for a regulation has been brought forward to introduce disclosure obligations on how institutional investors and asset managers integrate environmental, social and governance factors in their risk processes. We expect this to become mainstream in the coming years, with positions slowly shifting from traditional benchmarks to more sustainable alternatives.

Through its 2018-2021 business plan, Intesa Sanpaolo, which is already a leading bank in corporate social responsibility, aspires to become a world-class reference model on social and cultural responsibility. Furthermore, Market Hub, the brokerage & execution team of Banca IMI, provides to its clients full access to trade ESG-related financial products, giving the opportunity to exploit these increasingly relevant products.

©Best Execution 2019
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