As inputs for investment decision-making expand, processes to implement the decisions become more complex, and regulation gets more exacting, institutional technology systems need to keep up.

The investment-management business is moving toward open, modular frameworks that enable the most efficient workflows, but the shift has been gradual and the landscape remains cluttered with legacy processes. Older systems are typically clunky and siloed, with limited interoperability — in short, ill-suited to meet the needs of today’s investment decision makers  

“Buy-side firms see opportunities around alternative data and content, and new technologies like machine learning and AI, and what it all brings to the investment process,” said Kristina Karnovsky, Head of Research Business at FactSet Research Systems. “The question then becomes how to apply it and integrate it, and how to bring the whole investment-management platform forward to the next generation.”

Alternative data was an input in investment decision-making at 79% of financial firms in the third quarter of 2018, and four of five non-users plan to use alt data within a year, according to a WBR Insights survey of 100 portfolio managers and traders. With regard to artificial intelligence, 83% of buy-side firms are at least in the planning or research phase, and 61% expect to increase spending on the emerging technology over the next year, according to a separate Tabb Group survey.

Next-gen buy-side research systems can be considered a manifestation of the Fourth Industrial Revolution, also known as the second machine age, which is characterized by a fusion of physical and digital systems. “This is impacting every industry, not just financial services, and it is very exciting,” Karnovsky said.

“As technology providers, we need to think about how to help firms ingest new content types in frictionless and seamless ways,” Karnovsky told Markets Media. “Ultimately it means that there’s an opportunity for much greater connectivity and efficiency for our buy-side clients.”

‘Major Shift’

“There is a major shift happening in the production, distribution and consumption of research,” said David Easthope, who leads the Capital Markets practice at consultancy Celent.  

The tech evolution has centered around the research management system, which Easthope calls the nerve center of buy-side investment decision making. “The RMS is what supports analytics, news, broker research, company meetings, internal research notes, email, chat, contacts, earnings calls — all kinds of data flows.”   

Legacy systems spanned disparate parts that often didn’t work with each other, Easthope noted. “You might have email here, and your appointments and contacts in Outlook,” he said. “Something is on desktop, something else is on the shared drive. You have this on mobile and don’t have it on desktop, or vice versa.”

The challenge was replacing the shared-drive approach with a seamless, interoperable system to store, manage, tag, and aggregate data, that works across functions. Tech providers have done this, and they continue to raise the bar with improvements and upgrades.    

“Ultimately, why does all this matter?” Easthope asked. “Because it supports the investment workflow, the automation, the decisioning, and the supporting of recommendations from the analyst to the PM. And everyone can see it.”

One regulatory impetus for next-gen research systems is MiFID II, which requires that buy-side firms budget for, price, and justify research. The sweeping European ruleset took effect in January 2018 and effectively mandates firms bring systematization and transparency to an area that historically has had little of either.  

“Buy-side firm are under greater scrutiny to be transparent to asset owners on how they arrive at their recommendations,” Easthope added. “That transparency is not cheap — you need the right tools and the right technology.”

FactSet’s Karnovsky said that especially in light of constraints such as MiFID II and buy-side fee compression, firms’ research platforms must be up to speed.

“It’s critical that the insights derived from new content types make their way through the investment process in an efficient way,” she said. “All of the data has to be consistent, and systems need fast and high-quality integration. For example, a portfolio manager’s portal can have the notes from the research analyst’s work, right inside the portfolio dashboard where they can do trade simulation.”

“New content and new technologies are driving every industry, and financial services is no exception,” Karnovsky concluded. “How firms can tap into the opportunities that brings is going to determine success or failure.”

European investors said the majority of their exchange-traded investments are strategic, as opposed to tactical, in nature for the first time since consultancy Greenwich Associates began carrying out its annual survey in the region in 2014.

Greenwich Associates’ report, In Turbulent Times, European Institutions Turn to ETFs, said allocations to ETFs by institutions increased by 50% in last year, totalling 15% of total assets among the 127 institutional investors participating in the study.

*New* In Turbulent Times, European Institutions Turn to ETFs https://t.co/CpwNPEETNg via @GreenwichAssoc by #AndrewMcCollum pic.twitter.com/mEvPFyejPW

— Coalition Greenwich (a division of CRISIL) (@CoalitionGrnwch) February 28, 2019

“European institutions are increasingly using ETFs to obtain long-term investment exposures that play critical, strategic roles in their portfolios,” said the report. “For the first time since the debut of this study, European investors say the majority of their ETF investments are strategic, as opposed to tactical in nature.”

Approximately 60% of respondents used ETFs to obtain investment exposures in “core allocations” last year, up from 47% in 2017.

“The share using ETFs for international diversification—another critical strategic function— increased to 58% from 48%,” added the report.

Andrew McCollum, managing director at Greenwich Associates, who advises on the investment management market globally, said in the report that nearly 40% of existing institutional ETF investors plan to increase allocations this year.

ETF allocations were 15% of total assets last year, up from 10% in 2017 and almost double the 7.6% in 2016.

Globally ETFs had inflows of $315.8bn last year, the second-highest on record following the all-time high in 2017. Greenwich noted that last year’s inflows occurred despite volatile market conditions and the deep sell-off in global equity markets.

A respondent from a large UK investment manager said in the report that ETFs offer the “ease of affecting lower operational risk at a reasonable price.”

Fixed income

Greenwich said equity ETF investors more than doubled their allocations to approximately 28% of total assets last year, from 14.4% in 2017. In fixed income, ETF allocations doubled to 20% of total assets from just 6.5% in 2017.

“Bond ETF allocations were largest among institutional funds, at nearly a quarter of total fixed-income assets,” said Greenwich.

Approximately one fifth of current ETF investors expect to increase allocations in this year.

In addition nearly two-thirds, 61% of professional investors, expect flows into fixed income investment vehicles to increase this year when compared to 2018, according to a new survey from Tabula Investment Management, the European fixed income ETF provider.

“Increased flows could be partly fuelled by growing innovation in the fixed income ETF sector, with 69% of professional investors expecting up tick year,” said Tabula. “This could be reflected in more fixed income ETFs being launched in 2019  – 8% of professional investors expect to see a ‘dramatic’ increase in the number listed, and a further 43% anticipate a smaller increase.”

Tabula’s survey found that 70% of institutional investors said it is important that the new ETFs specialise in certain areas and develop propositions around this,  and 62% said this about having unique and innovative products.

Michael John Lytle, chief executive of Tabula said in a statement: “Flows into fixed income investments, particularly through ETFs, have increased. To succeed in this market, you need to offer new investment opportunities with competitive fees which address some of the key concerns that fixed income investors face.”

TradingScreen will relaunch its basket trading functionality in the first half of this year. Last month the order and execution management system partnered with BIDS Trading to give clients more access to block trading, which has become more important since MiFID II went live.

Surika Vosloo, European product manager at TradingScreen, told Markets Media: “A big focus for the first half of this year is relaunching our basket trading functionality. This will be revolutionary in providing visualisation of data to focus attention on relevant orders.”

The first clients for the improved basket trading functionality are due to go live in June according to Vosloo.

Last month TradingScreen announced a partnership with BIDS Trading, the US block trading alternative trading system which provides the technology behind Cboe LIS in Europe. MiFID II, the European Union regulations which went live at the beginning of last year, introduced double volume caps on equity trading in dark pools. However large-in-scale trades above a specified size and trades in periodic auctions on lit venues are both exempt from the volume caps, so their volumes have increased and are expected to continue to rise.

Vosloo said: “Our EMS has always been a significant market leader for hedge funds. We have made a successful effort to build share with long-only funds and block venues are a big part of their workflow.”

She continued that the partnership with BIDS gives TradingScreen access to Cboe LIS, for which there has been growing client demand. TradingScreen already accesses other block venues such as Liquidnet and ITG Posit and clients can work orders across these platforms at the same time.

Varghese Thomas, chief operating officer and chief strategy officer of TradingScreen, said in a statement: “Asset managers around the world will benefit from access to the institutional liquidity pool as BIDS becomes one of the dominant players in the space.”

Tim Cave, analyst at consultant Tabb Group, said in a report last month that MiFID II has been successful at preserving dark trading primarily for block-sized transactions.

He said average daily notional in trades exceeding the LIS thresholds was €1.12bn ($1.27bn) in January 2019, compared with €1.05bn in December 2018 and €658m in January 2018. Block volumes have stabilized at around 35% of dark volumes and 3% of overall order book volumes, up from 16% and 1.5% respectively two years ago.

Cave added: “But perhaps the bigger story within these figures has been the rapid growth of Cboe’s LIS block venue, a relative newcomer compared to the platforms run by Liquidnet, ITG Posit and Turquoise Plato Block Discovery.”

According to Cave, Cboe LIS has become the second-largest block venue, accounting for 22% of Europe’s LIS market.

New @TABBGroup EU equity volumes report out for Jan 2019 – ELP SI activity keeps on growing + competition intensifies in the block market https://t.co/YTUPPBldNb via @TabbFORUM

— Tim Cave (@_TimCave) February 27, 2019

“Cboe LIS is now experiencing larger average execution sizes than the Liquidnet platform,” added Cave. “Given recent news reports that Cboe may acquire US block trading platform BIDS Trading – which has partnered with Cboe on its LIS platform and provides the underlying buy-side desktop software – it will be interesting to see how the block market develops over the course of this year.”

Post-MiFID II

Vosloo continued that MIFID II consumed a lot of resources as firms wanted to ensure they were compliant.

“It is exciting that clients are now looking for new ideas and most of the focus is on workflow solutions and automation,” she added

Clients are automating low-touch workflows through tools such as auto routing and ‘algo wheel’ to focus on the larger high-touch trades where they can add value. Algo wheel is a term used for a set of automation tools that range from pure workflow automation to becoming a critical component in the optimization of transaction costs, broker selection, and experimentation.

Vosloo said: “We have helped clients meet the MiFID II best execution requirements by integrating pre-trade data to run ‘what if’ scenarios and providing powerful in-trade analytics to help them track their performance against custom benchmarks.”

TradingScreen has also have integrated with the API from the European Securities and Markets Authority to provide transparency data such as the double volume caps and LIS thresholds.

“Transaction cost analysis was a big focus post-MiFID II and was built out to allow clients to generate their best-execution outlier reports,’ added Vosloo. “They have the flexibility of using interactive dashboards to drill down to a specific dataset and really compare apples with apples.”

With apologies to game show host Richard Dawson, “Let’s bring on the Feud!”

Reminiscent of the television game show Family Feud, it’s the Exchanges versus the Securities and Exchange Commission on the topic of the Access Fee Pilot.

In a unique show of solidarity, recently exchange operators Nasdaq and Cboe Capital Markets have joined their downtown rival – the New York Stock Exchange – to sue the U.S. Securities and Exchange Commission. In what can be best described as détente between the normally contentious rivals, the exchanges have opted for an “all-in” strategy combining all their collective strength to stop the regulator from implementing its transaction fee pilot program.

The goal of the pilot program is to examine the fees charged by the exchanges for data and see if these charges are either exorbitant or harm investors and unfairly benefit exchanges. Either way, the move looks to keep the regulator from getting an inside look at the world of trading fees and rebates, which it says might be hurtful to the marketplace. The exchanges counter that these fees are reasonable and assist in making the stock markets efficient and keep trading costs low.

Traders Magazine recently spoke with Jacob Frenkel, chair of the Securities Enforcement practice at law firm Dickinson Wright to delve into this lawsuit and some of the outcomes. Frenkel is a former SEC Enforcement senior counsel, and a 30 plus year veteran of SEC enforcement, governance and regulatory practice.

Traders Magazine: What is the likelihood of success by the exchanges?

Jacob Frenkel: If the measure of success is in absolutes, that is win or lose, then the exchanges are not likely to prevail ultimately in this litigation.

The securities laws clearly authorize the SEC to determine the impact of fee models on our capital markets. Prior to adopting the new rule, the purpose of which is to enable the SEC to gather data so that the SEC down the road can determine whether there is a need for the agency to take regulatory action, the Commission received voluminous comments, including from the exchanges.

Only after considering all of the input did the SEC adopt the Transaction Fee Pilot. The exchanges will need to show that the SEC acted ‘arbitrarily and capriciously’ – a statutory legal standard governing rulemaking by all federal agencies and explained by the Supreme Court.  The SEC, through its rulemaking process, has made a compelling case in defense of the rule.

TM: Has there ever been such a case or similar one brought by market operators or others against the SEC?

Frenkel: The one case that comes to mind is a 1980s case filed by the Chicago Mercantile Exchange against the SEC and other exchanges, although not necessarily similar.

That case, which the Supreme Court declined to review, related to the trading on the American and Philadelphia Stock Exchanges of instruments similar to what we now know as ETFs. The courts found the instruments to be futures, not shares of stock, and set aside the SEC’s orders approving the applications by the two stock exchanges.

Much more common is the SEC bringing enforcement actions against the exchanges.  One that I remember vividly from my tenure at the SEC was the SEC’s mid-1990s action against the NASD, in which the SEC alleged that the NASD failed to comply with certain of its own rules and failed to enforce compliance with certain federal securities laws, rules and regulations.  Among the SEC’s findings was that the NASD failed to take appropriate action to investigate effectively and to address adequately violations and potential violations of the federal securities laws and the NASD’s rules.  The NASD neither admitted nor denied the SEC’s allegations, but consented to entry of an Order censuring the NASD and ordering it to comply with certain undertakings.

There are other examples of the SEC bringing enforcement actions against the exchanges.

In March 2018, the SEC charged two NYSE exchanges with violating regulations governing business continuity and disaster recovery, with the NYSE paying a $14 million penalty.  This case charged the NYSE with erroneously implementing a market-wide regulatory halt, negligently misrepresenting stock prices as ‘automated’, and applying price collars during unusual market volatility that resulted in slow resolution of order imbalances.  The SEC pointed out that the NYSE had settled rules violations four years earlier – without referring to the Exchange as a ‘recidivist’ – and paid a $4.5 million penalty for not having certain rules in place and failing to operate in compliance with other rules. And, lest we not forget the 2013 SEC actions against the NASDAQ in connection with the Facebook initial public offering – conduct that caused more than 30,000 Facebook orders to remain stuck in NASDAQ’s system – and resulted in the NASDAQ paying a $10 million penalty.  In short, the exchanges hit the courthouse steps with a blemished track-record when it comes to market participants’ best interests.

TM: Can there be a winner and loser in this case – in the traditional sense?

Frenkel: The SEC’s position is that the information gathered from the pilot is for the benefit of the markets and investors. The clear perception is that the exchanges are asserting positions designed to promote their own profit models and preferred ways of doing business. Regardless of the outcome, the winners need to be capital markets liquidity, transparency and investor protection and confidence. Such regulatory litigation over rule enactment does not produce winners and losers, because the worst-case scenario for the SEC is the SEC goes back and fixes whatever deficiencies the appellate court may find. Here, the SEC appears to have approached the rule-making thoughtfully and correctly, regardless of whether a market participant agrees with the rule.

TM: Can the exchanges and regulator co-exist in the aftermath of this suit or ruling?

Frenkel: Not only can the exchanges and regulators co-exist, but also, they will.  Such litigation is more like a fight between an older and younger sibling; that is, they are in the same family and find ways to co-exist. Even with the litigation pending, the exchanges and SEC will continue to work cooperatively in many areas.

TM: Overall, does a lawsuit help the market or hurt it?

Frenkel: We will know the answer when the court rules! Chairman Clayton set a key area of his focus as examining and addressing equity and fixed income market structure issues with an emphasis on fairness, efficiency and resiliency, recognizing that U.S. capital markets are ever-changing. The Transaction Fee Pilot is in furtherance of that focus; now, the United States Court of Appeals will decide.

Stéphane Boujnah, chief executive of Euronext, said the exchange group wants to expand its federal model in Europe and will continue to invest in London, even after the UK leaves the European Union.

Boujnah said at a media briefing today: “Since the Brexit vote we have expanded significantly in London and hiring Chris Topple shows the confidence of our ambitions.”

In July last year Euronext announced the appointment of Topple as chief executive of Euronext London, head of global sales across asset classes and a member of the managing board.

Topple had previously been co-head of Societe Generale Prime Services since May 2015 and was also responsible for leading prime brokerage and clearing services sales teams globally within Societe Generale’s Newedge Group.

At the briefing Topple said that London-based accounts make up 50% of revenues on Euronext’s core markets. He added there were significant opportunities for growth in London both organically post-Brexit and through acquisitions over the next year and a half.

Euronext completed its acquisition of spot FX trading network FastMatch in 2017 and purchased Commcise, the research evaluation and commission management software provider, in December last year.

“The first step was the acquisition of Fastmatch, and Commcise allows us to connect issuers and the buy side,” Topple added. “There will be more opportunities over the next 18 months.”

In foreign exchange, Fastmatch has three matching engines and Euronext expects to announce the location of an additional matching engine shortly.

“We are evaluating launching non-deliverable forwards and a broader FX product suite,” Topple added. “There is also a significant opportunity for client acquisition amongst the buyside and smaller banks.”

Another opportunity for organic growth is to gain more listings after Brexit. If issuers are already listed in London, they can join Euronext Dublin through a fast track process which only takes between four and six weeks.

“We had meetings last week and there is significant interest from issuers looking at dual listings post-Brexit,” said Topple. “Larger companies are are also looking at Paris and Amsterdam listings. Last year the largest fintech listing was in Amsterdam.”

Adyen went public in the Netherlands last year in an initial public offering which valued the payments company at approximately €7bn.

Mergers and acquisitions are also possible.

“There are lot of opportunities,” said Topple. “For example, CME’s acquisition on NEX showed there are opportunities to make value chains more efficient along the product lifecycle.”

Expansion

Boujnah continued that the exchange group has been successful in diversifying through the Commcise and Fastmatch deals. The group wants to expand further into new asset classes and non-volume related businesses, but will also continue to invest in organic growth.

“Corporate services did not exist in 2016 and now generates €20m in revenues,” added Boujnah. “We also want to expand our decentralised model and become the ‘home sweet home’ for exchanges who want to keep deploying their fundamental DNA but want the scale of being backed by a large regulated business.”

The pan-European exchange group acquired the Irish Stock Exchange last year and Euronext Dublin completed the migration to Optiq, the group’s proprietary trading platform last month.

We are pleased to announce the successful migration of the 53 companies currently listed on Euronext Dublin to Euronext’s proprietary trading platform, Optiq® https://t.co/F0YaCSpZ0m | @euronext_ie pic.twitter.com/6wEPRkfJ5Y

— Euronext (@euronext) February 5, 2019

Dublin has also become the centre of excellence for  debt and funds listings and exchange-traded funds within the Euronext group.

Euronext has also made an offer for Oslo Børs after shareholders held an auction against the wishes of the board of the Norwegian exchange. However, the Oslo Børs board has since invited an offer from Nasdaq.

“It is not a bidding war as we have already acquired more than 50.5% of the shares of Oslo Børs,” said Boujnah. “Once we have regulatory approval from the Norwegian authorities we will complete the transaction.”

Opinion article by Stéphane Boujnah: "We are convinced that Euronext + Oslo Børs VPS will be a good platform for Norwegian SMEs" ➡️ https://t.co/EAwppN8eOB pic.twitter.com/uTcov9yJdr

— Euronext (@euronext) February 13, 2019

Boujnah continued that the deal could be completed before the end of the second quarter.

“We could expand beyond Norway,” said Boujnah. “For the moment our focus is in Europe.”