This blog post also appears on ATMonitor.
With 2012 underway, it’s clear that caution is at an all-time high among investors. This is reflected in shrinking trading volumes and tighter brokerage commissions—a sharp contrast to years past, according to major media reports.
To stay ahead, brokerages across the globe will likely have to redouble their efforts to attract and keep more investors this year. Luckily, trading firms will have an array of regulatory reforms and directives, electronic trading and connectivity tools, emerging standards and some cutting-edge options at their disposal to help them attract more investors and bolster their fortunes.
The market reforms come as securities firms face an evolving trading landscape that is becoming ever more fragmented, creating challenges for those in the race for liquidity. The call for greater transparency eerily echoes the struggles of U.S. presidential candidates that want to know more about the money that secretly flows to the super-political action committees (super-PACs). The good news is that for investors and market players, transparency is coming via the regulators. The U.S. electorate will not be so fortunate.
Major players in the bilateral, over-the-counter (OTC) derivatives market such as ABN Amro, Citigroup, Credit Suisse and Citadel Securities will be part of a tamer market as regulations for increased transparency begin to take effect in 2012. This will drive OTC derivatives trading into an increasingly more electronic phase as established OTC processes and technologies will converge with those used for listed market trading.
In the U.S., the Dodd-Frank Act reforms are intended to create safer opportunities for those investors willing to take on OTC instruments that were not previously traded via traditional exchanges. Contract markets and new transaction platforms called “swap execution facilities” or SEFs will be the brave new venues for OTC transactions. Many existing and new players are readying systems and staffs for the next chapter of this new world for OTC instruments.
The OTC reforms will yield another protection for investors—clearinghouses for OTC instruments. CME Group, LCH Clearnet and the Intercontinental Exchange (ICE) have all been making major strides to provide OTC services.
European Reforms Aid Investors
Other reforms to ease investor concerns are underway in Europe and underscore the trend among regulators to heighten their focus on investors’ rights.
In particular, a key part of the European Commission’s Markets in Financial Instruments Directive, also known as MiFID II, will help trading participants view and analyze the same data after a trade has been transacted, thereby increasing transparency for investors across Europe and leveling the playing field.
A follow-up to a previous directive, MiFID II is intended to improve investment services for consumers and protect them from inappropriate financial products. The updated directive is also intended to make providers adhere to a new clarity for investors as they consider more complex financial arrangements.
The move to MiFID II could also facilitate closer coordination between regulators in the US and the European Union as they smooth out approaches to regulation, facilitate market stability and ensure that investors have similar protections regardless of where they decide to trade.
Streamlining Trading Engines
On the home front, trading firms will have to streamline their front-end systems. This will get easier as the Financial Information eXchange (FIX) electronic messaging standard gains more ground. FIX is becoming the market standard across not only execution data but market data, allocations and other asset classes. Investment firms will increasingly adopt FIX in order to help reduce their integration costs.
Along the same lines, broker-dealers will need greater automation for their clients’ orders and streamlined trading processes to help drive down costs as brokerage commissions continue to be under severe pressure.
Up and coming brokers will also need consolidated links to exchanges, which will reduce the number of technologies required to access liquidity. This will make it less expensive to maintain additional connections to more trading venues. Smaller trading firms will also need to stay competitive by focusing on geography or market sectors (such technology or global mid-cap stocks), which will attract buy-side firms that are looking for specialized expertise.
However, the challenge for finding new opportunities is different for the largest of the sell-side firms. They will need to offer a broad, global network of connectivity to major exchanges such as Nasdaq OMX and NYSE Euronext and to compelling new markets such as Brazil’s BM&FBOVESPA, which has a partnership with CME Group to enable the trading of contracts via both exchanges in real time. Not only will the big brokers have to provide direct market access and services to these venues, they will have to support multiple asset classes.
Tighter Connections to Trading Venues
Yet trading firms will have to do more than secure the network link. They also have to help ensure that orders arrive at different exchange venues at the same time. To help with this demanding situation, firms will need to adopt complex event processing (CEP) techniques.
CEP refers to a kind of technology that takes into account the multiple details of an event, such as detecting credit card fraud via multiple transactions or the ways a company can suffer a security breach. Using CEP, trading firms can take into account the parameters that their clients specify on orders and simultaneously assess the validity of the order, the exposure and the potential market impact.
Like many other business sectors, brokerages large and small will also have to consider reducing upfront and ongoing technology maintenance costs. One of the most effective ways to do this is via outsourcing and hosted applications on a Software-as-a-Service (SaaS) basis. These are the first steps toward a cautious embrace of cloud computing, which is giving trading firms pause because of security concerns.
Some firms may also want to revisit their advanced trading strategies to make sure that investors are still being well served by them.
For instance, formulas that guide specific operations in computing, known as algorithms, have recently caught on with a variety of businesses, from dating services to search engines. However, algorithms have been an important part of electronic trading for almost a decade. But algorithms for trading have become commoditized for many brokerage firms. To leapfrog the competition in 2012, firms will be buying more sophisticated algorithms—or purchasing the tools to build them—to help maintain the profitability of their algorithmic trading operations.
Like the U.S. auto industry, brokerages have been pulled in many directions over the past decade. But if trading firms can streamline their offerings and provide more assurances to their clients, they should be able to offer far more attractive investment vehicles in 2012.
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