Apr 24, 2017

Electronification of Capital Markets | Analyst Insights with Greenwich Associates

In this video blog, CMO of Numerix, James Jockle, sits down with Kevin McPartland, Managing Director of Greenwich Associates, to discuss their recent report “Buy-Side FX Traders Focus on Increasing Efficiency”. Mr. McPartland discusses the impact of Electronification on capital markets, and its effect on trading, corporate budgets, and innovation.

VIDEO TRANSCRIPT:

James Jockle (Host): Hi welcome to Numerix Video Blog, I’m your host Jim Jockle. Joining me today, Kevin McPartland Managing Director of Greenwich Associates, Kevin how are you?

Kevin McPartland (Guest): Great, how are you?

Jockle: So, you might have seen it on LinkedIn yesterday, a new report from Greenwich Associates on the Buy-Side FX trading desk by the numbers. So, at the top level let’s break this down: average desk size – 8 people, total people budget – 30.9 Million, and total tech budget – 19.8 million per year. So what’s the background that’s led to this?

McPartland: Sure, yes so we interviewed just shy of 100 investors, FX investors around the world to understand what their desks look like, how they worked, where they spent their money. So, a couple of top-level-trends about three-quarters of FX Volume done by the buy-side is done electronically. It’s one of the most electronic markets that we cover, although I think we hit a ceiling there so we haven’t seen much growth, but again still one of the most electronic markets that we cover. The real change, the top line numbers haven’t changed all that much, but what’s been changing is growth in the use of execution algorithms by the buy-side, you would think given how electronic the market was that their use would be widespread but until recently they were not. And then the other big focus has been around data and analytics, transaction cost analysis, both pre-trade, post-trade and to a less extent sort of during the trade, is become a real big focus of the buy-side as they focus more and more on best execution and sourcing liquidity from a variety of new places.

Jockle: So, in terms of the three-fourths that are fully electronified, what’s the balance in the barrier to the remaining volumes?

McPartland: Most of what’s still done over the phone is complex orders and large sized orders, in most markets that have a sizable amount of electronic trading that is the case. There’s a human element that will never go away. If you want to buy a house or a car, you still want to talk to somebody for the most part. You want to go to the dealer; you want to work with the broker. Same is true in capital markets, if the order is large, you want somebody who is an expert who spends their days doing this to help you along the way to make sure you’re making those right choices and even from a fiduciary respect, for some asset managers ensuring that you’re having those conversations and can show your client, your end-client, your investors that you’re doing the right thing is tremendously important.

Jockle: So arguably as a very mature market in terms of electronic trading, what other areas are now starting to dabble. Last week, we had a conversation here at Numerix looking at structured products distribution and the electronification of that particular market as we’re starting to see more volumes and pick-up in Europe. Where do you see the orders of priority utilizing FX as a benchmark?

McPartland: Yeah, sure so I think one thing that’s worth noting. When we talk about electronic trading and electronification, it’s a little bit semantics, but I think there are two separate things. When we think electronic trading their minds goes to high-speed order book trading like in equities or in futures. Whereas electronification is more we’re taking a process that was very manual before and applying technology to make it more efficient. So you know in markets where you’re doing a sort of traditional request for quote, which is a lot of FX, structured products, as well, we should encourage that that’s still a really good positive step forward; it makes sense given the product nature and the liquidity profile of those markets. But a lot of folks would say thought that’s not sort of electronic trading in the traditional sense, but it’s certainly electronification. Which we do believe is a good thing, it should be encouraged.

Jockle: Now let’s drill down on an average desk size of eight people. You know, is that a trend that we’ve seen kind of downward trend, less people one a desk because of different automation processes?

McPartland: Yeah I mean, over time the buy-side has seen their desk sizes shrink, the sell-side has as well. In both cases, it’s an efficiency play. Whereas the sell-side is getting hit by new regulations and reduce profit margins and they’re having to become more efficient the buy-side is hit by, you know, fee wars, moving to passive rather than active management where they can’t make as much money unless they’re doing huge volumes so they’re trying to figure out how to make their desk to be more efficient and a huge way to do that is investing in technology that goes back to the 20 million or so spent annually on tech. If we looked at the fixed income market is a great example because that’s evolving so quickly towards electronic trading. The shift of budget has moved year over year from people more and more into technology, which just wasn’t the case four-five years ago.

Jockle: Now in terms of the budget spend, we’d be remiss if we didn’t talk about the general trend of market making moving to the buy-side. You know, how is that going to influence some of these elements in terms of spend and management?

McPartland: So, I take some exception to saying the buy-side are market makers on what we’ve actually seen is the buy-side as price makers, right. So, if you can come to the market for a bond or even a structured FX product, and say this is the price I’m willing to trade this at, is anybody interested? To me, that’s fundamentally different than a market maker who’s, you know, sole purpose and way of making money is to provide continuous two-sided quotes and help other folks trade, you know, throughout the day. And that’s not, that’s not how the buy-side makes their money. But yeah, certainly they’re coming forward more and more as price makers; we’re seeing that particularly in corporate bonds where it’s a very new thing but you know, while it sounds radical, think about the equity market, really what you’re doing is putting in a limit order, right? A limit order is saying I want to buy IBM at 100 dollars a share is anybody interested? That doesn’t seem odd in equities, it does seem odd at some of these OTC markets, but I think we’ll see more of that.

Jockle: And last question for you, in terms of that 19.8 million dollar tech spend, how much of that is ring-fenced in terms of R&D? Are we seeing any elements of innovation, I mean obviously AI is the talk of the town, big data, things of that nature? How much, if any, is getting to new technologies in terms of FX?

McPartland: Yeah, so a lot, more and more of the buy-side is looking to third-party software providers to provide them a lot of their technology. So I think a lot of that innovation if being done, you know, in the vendor community, working very closely with their big buy-side clients. The two biggest spends as in that 20 million are their market data desktop, right. So FactSet, Bloomberg, Reuters, and their OMS, which is really like the command center for their day-to-day. And then, you know there’s other stuff in there about hardware, and analytics as we spoke about and such, but that again that’s where the innovation is happening. Is the partnerships they have with those vendors to bring in enhanced features and help make their day-to-day life easier.

Jockle: So, just one other question that you kind of invoked in me. You know, when you look at JP Morgan’s tech spend of say, 600 Billion annually. Do you see tech spending increasing in the buy-side giving these new technologies and almost a new role in some cases?

McPartland: yeah, I think we’ve seen and this will be going on probably for 20 years and I can’t believe we’ve been in the industry that long but probably for 20 years where, you’ve just seen a skillset shirt where in some cases you don’t necessarily have less people but rather than having Harvard MBA’s or finance majors, you’re having PhDs in math and computer science that are spending more time to write, create those algos and automate more processes. On the sell-side tech spend I find it pretty interesting is in the 90s when we were in the first .com boom, banks were spending, and spending, and spending on tech and wanted to beat tech companies. The bubble burst they decided wait a second, we’re not tech companies we shouldn’t do that anymore, and now it almost feels like we’re getting back to where we were, where banks are realizing they, actually, we do need to be technology companies that’s where our competition is.

Jockle: Well, there’s been a lot of recent reports in terms of Goldman Sachs, kind of leveraging its technology platform, SecDB. Same thing with JP Morgan and Athene, and you know it’s starting this debate again.

McPartland: Yeah, I mean I think we shouldn’t minimize the importance of relationships especially at the institutional level, the retail conversation I think is different, but the institutional level relationships don’t matter and having people that can help to you know, work with clients, and navigate complex situations it’s not going to go away but yeah making those people smarter with technology is the only way it’s going to go forward.

Jockle: Well Kevin I want to thank you so much for joining us. And again of course the report is “The Buy-Side FX Trading Desk by the Numbers” available on www.greenwich.com and I want to thank you for joining us. And of course we want to talk about the topics you want to talk about, please follow us on LinkedIn and on Twitter @nxanalytics. I’m Jim Jockle, thank you very much.

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