Breaking Dawn: The New Reality for the Buy-Side

By Steve Grob, Director of Group Strategy, Fidessa

Much has been written about the challenges facing the sell-side in the new world of high-touch regulation, fragmented liquidity and ongoing cost pressures. The buy-side is facing these challenges, too, but is increasingly taking the initiative itself rather than relying on its traditional sell-side relationships. Enlightened firms are facing these challenges head on and developing new business models and approaches at every stage of their workflow, from portfolio management and compliance through to execution and post-trade.

Steve Grob

From the portfolio manager’s perspective, new and creative ways to improve decision-making are needed as generating alpha across interconnecting asset classes is proving to be beyond all but the most powerful modelling programs. However, instead of beefing up the program itself, the smart approach is to feed it with better information and empower decision-makers with a real time view that is much closer to both current portfolios and likely cash flows. Known as the ‘Investment Book of Record’ (IBOR), this concept still provides a combined view of positions but, crucially, looks forward rather than simply providing the statement of record.

Improved information flow is also central to an evolved compliance function. Ideally, every order will cascade through a series of firm- and fund-specific checks before it can be executed with minimal delay, especially important for orders in fast-moving markets. Increased public and private scrutiny of investment services means that firms that can prove that compliance sits at the heart of their operation are winning mandates over those that cannot. But meeting the demands of complex client mandates and a broader array of regulatory obligations means that the process has become an unwieldy overhead. Consequently, more and more buy-sides are rethinking the way they manage the process, adopting a firm-wide approach that can drill down into individual funds and orders, and mitigating the costs of trading out of a compliance breach by focusing more on prevention than cure. Certain firms are also developing a more workflow-centric approach that enables portfolio managers to stress test their orders in advance and receive relevant updates throughout the day.

This is all well and good but it is when orders reach the dealing desk that the extent of the current challenge really becomes apparent. Venue proliferation, HFT noise and IOI spam have made effective execution particularly challenging, especially for large-scale orders where buy-side dealers have simply hit a wall of complexity.

Previously, the solution was a reliable relationship with a trusted sales trader. But with individuals replaced by algos, an alternative is needed. Two approaches are emerging. The first is to outsource execution to firms with the volume or the technology to achieve better results. That technology includes sophisticated execution management combined with regulatory and reporting capabilities and effective TCA to prove executional prowess. This approach illustrates how the traditional buy-side/sell-side divide is being deconstructed into specialist providers that are expert at one piece of the liquidity puzzle.

The alternative is to simply trade with other willing buy-sides. However, prohibitively low hit rates aside, this approach risks upsetting the broker-dealer community as it withdraws client or proprietary liquidity. What is needed is an approach that gets the broker-dealer community on board and uses technology to align the trajectory of orders so that they are guided towards each other rather than leaving it all to chance.

As the previously clear distinction between the buy-side and sell-side is breaking down it is being replaced by a quest for buy-side firms to find counterparties that have the other side or will trade on risk. Like all market participants they are dependent on trust at a time when people and time are expensive commodities.

The evolution of the buy-side has also bought post-trade into focus: it is increasingly being seen as the new battleground in the war on cost. While critical to the process, varying proprietary methods offer no competitive advantage, leading the industry to explore more collaborative ways of working. The key to such collaboration is a centralised workflow based on open standards.

As an example, re-purposing the FIX protocol for post-trade leverages existing infrastructure and enables information to be persisted from front- directly to middle- and back-office workflow. As well as reducing errors, it creates the right conditions for shorter settlement times that save money, reduce risk and make better use of capital. Post-trade is one example of a new, more collaborative approach amongst market participants that sets aside competitive differences in the search for common ground that achieves industry-wide cost reduction.

However the buy-side chooses to adapt to its new world, the focus has to be on enabling smart workflow within the organisation and ensuring a seamless, secure flow of information both internally and externally. At the centre of the process is intelligently designed technology that provides robust foundations for that workflow, while providing the flexibility to evolve and form new partnerships. Firms that see technology in this way look set to become the evolutionary winners.

By Steve Grob, Director of Group Strategy, Fidessa

Much has been written about the challenges facing the sell-side in the new world of high-touch regulation, fragmented liquidity and ongoing cost pressures. The buy-side is facing these challenges, too, but is increasingly taking the initiative itself rather than relying on its traditional sell-side relationships. Enlightened firms are facing these challenges head on and developing new business models and approaches at every stage of their workflow, from portfolio management and compliance through to execution and post-trade.

Steve Grob

From the portfolio manager’s perspective, new and creative ways to improve decision-making are needed as generating alpha across interconnecting asset classes is proving to be beyond all but the most powerful modelling programs. However, instead of beefing up the program itself, the smart approach is to feed it with better information and empower decision-makers with a real time view that is much closer to both current portfolios and likely cash flows. Known as the ‘Investment Book of Record’ (IBOR), this concept still provides a combined view of positions but, crucially, looks forward rather than simply providing the statement of record.

Improved information flow is also central to an evolved compliance function. Ideally, every order will cascade through a series of firm- and fund-specific checks before it can be executed with minimal delay, especially important for orders in fast-moving markets. Increased public and private scrutiny of investment services means that firms that can prove that compliance sits at the heart of their operation are winning mandates over those that cannot. But meeting the demands of complex client mandates and a broader array of regulatory obligations means that the process has become an unwieldy overhead. Consequently, more and more buy-sides are rethinking the way they manage the process, adopting a firm-wide approach that can drill down into individual funds and orders, and mitigating the costs of trading out of a compliance breach by focusing more on prevention than cure. Certain firms are also developing a more workflow-centric approach that enables portfolio managers to stress test their orders in advance and receive relevant updates throughout the day.

This is all well and good but it is when orders reach the dealing desk that the extent of the current challenge really becomes apparent. Venue proliferation, HFT noise and IOI spam have made effective execution particularly challenging, especially for large-scale orders where buy-side dealers have simply hit a wall of complexity.

Previously, the solution was a reliable relationship with a trusted sales trader. But with individuals replaced by algos, an alternative is needed. Two approaches are emerging. The first is to outsource execution to firms with the volume or the technology to achieve better results. That technology includes sophisticated execution management combined with regulatory and reporting capabilities and effective TCA to prove executional prowess. This approach illustrates how the traditional buy-side/sell-side divide is being deconstructed into specialist providers that are expert at one piece of the liquidity puzzle.

The alternative is to simply trade with other willing buy-sides. However, prohibitively low hit rates aside, this approach risks upsetting the broker-dealer community as it withdraws client or proprietary liquidity. What is needed is an approach that gets the broker-dealer community on board and uses technology to align the trajectory of orders so that they are guided towards each other rather than leaving it all to chance.

As the previously clear distinction between the buy-side and sell-side is breaking down it is being replaced by a quest for buy-side firms to find counterparties that have the other side or will trade on risk. Like all market participants they are dependent on trust at a time when people and time are expensive commodities.

The evolution of the buy-side has also bought post-trade into focus: it is increasingly being seen as the new battleground in the war on cost. While critical to the process, varying proprietary methods offer no competitive advantage, leading the industry to explore more collaborative ways of working. The key to such collaboration is a centralised workflow based on open standards.

As an example, re-purposing the FIX protocol for post-trade leverages existing infrastructure and enables information to be persisted from front- directly to middle- and back-office workflow. As well as reducing errors, it creates the right conditions for shorter settlement times that save money, reduce risk and make better use of capital. Post-trade is one example of a new, more collaborative approach amongst market participants that sets aside competitive differences in the search for common ground that achieves industry-wide cost reduction.

However the buy-side chooses to adapt to its new world, the focus has to be on enabling smart workflow within the organisation and ensuring a seamless, secure flow of information both internally and externally. At the centre of the process is intelligently designed technology that provides robust foundations for that workflow, while providing the flexibility to evolve and form new partnerships. Firms that see technology in this way look set to become the evolutionary winners.