With uncertainty in the global economy and debate over how many times central banks will raise interest rates to fight inflation, asset management firms are adding derivatives and emphasizing the need for resiliency and scalability in their trading technology.
In this complex environment, what’s ahead for the buy-side trading desk in 2023?
The future of the buy-side trading desk is moving toward multi-asset trading, according to comments from buy-side traders at a recent conference. In addition, buy-side firms are looking to expand their product offerings into derivatives and build out multi-asset trading desks without necessarily increasing headcounts.
At the STA market structure conference in Washington, DC, head traders from three of the industry’s leading asset managers, Fidelity Investments, J.P. Morgan Asset Management, and T. Rowe Price Investment Management, spoke about what their priorities will be over the next few years. Collectively the firms oversee about $10 trillion in assets under management. Head traders also spoke about a range of other issues including the evolving role of the buy-side trader, future skillsets, data analytics, and potential regulatory changes which could pose a risk to liquidity.
One of the major themes for 2023 is the emphasis on multi-asset trading and the focus on efficiency and scalability across regions and countries. In the past, a trader focused on a single asset class such as equities or bonds, whereas today with the migration to electronic trading, the desk can automate workflows and manage executions across all asset classes.
“Historically, firms have had trading separated between fixed income, options, and equities. The new trader may be asked to trade all of those together. So, we need the system and technology to support scalability,” said Tammy Wiggs, Head of Equity Trading at T. Rowe Price Investment Management, speaking on the buy-side panel. For example, when adding several compliance rules to satisfy three new clients, “there might be a more scalable way to do that,” said Wiggs, adding “that needs to be across multi-asset platforms.
In addition to scalability, a top priority is harmonizing and building platform resiliency across regions and countries, said Bojan Petrovic, Head of Global Equity Trading at J.P. Morgan Asset Management on the panel. For example, diagnostics, maintenance, and support should look the same, he said.
On the buy-side panel, head traders at STA said this year asset management firms are expanding into derivatives or “alternatives” to be brought under their multi-asset platforms.
“We are shifting our focus a little bit to alternatives, and we have a really big umbrella there – anything from derivatives to convertibles to hedged equity to essentially new strategies and products that are coming down the pike for us,” said Ashley Banfield, Head of Americas Trading, Equities at Fidelity Investments on the STA panel.
Petrovic said there is a growing mandate to offer more derivative trading capabilities and products. “Being able to build and scale that and not just in a listed format, but also within the OTC space is an ever-growing ask,” said J.P. Morgan Asset Management’s head of global equity trading.
A key focus in 2023 and beyond is ensuring the firm has the infrastructure to support these asset classes and the right talent in the seats, said the head traders. Investment managers plan to update their technology stacks to accommodate the expansion into multi-asset trading.
“We’re focusing on putting legacy technology back in the box where appropriate because that’s what keeps a lot of us up at night,” said Wiggs, who also stressed the importance of ensuring data is correct and that data is used more efficiently.
However, there is considerable debate about inflation and whether the U.S. economy will avoid a recession, potentially causing some C-suite executives to reconsider their technology budgets, according to one expert.
“Cutting costs and optimizing costs are top of mind,” said Blair Kanter, an independent technology consultant to asset managers and wealth management firms. “2023 is unclear so far. Investment management firms are looking at how they can cut costs and what impact does that have on technology decisions in 2023,” said Kanter, a former PwC and IBM consultant.
“Is there going to be a recession? Will assets under management decline; will revenues decline? These are considerations which could alter plans, he said. With companies across various industries announcing layoffs, including Google and Microsoft in the big tech sector and Goldman Sachs in investment banking, the buy side is cautious, said Kanter.
On the other hand, systems consolidation is a way to save costs. Many investment management firms have grown through mergers and acquisitions and operate duplicate systems, he said.
European Focus on Fixed Income
Meanwhile, European buy-side desks are looking at how they can consolidate siloed trading platforms through a multi-asset EMS.
“In Europe, the driver is fixed income automation because fixed income has been a silo,” said Anita Karppi, Senior Vice President, Sales and Business Development at FlexTrade EMEA. Firms are interested in managing different asset classes in the same blotter, said Karppi.
While in equities, the EMS is now critical to trading desks – the drive to automate fixed income is now causing firms to reconsider their approach. They see the potential to apply sophisticated automated workflows to multiple asset classes and gain efficiencies in fixed income.
In addition, using separate technology for each siloed asset class has increased cost for the buy side, observed Karppi. Instead, through an EMS, there is the ability to switch between asset classes, seamlessly supported by intelligent technology and apply a common set of proven efficient workflow, which can be replicated across distinct instruments. By automating the simpler orders, the trader can concentrate on executing the more complex orders.
On the panel, a buy-side trader referred to automating order flow as opening the door to handling derivatives along with other asset classes. “Though some products are more laborious especially on the structured notes side, it’s possible to offer new products to clients without expanding head count and still do it in a streamlined and effective way.”
Build vs. Buy OMS/EMS Decisions
With the addition of new asset classes like derivatives, large asset managers are weighing the build-versus-buy decision. Some traders noted their firms had built proprietary OMSs and EMSs in the past, but when it comes to derivatives, they plan to partner with external providers. Specifically, in the case of trading structured notes or OTC derivatives, Petrovic said the firm is going to rely on and leverage external vendors rather than build an RFQ (request for quote) platform.”
For the alternative space, buy-side firms said they are not going to build EMSs themselves if the capabilities are not in-house. “It’s often cheaper and faster to enter a market to buy vs. build,” said a head trader.
New Trader Skillsets: Evolving Role
With the advent of data and technology, panelists said that buy-side traders have expanded their skillsets and are playing an active role in the investment process. “We have traders that by day are trading, yet they are constantly looking to process improve,” said Wiggs at T. Rowe Price Investment Management. In a sign of how traders are evolving their skills, T. Rowe Price offers a coding club to learn new skills. “Some traders are coding because someone wants an earnings recap in a certain way, or they’re working with short interest in a different way, or grabbing an open API in the equity capital markets space and converting it into a tool to capture deal flow,” explained Wiggs.
Electronic trading has freed up the buy-side trader to play a more value-added role to PMs. “The legacy role of trader was clicking buttons and venue selection or broker selection. Today, the buy-side trader knows not only the liquidity characteristics of a stock, but also the fundamentals of the stock and the catalysts that are coming up and can give good advice to PMs around execution strategy while moving away from the mundane tasks of order routing.”
Over the past 12 years, J.P. Morgan Asset Management has automated a lot of order flows. This is freeing up time for traders to participate with PMs and analysts on company management calls, said Petrovic.
“We get more of a 3D view, and front-row seat into how we think about the investment process, as well as the prospects of the company going forward. I don’t think we had that before, because you were focused on trading and handling order flow,” said Petrovic.
Data & Analytics
While trading desks consume a firehose of data, another challenge is filtering out what is noise from meaningful information. In addition to relying on their sell-side partners for market color, buy-side desks filter incoming data based on the morning meetings and knowing the strategies that portfolio managers are running.
One firm said its traders are focusing on “sentiment data, positions, retail trading and other items that are empirical based on actual flows to inform knowledge share, rather than just qualitative content.”
Liquidity and Regulations
Regulatory changes are also on the buy-side agenda. In 2023, Wiggs noted that T. Rowe Price plans to review the proposed SEC equity market structure rules for “unintended consequences” that could impact liquidity for both their retail and institutional clients. Comment letters are due on March 31. Traders suggested they were open to changes “on the margins,” such as improvements in transparency around 605 reporting for broker-dealers, and potentially exploring some type of intelligent tick regime that was less complicated than some proposed ideas. “I don’t think there’s a one-size fits all market,” said a head trader.
In response to the SEC’s Order Competition rule, requiring certain individual orders to be routed to fair and open auctions, Fidelity’s Banfield had concerns. “(It’s) not because I think it doesn’t offer a benefit to open up retail liquidity directly to institutions, but because it could introduce a lot of operational complexity into markets and potentially new risks there,” said a buy-side trader.
Firms are also spending time on FINRA’s over the counter (OTC) options trade reporting proposal and a buy-backs proposal on corporates. Wiggs questioned whether “it is good for the markets to have that data out every day, or if it’s going to cause more volatility.”
“While FINRA has access to data on all listed options transactions, there is currently no requirement to report all OTC options transactions even where the OTC options are virtually identical to listed options,” wrote the lawyers at Katten on September in “FINRA Proposes Trade Reporting Requirements for OTC Options Transactions.”
Automated Tools and Algo Wheels
When asked what about the major changes in markets and tools, STA panelists pointed to algo wheels, the importance and growth of electronic trading and algo trading, along with the proliferation of ATSs and the innovation within those ATSs. Buy-side traders are increasingly using data driven tools to find liquidity and providing insights to their portfolio managers.
“There is a feedback loop where traders use the tools to evaluate PM trading decisions and go through analytics to walk the PM through what the process looks like to the trader. They evaluate distinct characteristics such as momentum, turnover, among others, with the goal of showing them data,” said a head equity trader.
Looking ahead to the next few years, one head trader plans to use data more creatively and building better automation into its tools and processes. Specifically, it’s working with the firm’s quantitative and systematic trading team, which has done a lot of work around automated trading technologies, leveraging machine learning technologies and working with its AI center for excellence.
As the buy-side trading desk evolves, what has changed is pace of innovation, wearing many hats and becoming a more strategic partner within the investment team . “There is a mindset of continuing to drive toward a higher level of performance in order to improve results and help grow assets,” said Petrovic.