Over the last twelve months, Object Trading has conducted extensive research into how trends in the futures industry are affecting the buy-side. We interviewed a range of buy-side representatives including large systematic hedge funds, proprietary trading houses, market makers, and medium and long term CTAs. We also convened two round-tables, the first just for proprietary trading shops and the second for CTAs, hedge funds and prop firms.
[Download a copy of our research paper, Velocity of Change Demands a New Approach]
Buy-side firms are increasingly also affected by the challenges facing the sell-side. Onerous capital requirements and their associated balance sheet impacts mean that sell-sides are reconfiguring their prime brokerage and clearing businesses at an unprecedented rate. Several high-profile firms have completely eliminated their clearing businesses, whilst nearly all have reviewed their offerings for profitability and to manage capital consumption. Buy-side firms are facing escalating costs and reduced services from their prime brokers, which is forcing them to re-evaluate and optimize their business strategy.
Buy-Sides Take Control
The buy-side currently faces a number of challenges, including sell-side retrenchment, dealing with execution quality and slippage, and liquidity fragmentation, all of which forces trading costs up and squeezes profitability. In the face of these challenges, some buy-sides are choosing to “hunker down” and wait for better times to return. But others, convinced the current paradigm represents the new normal, are taking a more proactive approach, optimizing their trading strategies and business models for today’s market conditions in order to stay competitive. Some buy-sides are establishing relationships with new FCMs, while others are working more directly with exchanges and clearinghouses to gain market access independently of their prime-brokerage relationships.
Investing heavily in trading strategy R&D is one way in which firms are optimizing for resilience. The low-hanging fruit has all been plucked, so funds are developing ever more complex strategies across multiple asset classes, products and geographic regions in their search for alpha. Strategy lifespans are also shorter. When they find a strategy that works in one market or asset class, they look to quickly leverage it in others. Therefore the need for portability of R&D practices is increasing, along with the need for performant access to a broad range of markets. The investment effort required to create and benchmark new strategies is thus also increasing exponentially.
Technology Burden Shifts to the Buy-Side
As brokers withdraw and narrow the services they provide, buy-sides are taking on much of the technology burden that has traditionally been shouldered by the sell-side. Market access, risk controls and cost-effective execution management are gradually becoming the buy-side’s responsibility. This is leaving buy-side firms exposed to many challenges the sell-side used to solve on their behalf, but can no longer afford to offer. However, it also represents tremendous opportunities for buy-sides to take control of their trading environments.
Take, for example, market access. In order to port successful strategies to new markets and geographies, trading firms need low-latency access to more markets than ever. In the past, brokers were willing to expand market coverage to appeal to a wide market of buy-sides, but today, they’re shrinking their coverage to reduce costs and specialize. In many cases, buy-sides now choose to provide their own market access, independent of their prime service relationships.
The Downside of Screen Vendor DMA
While trading firms can have market access provided to them by screen vendors, when multiple screens are used, this inevitably leads to uneven and fragmented coverage, an opaque view of risk, and a high degree of complexity on the back end. As with the sell-side, buy-side firms are better off decoupling order generation from market access, maintaining use of their preferred screens on the front end and connecting to whichever markets they want on the back-end through a single API. Accessing multiple markets via a single API provides not only a lower TCO for market access, but also a consolidated view of the markets and positions for optimized real-time risk management.
[See our previous research report Removing the Limitations to Innovation and Growth for more insight into how firms can shed operational complexity and improve risk management by simplifying their approach to exchange connectivity.]
Having a single market access infrastructure optimized for the most demanding front-office requirements, along with an independent risk control framework that meets the sell-side’s regulatory obligations, allows buy-sides to gain a consistent, scalable, normalized route to market, no matter which broker or clearer they work with, nor how many. It also has the potential to make a given buy-side more attractive as a commercially viable client, because the sell-side doesn’t have to increase spending on market access to support that client’s business.
Taking control of their market access enables buy-sides to free themselves from the restrictions placed on them by brokers, vendors and exchange business models. This is the only way they can achieve superior agility and flexibility—trading what they want, where they want, when they want, with the technology they want. This approach will empower buy-sides to be better prepared for and properly respond to the increasing velocity of change.
For more insight into this topic, check out the full buy-side research report, Velocity of Change Demands a New Approach. See also a special report we co-produced with Futures and Options World Magazine: FOW Special Report: CTAs Piece Together Fragmented Market.