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Cross-asset class trading platforms: dream or reality?

28 July 2011

As traders diversify to realise greater opportunities for arbitrage and move into new markets, the demand for cross-asset class trading capabilities has never been greater. Roger Aitken looks at what solutions are out there and how traders are increasingly looking for platforms that can trade equities, derivatives, FX and commodities and how the search for low and ultra low latency is defining the evolution of the market.

Read more: Cross-asset trading platforms electronic trading Roger Aitken

Banks, brokers and traders are increasingly breaking down silos, ending the traditional separation of asset classes into distinct business activities with incompatible trading systems. Today the drive to automate virtually every shade and variety of trading is creating a growing demand for cross-asset systems.

Clearly, an integrated multi-asset trading platform that allows market players to trade foreign exchange, cash equities, futures and options and other instruments is a very powerful proposition. However, the jury is still out as to whether the ‘holy grail’ of true multi-asset class trading on a single platform is a realistic goal.

Growing demand

Change is happening, however, driven by investor appetite for reduced transaction costs, access to higher liquidity, greater arbitrage opportunities and the growth of electronic trading across asset classes from equities to FX.

Mike Hughes, business development consultant at Fidessa, said that the market was being driven by both cost and the need for centrally managed risk systems. “There is a big push for multi-asset systems in the market.

“We are seeing demand for risk and execution systems to be put into one platform across asset classes with risk systems that can report margin requirements across all assets in a portfolio.”

Gerard Rafie, senior vice-president of product management at Calypso Technology, a global capital markets platform provider, says that the cross-asset trading evolution really began in the late 1990s in Europe where market participants had systems that managed multiple and cross-assets in one system that was “all singing all dancing.” By contrast, the US marketplace at the time was still trading on single platforms.

Europe started out on the trend by virtue of structured product desks and the need to build swaps but the North American market caught up pretty fast. Rafie says that the “cross-asset notion” has emerged strongly in the Asia-Pacific region over the past five years and, in the last two years he sees emerging markets such as Russia and Latin America coming up strongly on the radar.

Evidencing the trend, Banco de Crédito del Peru (BCP) recently signed up with Calypso for its front-to-back office system supporting FX, interest rate derivatives, FX derivatives, commodities derivatives and fixed-income products.

Challenges

Calypso is investing heavily in developing cross-asset products including collateral optimisation and credit risk areas like Credit Value Adjustment (CVA). Rafie says that the company sees an opportunity in creating a system that combines OTC clearing and exchange-traded clearing in one system or platform.

“It’s a virgin market and one where there is opportunity,” he says.

Despite the demand, there are a number of obstacles in the development of cross-asset class platforms. Rafie says that the more you put in a cross-asset feature, the more complex pricing and risk management aspects become.

“For example, what might happen in a certain applicable product to the long-term FX exposure if the long-term interest rate moves? The risk exposure will become very much interlinked and the valuation risk will become more difficult,” he says.

Also, processing difficulties can be encountered at the back end. Take a product that is priced say in Danish Krona while the return is in Euros. “This means that the processing - back office and the accounting functions - all have to come into alignment. And, let’s suppose there is no software, just managing it manually can be a nightmare,” adds Rafie.

Another challenge is that market structures pertaining to different asset classes can be very different. Equities are an order-driven market where orders are met by a particular exchange’s technology and the rule book of that exchange is implemented in that technology. By contrast, many OTC markets are quote driven with traders coming in and requesting quotes.

There are also different rules on different markets that have to be navigated. Rob Flatley, chief executive and president of Netik, a financial data management vendor, says: “From exchange to exchange the rule books are very different, such that Euribor trades differently to the way US Treasury futures and the Eurodollar on the Chicago Mercantile Exchange (CME) are traded. Liffe and the CME are very different in the data they distribute.

“Market data is certainly an important aspect to get a handle on. But the first order of the day is fundamentally an understanding of the relationship between the market structure and the instruments themselves. Then trying to figure out what is the optimum way to capture liquidity using electronic means.”

Limited scope

The diversity of exchange rules and market structure is one barrier to the development of cross asset-class platforms but so too is the diversity of the underlyers, which means that demand may be limited to specific areas.

Kevin Rush, Head of eDistribution, Barclays Capital (BarCap) in London, explains that over the past decade Barclays Capital has chosen to become a “flow monster” as opposed to a proprietary-trading supported business, offering a platform which spans big block products including futures, fixed income, FX, emerging markets, equities, commodities, and securitised products.

However, in terms of related cross-asset class trading of products, Rush says that you will seldom see one person trading equities against bonds against commodities. “It simply doesn’t exist. And, when looking at pure cross-asset class trading, one has to make sure that different products can actually be traded against each other,” he adds.

For example, doing a basis trade in certain products (e.g. selling Malaysian government bonds and buying Malaysian palm oil futures) does not work as the two markets/products do not exist in the same way as with other more aligned and better suited products.

Netik’s Flatley agrees: “I’ve never seen someone trade two disparate asset classes at the same time. It doesn’t really work that way. Yes, you’ll send an order where you’re going to trade futures and stock, or options and stock together. However, you don’t have a guy who trades interest rate swaps simultaneously with equities. I don’t see people doing that.”

Flatley says that where Netik’s sits is very much where “the action” is happening in cross-asset class trading today given the plethora of ETFs or other hybrid exchange traded products available.

Rush adds: “What you will see, however, is that within certain asset classes such as rates, clients who want to buy/sell a bond, or buy/sell a future or pay/receive in a swap or sell a bond or sell a future.

“So, you’ll see related cross-asset class trading within a given product directly. And, then the rest will be a facilitation where the clients who have a broad range of business would be able to access all the products on the same platform.”

Multi-asset vs cross-asset

A key enabler of cross-asset platforms has been the move towards electronic trading. Marek Robertson, head of e-distribution (EMEA), Barclays Capital, says: “We do see quantitative-based activity where a client who starts out in one asset class, such as futures, then wishes to extend their activity into alpha-seeking strategies in FX or the government bond market. (Multi-legging strategies between quoted markets can be performed too).

“This type of activity is taking place mostly from clients based in the US and in Europe, but will probably grow in Asia. That’s not so much cross-asset class trading but rather clients trading in the many asset classes that we support.”

Commenting on the areas of convergence in cross-asset trading, Robertson says: “A whole range of cross-asset and nearby asset activity is becoming more electronic over time. The common areas of convergence are around, for example, on the FX side where a treasury dealer might have interest to also trade money market products and perhaps metals.”

He adds: “Our fixed-income proprietary platform is available through that same channel. So, government bonds, short securities, interest rate derivatives, etc. In that example, BARX offers a single environment with tabbed access to products, as permissioned on our side. If a client does not wish to see that range of products on one screen they don’t have it crowding out their interface.”

Barclays also has an offering called COMET that sits within the BARX platform, which is designed for private banks and other wealth type businesses. This allows clients to structure their own notes, generate a variety of payoffs (e.g. Single-stocks, baskets, indices, currencies or commodities), conduct ‘what if’ scenarios, and then execute electronically on behalf of their client investors.”

High requirements

Another factor holding back the development of a unified cross-asset class trading platform is the requirement for top of the range platforms for each asset class, something that is difficult to achieve for a broad range.

Gavin Lavelle, chief executive of Brady, a UK AIM-listed technology vendor specialising in providing solutions for trading and risk management for the commodities markets, says: “The real challenge is that if you trade across assets - whether it be metals and energy or equally FX and equities - traders need best-of-breed components.

“Traders are working in very short timeframes. They’re trying to make instant decisions and once a decision is made they need to get their deals into their system extremely swiftly as well as wanting to see their positions updated, so that they can see their overall exposure and calculate their P&L. So, traders will want excellent ergonomics and high-speed performance - all tied to highly reliable technology.”

A big difference with the commodities trading sector versus other financially traded instruments (equities, derivatives, etc.) is that there are many underlying markets and the physical delivery and logistic aspects are fairly complicated.

Brady, for example, provides trading and risk management systems to handle raw materials, which can span anything from concentrates needing to be transported to a smelter (i.e. dirt from a mine), refined and precious metals, soft commodities (e.g. cocoa, cotton, sugar) as well as electricity, gas, oil, coal and carbon products.

Lavelle says: “The challenge is that if you have a best-of-breed input screen for a metals trader it’s going to be different from that best-of-breed entry for an energy, equities or even an FX trading participant.

“And, the risk in some of the cross-asset components is that if one attempts to make a ‘one-size fits all’ it can in fact result in the lowest common denominator being achieved. Therefore, it’s very important to have best of breed components.” Consequently specialisation in tools and applications for traders is key.

“If one looks at the largest financial organisations and Tier-1 banks today, it just never happens that way,” adds Lavelle. “You’re not going to get one system that handles equities and FX in these institutions to satisfy the primary dealers in both markets. It’s too complicated.”

Fidessa has spent six years building derivative capabilities into its equity platforms. The company is building a platform that can service the full trade cycle from pre-trade risk checks to execution to post trade processing.

“The blue sky vision is that everything can be traded from one front end. Currently big banks will have different platforms for different assets and different functions,” says Hughes. “They might have one system to trade FIX orders, one for risk, one for trading and execution and maybe even one for a specific exchange.

“We are developing a post-trade and pre-trade system that services execution, workflow and order management both on and off market across a range of asset classes on a single platform.”

Service Orientated Architecture

Lavelle says that the market is moving towards a Service Orientated Architecture (SOA), where a suite of interoperable services from multiple systems can be accessed on one platform.

Here you will have best-of-breed components spanning a best-of-breed equity deal capture, best of breed FX deal capture, etc. Then it’s down to the IT and infrastructure teams to ensure through SOA that deals are routed through to whatever risk and payment systems as well as other necessary destinations.

“So, rather than saying I’ve got one big blob that handles equity and FX and trying to be all things to all people - one goes to the FX guys and says ‘These are the tools...your trade capture, portfolio upload and this is the best-of-breed component for you’. On the equity side you’ll have similar tools available,” Lavelle says.

He also stresses the need for having an open architecture and getting data in/out of trading firms’ applications in a timely and efficient manner, which is more important than trying to perform everything on that “one giant blob” or single unified platform trading multiple assets. This, he maintains is “especially pertinent” where exporting trading data into risk systems is concerned - not just for market risk and counterparty risk but regulation and compliance too.

Early movers

Despite the challenges and limitations of cross-asset provision, there are a number of companies developing innovative solutions in the space. One such company is OpenLink, a developer of software solutions and support services for trading and risk management in various global financial and energy markets.

Markus Seiser, optimisation division president at OpenLink, says: “The platform should ultimately be very straightforward in that it allows straight-through-processing (STP) across the front, middle and back office.”

Berlin-based Seiser says in addition to flexibility that scalability in platform capability is a key attribute. “Clients should be able to flexibly expand via previous capabilities to any market they wish to enter, whether it’s going into Asian markets, trading oil in Malaysia or whatever it happens to be.” It should not necessarily require a vendor to expand the system if a client decides to trade the Henry Hub in North America.

To that end, Seiser contends that OpenLink’s USP is to support the greatest number of asset classes out of one system, whether a market participant is trading money market and hybrid instruments, or they’re looking at the complexity involved in power and gas products or even bulk commodities (e.g. crude, coal and other refined products).

By contrast to banks who are well known for having separate systems for interest rate swaps, a separate system for FX and another for Treasury, Seiser says that many energy companies see it differently and “would like as far as it’s possible to have everything in one system.”

He adds: “However, you will not find a trader trading NordPool together with Italian power. You won’t see that. So, consequently we make the differentiation of screens where we leverage the benefit for clients. We bring it together where we should bring it together, which is in the risk numbers, the back office processing and all the associated STP.”

SunGard is also making strides in the development of cross-asset class trading. Tim Dodd, head of product management at SunGard’s Front Arena business unit, a cross-asset platform that spans equities, interest rate, credit, commodity, FX and MM derivatives and their underlyings, says: “Fundamentally a built-for-purpose platform needs to have a good set of robust functionality by asset class, but also be flexible enough to plumb in other instruments and facilitate good workflows around those instruments - without breaking everything downstream.

“Flexibility of platform model type is therefore important. But on top of this control, standard approach and robust technology that deals with fixings across every asset class in the same manner are among key attributes. So, where possible it needs to be standard yet allow flexibility for exception management, to map to the way in which a bank or financial institution works, and to plumb in their special source model as necessary.”

It’s also important to realise that different traders think differently about their different asset classes. For example, a forward FX swaps trader will think in pips, whereas an ordinary swaps trader thinks in basis points of yield. As a result workflows need to be able to accommodate such differences.

As a cross-asset and front-to-back platform, Front Arena offers both connectivity to various liquidity venues electronically and OTC derivative position keeping functionality. Dodd describes it as a “position and control platform” with four main pillars, with deployments either in-house at the client site or hosted.

Dodd adds: “Electronification of all derivatives markets is moving to a new level. There are market participants who need to connect to liquidity pools that have not existed before and other people who are starting to see requests to do electronic flow business in areas that they’ve not done in it before.”

In terms of growth areas and the regions for adoption of greater cross-asset trading and systems, Dodd contends: “Emerging markets are certainly very important to us as they are to the rest of SunGard. But we also see opportunity because of greater electronification globally and our unique positioning through the combination of electronic connections and OTC market expertise, which allows us to take advantage of this paradigm shift. As such we see potential growth in western, middle eastern and far eastern markets.”

He nevertheless contends that some “tropicalisation” and tweaking is necessary to accommodate the particular needs of emerging markets. He says: “Tropicalisation of an application so it can handle say Brazilian bonds is important. As is the having the appropriate language within the skinning of your interface (GUI). Nuancing therefore by geography is clearly as important as nuancing by asset class.”

Box: Emerging markets - Russia

In relation the Russian markets, Tim Bevan, Director of Global Electronic Trading Services, Otkritie Securities, a dominant Russian broker for depository receipts (DRs) and derivatives traded electronically there, says: “We do see some cross asset trading already in Moscow and this can be trading cash equities on the depository receipts (DRs) versus the local Rouble-denominated shares, which is effectively an FX trade. Market participants can be using an FX future to hedge their FX or spot FX to hedge your FX - or both.”

Bevan adds: “The same applies for the index arbitrage as well since you have the DRs (in US$) and the Local shares (in Roubles). There’s a big FX element into this trade as well. So, some of the core strategies that we support are already strictly speaking cross asset strategies.” Clients can use Otkritie’s central platform and connect to it via FIX using their own front ends of use a front end called Quik from the broker.

The ex-London Stock Exchange executive who shuttles between London and Moscow indicates that Otkritie has recently been responding to client demands by building ever-improved FX access as the “arbitrage channel” has narrowed. Bevan indicates that a healthy pipeline of high frequency trading (HFT) participants and prop shops are coming on board with Otkritie to trade Russia, while discussions are “getting close” with several Tier-1 institutions.

The Russian Trading System (RTS) and MiCEX - exchanges who are in the process of merging - exhibit deep liquidity. Indeed, recent figures show that on a daily basis c.$10bn is going through the derivatives market in Russia, a similar amount through the FX market and $2.5bn-$3bn in the equities space.

Box: Nordic developments 

Elsewhere besides Russia, the Nordic region has become an important “epicentre” for trading lately given a plethora of markets under the Nasdaq OMX umbrella that includes Stockholm (Sweden), Helsinki (Finland) and Baltic markets (Estonia, Latvia and Lithuania), MTFs like Chi-X and Burgundy, the Nordic Growth Market (NGM) and NordPool for spot electricity.

While most of these markets are physically located in datacentres in and around Stockholm, Norway’s Oslo Bors is an exception with its matching engine located in London (part of the LSE’s infrastructure). While a number of Nordic players want to reach liquidity London and Frankfurt (Deutsche Boerse/Eurex), investment banks in London also want to reach liquidity in the Nordics.   

Noting this “Two-way Street”, Tony Moulange, senior business development manager, Colt Technology Solutions, a business communications and IT services provider, says: “Stockholm for us is a spring board to Moscow since our fibre-optic from our datacentre runs across the Baltic to Russia. And, we’re certainly receiving interest in that route too, which wasn’t the case even just a few months ago.”

Colt, which touts a 4.22 milliseconds (mls) roundtrip latency between its Points-of-Presence in London and Frankfurt (one of two Deutsche Boerse's gateways), through sister company KVH runs lines across the Pacific linking up Asian trading venues via Chicago - from London. 

Moulange adds: “Our brief fundamentally is that we connect clients to liquidity wherever that happens to be. To that end, we’ve recently pushed our fibre-optic network elsewhere into eastern Europe to cities such as Warsaw, Prague and Budapest. This is effectively us taking a view on the future into 2012-13 as countries adopt the euro and their markets become much more liquid.”  


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