The broker-dealer’s front office has a great opportunity to use the advances in automation to enable them to meet the demands of coming regulations and lower their cost structure and risk. By focusing on their core competence and uniqueness they can now automate routine and repetitive functions and outsource any area they don’t want to have in-house.
In order to satisfy the reporting requirements of MiFID II they get to invest in the latest technology that will enable them to be transparent with their clients, update their operations and improve how they interact with the market and report their trades. Opportunities exist in risk and compliance, through software and technology, to outsource all or part of these changes.
The firms that choose to embrace change, use technology, be transparent and be early adopters will see all the advantages of a market that will have to make these changes to satisfy the regulators. The Fundamental Review of the Trading Book (FRTB) is driving a substantial change in the relationship between the front and the middle office. It requires an alignment of models from the front office and risk which is driving the consolidation of platforms. Having a separate risk platform and trading platforms is proving challenging to maintain.
As such, FRTB is giving firms an opportunity to reassess the number of trading systems they have. Many are consolidating from multiple asset-class-specific trading systems down to a single integrated trading and risk infrastructure. Regulatory headaches can be turned to an advantage by brokers by securing significant cost savings.
However the response to regulation is not always to build process and systems to allow compliance. The response can be to get out of certain businesses. The capital rules affecting banks are punitive for business lines that provide infrequent turnover on high ticket items. The cost of capital for trading an illiquid asset can be too high to make it worthwhile.
Where that impacts liquidity there is still a need to trade those assets. Automating workflows allows more efficient matching of orders which helps to reduce the impact of reduced sell-side liquidity. In trading over-the-counter (OTC) instruments, we simultaneously see regulation requiring firms to apply more technology in order to demonstrate transparency via best execution reports, and cost pressure moving the traditional workflow away from sales and trading shouting at one another, and towards an electronic workflow.
To understand how to handle cost pressure and regulatory demand through automation, brokers first need to assess what gives them a competitive edge and what does not. Non-differentiating functions can be outsourced, but if there are elements that give them some competitive advantage they need to retain control.
The second thing is that outsourcing some of a firm’s core functions to vendor can only take place with a reliable partner, with a strong balance sheet engaging in activity it has done it and operates at scale. This cannot be a technology start-up operating out of a garage.
Sell-side firms are facing existential questions about engaging in lines of business. Their cost models are changing and to maintain their position in any given field they need to use automation and utility to support themselves more effectively.
These changes, driven by regulatory changes and clients seeking transparency, represent an opportunity for first movers to redefine not only themselves and how they operate but set a standard for all who follow. The advantage will go to those who embrace technology, automation and use outsourcing of non-core competencies to lower their risk and cost. With great change comes great opportunity and those swift to embrace them will be rewarded.
With constrained resources and shifting demands, getting better use of expenditure is vital. Developing a flexible, scalable set of systems is leading firms to move more operational functions to experienced solution providers who are positioned to help them adapt to industry and business changes.
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