As liquidity in global markets continues to fragment, sell-side firms of all sizes realize that deploying a liquidity management strategy and its supporting infrastructure isn’t just about reaping the extra profits, but also meeting new regulatory requirements. Dealing With Technology speaks with David Morgan, marketing director, trading and client connectivity, SunGard Global Trading, to discuss the benefits and issues surrounding the adoption of such platforms.
1 – Has the industry redefined what it means by liquidity management in regards to the front office? Has smart order routing taken over liquidity management?
In the context of the US and European equity market sell-sides, the answer is a partial ‘Yes’, in that the smart order router is the core element in the architecture of any broker who is managing liquidity across multiple venues. It is not the only element in the case of the major brokers, as almost all of them also have a strong internalization drive as part of their trading strategies. Therefore an in-house crossing or matching engine, often supporting a dark pool that may also be linked to those at other brokers, is a vital element of liquidity management for these firms. It is of course necessary to integrate these liquidity management system elements closely together in order to ensure that the brokerage firm meets its Best Execution obligations, and integrated middle-office links are also important, both for the trade databasing necessary to meet regulatory obligations and, in Europe, the complexities involved in the multiple clearing house interfaces.
2 – How essential is it to deploy a liquidity management system (LMS) to support a liquidity management strategy? What are the immediate and long term benefits of deploying a LMS platform?
It is absolutely essential – either a brokerage firm outsources its liquidity management strategy to, usually, a larger firm that has the necessary capabilities in place, or it puts in place its own architecture to support that strategy – i.e. an LMS platform in your terms. Right now in Europe there are still many firms doing neither of these things – i.e. still simply routing all orders for each equity market to the established ‘home’ exchange. Putting it bluntly, this essentially means that these firms do not currently have a liquidity management strategy for the post-MiFID market environment: they are managing their businesses and client relationships without one. Such a position is, we would say, likely to become increasingly less tenable for business on those major exchanges where fragmentation of the market has reached significant levels, and where there is clear evidence that better prices can frequently be obtained on the MTF platforms or (for larger orders) in the dark pools that are now gaining traction in the marketplace.
The benefits of deploying an LMS platform are the other side of this coin: reports from brokerage users of SunGard’s smart router and other LMS components show that they can routinely obtain price improvements for their buy-side clients of 8 -10 bps for the increasing proportions of their trades that they route away from the established exchanges, while they benefit also from the aggressive maker/taker fee tariffs of the MTFs and lower associated clearing costs. Overall reductions in trading and clearing fee costs of 20% are readily achievable. As immediate benefits these are very clear, while in the longer term the main plus is likely to be the competitive advantage that will accrue from a well implemented liquidity management strategy.
3 – Who are the early adopters and what return have they seen since implementing liquidity management?
The initial leaders on both sides of the Atlantic have been primarily the bulge-bracket brokers. Having worked with pre- and post-NMS fragmentation in the US, they knew that the impact of MiFID would be significant and saw the opportunity to gain competitive advantage in Europe. Also, their large volumes meant that they had the most to gain from the trading cost reductions that have been prompted by increased competition between trading venues. And in many cases, these brokers already had the technology to maximize crossing opportunities for their large pools of internal liquidity.
The other early adopters are typically technology-aware agency brokers who have realized that, in the context of the DMA boom and increased buy-side empowerment, they must find new ways to provide value and differentiate themselves in the post-MiFID landscape. Offering smart routing allows them to provide superior execution services, pricing and efficiency, and hence to justify their role as liquidity sourcers to their clients.
We’ve discussed earlier the returns in terms of the benefits listed in Question 2: significant price improvements obtained for buy-side clients, and equally marked reductions in trading and clearing fee costs for the broker.
4 – Have firms broaden their liquidity management platforms to support cross-asset trading?
At present this is probably a bridge too far for most firms, at least on the sell-side, but the potential clearly exists for all asset classes where multiple trading platforms are in operation. SunGard clients in the US and Europe deploy our smart routers across options and bond markets as well as equities, and foreign exchange is the probable next step. We have seen increasing interest in multi-asset trading architectures partly as a result of rationalization at trading firms during the recent market downturn, although it must be said that this is primarily a buy-side phenomenon.
At sell-side level, for the immediate future we foresee liquidity management developments taking place largely on a single-asset class basis. The market structures differ radically, and for now the brokerage industry is sufficiently challenged by developing and optimizing its liquidity management strategies for each asset class, each based around a platform designed and optimized for that group of instruments.
5 – What infrastructure issues do firms typically need to address before successfully deploying a liquidity management system?
The answer depends greatly on the fundamental approach taken. At one extreme, (typically) a large broking firm might undertake its own development of all elements of the liquidity management system, intending to establish unique capabilities and hence competitive advantage. In this case, first, connectivity has to be established to each of the multiple trading venues and their respective clearing houses – meaning both physical telecoms links (remembering that latency is a vital factor in a smart routing context) and the specific gateway software required.
Secondly, high-capacity client connectivity will be required, particularly where there is to be Direct Market Access trading by major clients.
Thirdly, tight integration will need to be established with existing infrastructure, such as algo trading engines and proprietary trading systems. Last but not least, the firm needs people with the capabilities to build a leading-edge LMS platform to link all of the above and incorporate unique smart routing and matching algorithms.
Clearly, this is a game that few can afford to play. Smaller firms have to consider carefully what makes sense for them to build and operate themselves, and what to buy in and/or have managed for them. ISVs like SunGard have a key role to play here: we have recognized the need to package the complex liquidity management technologies as far as possible, in order to make them affordable and manageable for mid-sized specialist and regional brokers. So, for example, we offer as ASP services trading and clearing connectivity to all significant European venues, plus our (highly customizable) smart routing capability. Simply put, firms can deploy liquidity management systems using this approach with no infrastructure prerequisites. So, as stated above, it really does depend!
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