Electronic trading and the need for speed

The connection of electronic pricing and trading engines between investment banks and private banking clients has increased dramatically during the past couple of years as sophisticated new systems have been introduced. What is the competitive advantage of this process industrialisation? And how does it fit in against the overall balance of closed versus open architecture at private banks? Harry Thompson reports

Around two years ago, most dealers started to ready automatic price-quoting systems, based on emails, that enabled private banks to get prices for certain regularly used products at the touch of a button. A few years earlier, UBS even took the step of developing a full click-and-trade system that enabled the relationship managers at its private bank to browse products and underlyings and experiment with different calibrations of pricing and payoff.

Now, during the post-crisis lull, banks are investing significant sums into IT, some developing similar click-and-trade systems to UBS – with Barclays Capital, Credit Suisse and Royal Bank of Scotland (RBS) all having got their own systems up and running this year – while others are building out their email-based pricing services by offering new markets and adding product lines to their systems. What is more, there are noises that these expanded systems, primarily developed in Asia, could be the start of something bigger – a kind of quasi-exchange for private banking products in the region.

The reasons behind the recent spate of investment are multiple, but central among them appears to be the need to not get left behind by other banks. Banks are broadly trying to ensure clients can both price and execute using their platforms as this is expected to enable them to absorb large volumes of trades. Furthermore, hedge funds and other institutions are also interested in using the full click-and-trade services and, from a technical standpoint, it would not be too difficult to expand the product offering beyond just private banks.

Perhaps most importantly, while the private banking market is relatively quiet at present – with some estimating that though volumes are roughly the same as they were in 2007, ticket sizes are on average five times lower – the expectation among bankers is that eventually the markets will pick up and investors will return, and at that point firms that have failed to bring their IT up-to-date will be outmatched by their better-equipped competitors. “Right now, pretty much everyone is working on the same thing. It is not about competitive advantage, it is almost talking about you having to catch up to ensure you are not left alone [when the market picks up],” says William Lee, head of equity derivatives, Asia Pacific, at JP Morgan in Hong Kong. “When we assessed the cost a few years ago, the competitive advantage was relatively clear.” Some bankers note that UBS in introducing its direct trading system with its private bank made it difficult for competitors to get into that area.

Nicolas Cohen-Addad, head of equity derivatives trading, Asia, at Barclays Capital, also says banks generally are building up their IT – noting in particular the growing number looking to develop click-and-trade systems. “It’s certainly a response in terms of banks emerging from the crisis asking ‘how do we rationalise our business’? And when it comes to equity derivatives structured products, ‘how do we become more scalable?’ It’s both about improving the service to the clients, improving the visibility and the collection of content throughout the OTC derivatives market.” OTC markets are typically invisible, but you can create visibility for both the bank and the client by providing access to a wide range of products on one platform, says Cohen-Addad.

The idea of scalability extends right down the value chain, supposedly making business more efficient, not just for pricing via the single point of entry, but also for trading, risk management and lifecycle management. Along with this, says Cohen-Addad, using an electronic platform efficiently gives better visibility in terms of instant access to positions and flows, both for the client and the bank. “It’s more than just enhancing volumes, it is creating content. We don’t reveal client names but we can show clients what the market flows are. It also can provide real-time granular information to sales,” he says.

Bankers also cite other benefits, for example, from an operational risk standpoint electronic platforms minimise mistakes, such as ‘fat finger’ keying errors made from time to time by traders. Moreover, bankers believe the platforms will help enable firms to meet the fast turnaround of new products expected with the return of the market. “The winners will be the ones who can adapt very quickly to a new type of product or a new type of payoff, and be able to commoditise this payoff through the different channels: email, online or over the phone,” says Cohen-Addad. “That’s also part of the scalability. If I have a new payoff and it takes me 12 weeks to be able to trade an unlimited number of tickets or price requests on that payoff, then it’s not working because 12 weeks is already what we call the half-life of the product. We need to be able to turn around the new payoff in the shortest [time] possible. That’s why everyone is going through extensive IT investment and system revamps to achieve that.

“We haven’t seen a blockbuster like the accumulator for a while,” adds Cohen-Addad. Having his product desk freed up by the electronic platform enables his team to work on the ‘next blockbuster’, he adds.

With a properly set up e-trading system, a bank can handle large or small numbers of trades with equal ease. Both Lee and Cohen-Addad say this is changing the role of structurers. Lee says that previously some firms would hire a large number of very junior structurers whose job was effectively “pressing F9 to generate the price – but now it should all be done by the server”, says Lee. “For us, we’re actually moving away from the marketer but not from the structurer – our structuring team has historically priced second-generation exotic products.”

This means that if a bank expects market turnover per year to grow by a certain percentage, it no longer needs to go out and hire a proportional number of structurers – and suffer the consequences of over- or under-hiring. “If the new version of the accumulator came tomorrow, with our new system we could move almost as fast as the market,” says Kevin Chin, head of derivatives platform sales for Asia at RBS in Hong Kong. “Essentially it’s a paradigm shift. It used to be the big fish eating the small. Now it’s the fast eating everyone.”

Margin squeeze

The ‘industrialisation’ of wealth product distribution may ultimately also hurt bank margins but that pressure doesn’t appear to be causing much concern at the moment. “Intuitively you would think electronic banking would squeeze margins for investment banks, but we haven’t seen that. We’ve noticed that if you can service a bank with a price fast enough you will still get the transaction,” says Chin, who says opportunities in such a fast-moving market do not last for long.

According to Ben Chan, executive director of equity derivatives sales for Asia Pacific ex-Japan at UBS in Hong Kong, electronic trading may squeeze margins, but that is not the full story. “Margins have been under pressure for all investment banks,” he says. “But the reason for pulling the platforms together is primarily to improve front-to-back office efficiency, as opposed to aggressive pricing.” He adds that the differences in efficiency will “really show in a busy market”.

JP Morgan’s Lee, however, says while e-trading is good for investors “from an investment bank point of view, it actually becomes very tough to do business, because there is no more price discovery and price competition is extremely tight”.

Anurang Mahesh, Asia Pacific head of global investment solutions for Deutsche Bank Private Wealth Management in Singapore, says electronic platforms have helped private banks’ clients secure better prices, but have not helped the buy side in terms of profitability. “In the flow space, the determining factor for a successful trade is price,” says Mahesh, adding that speed of response is also a factor. Banks that cannot come back with a price in five hours are “not even in the running” for trades, he says.

In the private banking community, there are questions about the changing make-up of the private banking client base, with greater segmentation showing between high-net-worth and ultra-high-net-worth (UHNW) clients. Private banks are increasingly tailoring their services towards the UHNW. Moreover, boutiques are increasingly being set up to capture market share from the private banks and act as a kind of prime broker to the family offices of the UHNW individuals. The change is already taking place, and Chin notes that e-platforms help firms with different business models to operate more efficiently and effectively, as well as differentiate themselves. Moreover, “since family offices function like a hedge fund they just want to click and trade”, he says, and notes that some family offices are directly accessing platforms such as RBS’s. Chin doubts these platforms will replace private banks, however.

Debashish Dutta Gupta, head of investment and wealth management at Citi Private Bank in Singapore, agrees there is no threat to the private banks, saying e-platforms “are not generally for the client – they still like to hear a voice”.

“They are very dependent on having a conversation and getting advice... the way we see it, it’s not a tool in the hands of clients, it’s a tool in the hands of sales,” he says. Dutta Gupta adds that from his perspective, documentation, disclosure and after-sales service by the provider are also important alongside price, and that even with a click-and-trade system, private banks can need a heavy infrastructure to filter out the best providers on these fronts.

Future quasi-exchange?

One possibility – though at this stage just a possibility that bankers may be tentatively discussing among themselves at this moment – is that the e-trading systems may evolve into some kind of quasi-exchange. Some speculate that this could happen in the next five years, with the big issuers beginning to get together to offer shared pricing within the next two years.

An arrangement such as this is not unheard of – for example, when banks in Switzerland issue a structured product, the customer can request that it be put on an exchange. This makes prices transparent, and means the issuer has a commitment to exchange secondary trading, which promotes liquidity for clients. In Europe, the secondary trading market is already highly active, but this is not the case in Asia, where there is currently little to no activity – although broadly bankers hope this business line might grow. Cohen-Addad is particularly positive on the idea of quasi-exchanges developing, saying that at first it may be a case of the big issuers working together motivated by the desire for greater standardisation and accessibility, with the exchanges perhaps coming onboard when the idea gains traction. Cohen-Addad notes that a quasi-exchange would create even better visibility on market size and flows in the market than one bank’s click-and-trade system.

JP Morgan’s Lee says the development is possible, but is less positive on the outlook for it taking root. He notes a comparison that exists between warrants and listed options – the market can allow both to develop. “[Exchanges] clearly want to allow the listed options, but why warrants have a bigger volume is because each warrant is related to the issuer name,” he says. “So you can imagine that if this kind of auto-quoting system is related to our house name, we will try to make it better to beat other people. Instead of standardising for the whole market, creativity lies more in a proprietary platform.”

Dutta Gupta similarly says for an exchange to function things need to be standardised first, and there is a need for market making. “If you handle the counterparty risk, and disclosures are standardised, then getting one up and running would be pretty straightforward,” he says. Dutta Gupta adds that this would not necessarily see non-exchange traded transactions die out either, because of the need for bespoke solutions. “It is like buying a suit from a tailor versus off-the-rack. There is always going to be a market for off-the-rack, but then there’s always going to be a market for tailored. The two will co-exist,” he says.

Dutta Gupta, however, believes an exchange would actually be somewhat negative for the private banks, because margins are higher on bespoke transactions, although he says if that really happens the revenue stream will shift “for example to the trading room”, where the private banks would instead make money through higher volumes. “It’s volumes versus margins. Lower margins and transparency will lead to higher volumes, so volumes will compensate for lowered margins,” he says.

The nature of the provider is also of concern to market participants, with several saying banks are unlikely to trust an exchange run by an investment bank, although several suggested it is something Reuters or Bloomberg could easily become involved in effectively for use via their terminals, or another platform. Others, meanwhile, suggest that the exchanges themselves would probably be interested in becoming involved. Private bankers also note there would still be a need for checks on best execution among the investment banks, an activity that is intensive on back office.

“We need to have one place for banks to come, and we could simply have an aggregator website that talks to all of the other websites,” he says. “I’ve toyed with the idea of doing this, particularly in the cash bond space. With the private banks going together, this could lead to better execution,” says Mahesh, who adds that “the value of such a website would be that the more membership it has, the more effective it is”.

He notes that in the debt space, this would be particularly useful for tightening the bid-offer spread in the client’s favour. But such developments still seem some way from getting up and running.