Cutthroat competition, high levels of automation and a wealth of information that must be absorbed literally at the speed of delivery have turned the US equity execution into a complex science for sell-side firms.
It is this high dependency on automation, writes Miranda Mizen, senior consultant and author of TABB Group’s new research report, “Real-Time Risk: Managing Execution Risk in an Increasingly Electronic World,” that raises the need to control execution risk as an entirely new type of risk that must be aggregated into other risk management efforts.
“It is global expansion,” says Mizen, “that is accelerating four execution risk forces that need to be managed by sell side firms: trading automation within asset classes; cross- asset class investment strategies; market structure changes; and increasing product complexity. The combined effect of these four forces happening at once is serving to create a perfect storm for managing risk across the desk in real time. As the level of automated trading already seen in the US equity market stretches further within the US as well as across continents, the potential for the failure of any one of these moving parts is enormous.”
She adds that real-time risk cannot be monitored in silos, but has to incorporate much wider, cross-organizational, enterprise-wide views to have any effect.
“Trading’s not what it used to be,” writes Mizen. In 2006, order flow was centered in one or several primary venues, surrounded by little competition and a handful of dark pools with low volume with the majority of volume controlled by sales traders who fiercely guarded client relationships and had responsibility for best execution. However, she adds, in one fell swoop, the US Securities and Exchange Commission’s overhaul of equities trading, Regulation National Market Structure (NMS), broke the stranglehold held by the exchanges and changed the competitive landscape.”
“In a little over a year, US equity execution has evolved into a more complex science, as Regulation NMS requires that the best displayed prices be respected, leading to the rise and importance of smart order routing (SOR).”
Accordingly, sell-side firms are racing to develop strategies and tools that allow them to improve, measure, monitor and control the execution process, eager to reduce execution risk through the combination of accurate data, fast processing, comprehensive views of the market place and the ability to anticipate or minimise issues as they occur. Those that do not control execution risk will see their opportunities limited and their organisation exposed, while competitors take advantage of more trading opportunities as well as have a superior quality of execution.”
With the emphasis on managing risk at an all-time high, to maintain this accelerated pace, sell-side firms will continue to spend on equity analytics at a compound annual growth rate (CAGR) of 5% through 2012 globally. In 2008 alone, TABB Group forecasts they will spend $157 million on technology relating to algorithms, smart routers and analytics technology.
“Managing risk is a survival test,” says Larry Tabb, founder and CEO, TABB Group. “As Miranda writes, enterprise risk management is already on everyone’s radar, but in these fast-moving, high-volume, global markets, execution-time risk needs to be developed, broadened and redefined. Global expansion will escalate the stakes, which are already high and getting higher, as automation grips every asset class and each continent, accelerating the gap between the winners who maximise their ability to manage risk profitably and the others, who might just risk losing their shirts.”