The New Face Of Prime Brokerage

Posted on April 26, 2010 by Ian

The prime brokerage landscape has changed dramatically since the Lehman’s  collapse in 2008.

A couple of years ago both Goldman Sachs and Morgan Stanley had 2/3rds of the Prime Brokerage Market.

Today, the top 4 brokers now control 68% of the prime market, representing a significant redistribution of power within the prime brokerage industry.

Evolution
Historically, hedge funds and institutional investors would use a prime broker to provide :

•    Centralised Clearing
•    Single Set of Books and Records
•    Consolidated Position Keeping
•    Efficient Cross Margining

During the credit crisis, the amount of leverage available to hedge funds drastically reduced from 30 to 16  times against a prediction that 30% of hedge funds would go bust. At the same time, prime brokerage profit and revenues plunged.

Multi Prime Relationships
Counterparty risk and the fall out Lehman’s proved to be the final nail in coffin for the single prime brokerage model.

Market participants became only too aware that no prime broker (PB) was too big to fail. There was a need to spread their counterparty risk across several prime brokerages introducing the arrival of the multi prime relationships.

Hedge funds of all size now demand multi custodial relationships, which introduce additional complexity  such as increased reconciliation, margining and asset servicing across several custodians and ultimately prime brokers.

Market Structure
Without a captive single prime model, the high cost structure that leading prime brokerage firms now face is no longer viable to service small hedge funds based on pure economics. This has been seen with PBs  being more selective on what type and size of funds they manage.

Conversely, funds in less liquid or highly leveraged assets are finding is a lot harder to attract and maintain a top tier prime relationship.

Smaller hedge fund (HF) have historically been serviced by the midi and mini primes who are now expanding their offerings to attract new funds. The mini primes, such as Merlin, still use the clearing and financing services from the large primes and have ultimately developed a cost structure to allow a profitable PB service to be developed for the smaller tier HFs.

The major players are now sharing the prime landscape with both the midi and mini primes, who  are proliferating fast with a number of new entrants coming to market.  To date, there are 3 mid sized operators and about 20 minis with 10 more planning to enter the market  soon.

Commoditisation of Prime
As the market matures along with a high level of competition across the sector, the commoditisation of prime brokerage has started.

Profit margins are lower for the mini and midis which only provide basic services and will struggle against the majors who make most of their money from complex strategies and the financing of large portfolios.

The conventional business lines between prime brokers and hedge funds are starting to blur with many  Prime Brokers now acting as business partners. As part of this service, PBs  provide business plans to the HF community, publish white papers, arrange office space leasing  and advise on risk management services and strategies.

Winners
The clear winners in the prime brokerage race will be the players who can differentiate their service offering.

Key to this is being able to leverage technology to deliver a new Prime Brokerage infrastructure that can support aggregate multi prime relationship along with real time reporting of critical data such as PnL, risk and margining.

The ultimate challenge is to become the provider of choice with a true cross product capability across FX, equities and fixed income.

The winners will be the prime brokers who understand and act on the new economies of the market.

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Equity Markets | Leave a comment

Top 10 Challenges For Investment Banks

Posted on April 12, 2010 by Ian

Following on from my interview in Banking Technology on rebuilding the investment bank, Accenture have recently published an interesting white paper on the key challenges facing the sector.

Here are the key highlights :

Sustainable Risk and Cost Management

• Challenge: Manage Liquidity Risk
• Challenge: Embed Risk Accountability
• Challenge: Prepare for New Regulation
• Challenge: Reposition the Workforce for Growth

New Operating Models

 • Challenge: Rebuild the Client Proposition
• Challenge: Execute the Strategy
• Challenge: Realize the Value from Mergers, Acquisitions and Divestitures
• Challenge: Exploit the Potential of Shared Services

Technology Refresh

 • Challenge: Harness Alternative Technologies
• Challenge: Evolve the E-Commerce Offering

 IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Transformation | Leave a comment

Exchange Independence

Posted on March 25, 2010 by Ian

Over the last 100 years, exchanges have continued to provide a key service in the form of price discover, that is matching buyers and sellers and ultimately discovering the price that a trade will take place.

The price discovery process has been central to the exchange model and has remained largely unchanged until now.

Against a backdrop of constant downward pressure to minimise trading costs, a new competitor is challenging the once dominant position held by the exchanges.

New Entrants
The new entrants are in the form of Multilateral Trading Facility (or MTF), backed by large market participants. The MTFs have drastically changed the landscape introducing intense competition which has directly benefited the market in terms of :

 • Tighter bid / ask spreads
• Lower commissions
• Increased market depth and liquidity
• Average ticket sizes have fallen

MTFs continuing to take market share  – the number of MTFs have exploded from nowhere to in excess of 130 in Europe within a couple of years.

A recent Thompson Reuters pan European survey reported that the LSE has 13.5% monthly market share by turnover, compared to Chi-X which has 15.2%.

This trend of MTF taking market share at the expense of the established exchanges looks set to continue.

MTF Allegiance
The previous market structure once enjoyed by the primary listing exchanges is no longer tenable and needs to be re-examined.

One of the key areas that needs to be revised is the area of Governance

As demutualised and public owned organisations, exchanges are unable to favour specific customers or groups and have to treat all customers fairly.

A large number of the new MTFs are owned by professional trading organisations which have a vested interest to obtain the best price of their own trades, representing a significant conflict of interest that the regulators need to address.

A key question that needs to be asked is what is the true allegiance of the MTFs ?

Are they looking for the best price for the customer or alternatively to drive the bid / offer spread wide in order to achieve the best price for the own member firm. ?

In the current economic climate, the regulators continue to focus their efforts on a limited number of issues, such as insider trading, front running and flash orders and have lost the battle in maintaining the impartial price discovery process.

Conclusion
As new entrants, the MTFs have been highly successfully in leveraging both technology and process innovation to rewrite the exchange model. MTFs provide increased completion and have been highly successful in driving costs down.

With many of the larger MTFS owned by market participants, the regulators need to ensure that the price discovery process remains transparent, impartial and is not manipulated or abused by a minority for the benefit of their own trading operations.

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Equity Markets, Risk / Regulation | Leave a comment

Rebuilding The Investment Bank

Posted on March 12, 2010 by Ian

 

 

Check out a great article from Banking Technology magazine on my views, along with Philip Freeborn (CIO, Barclay Capital) and Mark Butterfield (CIO, Nomura), on rebuilding the investment banking model ​

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Press | Leave a comment

Risk Management – Looking Ahead

Posted on March 6, 2010 by Ian

Flaws in risk management have been stated as the major cause of the credit crunch.

A recent S& P Survey found that less than 2% of fund managers have adequate systems to manage risk, or in other words, 98% of fund professionals are unable to accurately predict, model and report financial risk

Based on the above stats, coupled with today’s tighter oversight, lower leverage and heavily regulated environment, what will the future risk management landscape look like ?

Building Blocks
Historically, the fundamentals of any risk management system was that it had to be practical, accurate and comprehensive and be able to provide the following Inter-Day functionality :-

 • VaR across all positions
• Stress , Scenario testing across all positions
• Counterparty risk
• Inter Day covering position changes, market changes
• Extensible

As well as more importantly being able to calculate risk across multiple and sometime illiquid assets by :-

 • Trader, desk
• Region / entity
• Asset class etc

This proved to be a significant undertaking for any organisation, requiring significant technology resources to manage the complexity, incurring prohibitive high costs.

Limitations
Many corporations are currently inhibited in their ability to fully grasp their risk exposure due to outdated or poorly integrated risk systems.

As a result of several large scale integration and acquisitions, several banks are being constrained by disjointed and duplicated IT systems which severely constrain their ability to identity and manage their true risk exposure.

Rear View Mirror
At the recent Trade Tech Architecture conference, Dr Tony Chau, Chief Architect J.P. Morgan described the current approach to Risk Management as a “Rear View Mirror Approach” that focused too heavily on where you have come from as opposed to looking ahead on where you are going.

This is akin to driving down a major road at speed, deciding to navigate by looking in your Rear View Mirror on where you have come from as opposed to looking ahead on what is approaching.

Forward Looking Work Flow
What is needed, is a forward looking view on Risk Management, where the intraday work flow would consist of the following :

 • Multiple market environments, typically one per asset type e.g. futures, bonds, swaps
• Transaction are flowing real time into the risk system
• Multiple models and parameters are enabled – allowing the user to balance between accuracy and performance
• Run what if scenarios and strategies by tweaking market environment and parameters

The intraday risk work flow needs to be scalable and extensible to provide speed and flexibility for a new and improved approach to risk management.

This approach needs to be overlapped with pricing and back end functionality that is in use across the enterprise.

High Performance Chipset
In addition, due to the volumes of data required especially when dealing with historical data trends, there is a central need to leverage best of breed performance devices such as the high performance FPGA and GPU devices in order to be able to guarantee increased accuracy and timeliness of information in a near real time environment.

Looking Ahead
Only by moving to an improved risk management model, that provides a more accurate view of risk can an organisation truly migrate to a forward looking model and be able to predict, model and report financial risk in a near real time environment.

This will ultimately be a win-win solution for hedge funds, investors and regulators alike.

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Risk / Regulation | Leave a comment

Market Evolution – Post MiFID

Posted on February 23, 2010 by Ian

European Capital Markets Institute (ECMI) made an interesting presentation on how the Financial Markets have evolved since the introduction of the Market in Financial Instruments Directive (MiFID).

The pan European MiFID directive was introduced on 1st November 2007 and had a profound, long term impact on the Securities market.

It saw banks operating as exchanges, the decentralisation of execution venues as well as introducing longer term strategic opportunities for nimble and innovative technology players to compete with the exchanges.

Exchange Impact
Some interesting facts have emerged on how the exchanges have been impacted post MiFID. The following table details the trading volumes and turn over from the London Stock Exchange (LSE) :

Trades       Turnover
2008    2.22 million      €24.04 billion
2009    2.17 million      €14.29 billion

Trading turnover was down by almost half in 2008 – 2009, whilst trading volumes remained constant.

During this period, the LSE has lost market share down from 35% to 24%. The primary benefactor has been Chi X which has seen its market share grow in only a few years to 12%.

The is mirrored across the Atlantic, where the NYSE has lost market share down from 60% in 2003 to 27% today.

New Entrants
The new entrants ushered in by MiFID, such as the MTFs (multi lateral trading facilities) , crossing networks and dark pools, have turned the conventional exchange model on its head.

The exchanges are struggling to control their cost base while at the same time increased competition has reduced trading fees and pushed down tick sizes.

In addition, MiFID failed on one of its primary objective to deliver best execution. With the evolution of the virtual exchanges ( such as MTFs), price transparency has deteriorated and had driven liquidity away from the lit venues and onto the dark venues such as dark pools and crossing networks.

Unique Challenges
There are still a number of unique challenges that the regulators need to overcome in order to balance the need for strict regulation against the need to maintain a liquid and efficient market place.

In today’s global markets, if the regulatory response is fragmented by jurisdiction, political administration or geography, such as a divergence of EU and US regulation, this will only drive further liquidity onto the unlit and fragmented venues and will truly leave the legacy exchanges to be a shadow of their former glory.

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Risk / Regulation | Leave a comment

Commodities – The Super Cycle

Posted on February 5, 2010 by Ian

Over the past few years, the commodity markets have experienced a worldwide boom which can only best be described as a super cycle. This growth has been directly powered by the emerging BRIC economies of Brazil, Russia, India and China along with the emergence of new players such as hedge funds and banks that are now aggressively trading commodities.

This has significantly reshaped the commodities markets which is now seen as a new asset class and an essential part of any investment portfolio.

Exchange Evolution
The recent increase in transaction volumes has changed the markets dramatically and has challenged the commodity exchanges to meet increased transaction volumes and in particular the need for continuous liquidity.

This has been further stressed by the arrival of new speculative participants, such as hedge funds, introducing increased volatility within the market place.

During times of sustained volatility, the clearing houses such as the London Metal Exchange had to increase initial margin calls by 500% from $5,000 to $25,000 per contract.

Larger firms can afford to trade, but smaller players have been squeezed to reduce the number of contracts they hold. This has directly reduced market interest, leading to greater volatility and further upward pressure on margins.

To support this evolution of the commodities landscape, it is my view there are a number of unique challenges that need to be overcome.

Managing Risk
Many market participants are using obsolete solutions or even spreadsheets to manage their risk which is unthinkable in today’s heavily regulated and faced paced market place.

In addition, many ‘non bank’ market participants lack the standard risk management tools such as being able to calculate Value at Risk (VaR)  across the complete portfolio along with being able to generate Basis point sensitivity to various underlying risk factors.

Furthermore, the ‘non bank’ players are lacking the standard scenario modelling tools available to Investment Banks to run historic scenarios or model future events and outcomes.

The challenge here is for all market players to develop comprehensive and robust solutions to manage risk in a real time environment.

Automation
Automation has been proven to bring transparency and risk reduction through reduced trading errors as well as introducing cost savings and efficiency gains.

A key challenge for the market relates to the post trade processing of large volumes of trades.  Historically, this has been a highly manual process that has been unable to scale due to the lack of standardization contracts, making STP difficult and in turn increasing risk and cost.

This can only be achieved by introducing standardization across the market place, defining standard contacts and introducing flexible and open multi asset architecture.

Arbitrage
Another significant development in the industry is the arrival of arbitrage and speculative players.

Historically, commodity arbitrage used to focus on maturities but has now expanded to include a wide range of spread opportunities including electricity market price versus its production price (spark spread) or oil futures / gasoline and heating oil futures (crack spreads).

The development of new arbitrage and speculation requires market participants to develop a detailed understanding of correlation controls and a flexible management to analyze assets in real time to increase transparency of both market exposure and risk.

This can only be delivered by the introduction of robust real time trading tools. It is essential that the pure commodity players equip themselves with the real time order management, pricing and risk management tools that the banking community has come to know and expect.

Market Access
Effective market access in the commodities sector is highly dependent on technology. Market participants need to ensure that all the different market rules and traded products are included in a single portfolio and cross asset risks management system.

Specific commodity requirements include defining storage constraints, perishing or refining details, along with seasonality constraints and transportation losses etc. These details directly impact process and are an essential pre requisite when trading in a global commodities market spanning regulatory regimes and international boundaries.

Real Time Data
Access to real time data is an essential requirement. A connection must be available to all specialist data providers in all commodity markets. In addition, the software must be robust enough to handle extreme volumes of data both for pricing and risk analysis.

It is essential to provide the trader with flexible portfolio architecture to allow him to manage and view his position, PnL and risk factors at different aggregate levels and across multiple views.

Summary
In today’s fast changing global trading environment, the benefits of faster and more transparent processing is a must have.  The route to full automation is both desirable and necessary.

The commodity market place cannot continue to meet the volume and regulatory expectations without fundamentally embracing technology automation, real time trading tools along with robust risk management control.

To succeed, it needs to adapt quickly and be flexible. Only then, can the commodities market truly flourish as an efficient asset class in its own right.

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Commodities | Leave a comment

Looking Over The Precipice – PART 3

Posted on December 18, 2009 by Ian

In parts 1 and 2 of “Looking Over The Precipice”, I discussed the current barriers to innovation along with the 3 stages of how an organisation responds to the global downturn.

In the final posting for the series, I will explore how you can use active Risk Management to predict the future.

“Innovation distinguishes between a leader and a follower”, Steve Jobs 1995

In the current global market, you can only survive by innovating. If your organisation is growing, you need to innovate to maintain market share. If your organisation is shrinking, you need to innovate to stop the decline. At all times, you have to assume that everyone else is innovating including your competition.

Key to the success of Innovation is embracing your role as a Futurologist.

The Role Of The Futurologist
Since the dawn of time, man has chased the dream of being able to predict the future for social, monetary or business success. Over time, we have learnt to utilise a number of risk management techniques and tools to manage a potential future outcome today.

The most basic of these, owes its origins to Philosophy and being able to evaluate a number of possible outcomes for a predefined event. This in its simplest form is the basis of wisdom or learning to be wise.

Only when we are equipped with knowledge of how to deal with various outcomes to a scenario such as how to deal with a new product development or global rollout is an individual deemed to be wise.

Although Philosophy provides a systematic approach and reasoned argument to dealing with a specific matter, it is the role of the Futurologist to study the philosophy of what the technology future beholds.

Weather Man or Mystic Meg ?
The role of the technology Futurologist is to peer into the crystal ball of the future and identify the long term technological change and its impact on business and society. Whereas a mystic will predict a specific outcome, it is the role of the futurologist to forecast multiple possible outcomes.

As a leading Silicon Valley futurologist, Paul Saffo has spent the last 2 decades looking into this crystal ball. Paul recently commented that you need to forecast all possible outcomes and eventualities. Coupled with this, you need to “understand that everything can happen, will happen” which is more commonly known as Murphy’s law which states that “anything that can go wrong will go wrong.

Only when you have armed yourself with this information, can you control the future and choose which outcome actually happens.

Fifth Technology Wave of Innovation
Having recently spoken on technology trends at the recent Waters Power conference in London earlier this year, one of the key topics discussed that we are now on the 5th technology wave.

This wave follows on from the Steam, Rail, Electricity and Internal combustion engine revolutions over the past 300 years. This time, the wave differs in that the speed of the next technology revolution will be faster and bigger, throwing up more dilemmas in its wake than ever before.

As we look to the future, it is the CIOs role to embrace both active Risk Management and his role as a Futurologist to lead the new wave of technology. Only by forecasting the opportunities for revenue growth, increased efficiencies can the CIO act with confidence and choose what outcome actually happens.

If you would like to discuss this topic in more detail or provide me with your personal insight just contact me today.

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Innovation | Leave a comment

Looking Over The Precipice – PART 2

Posted on December 11, 2009 by Ian

In my previous post “Looking Over The Precipice – PART 1”, I discussed that 66% of organisations have no clear strategy for innovation. In this posting, I will explain how to get behind the statistics and how you can embrace innovation to drive your organisation out of recession.

Across all market sectors, organisations have responded to the global down turn with 3 stages of response :

1. Looking Over The Precipice
2. Middle Ground
3. Coming Out

Key to this, is understanding which distinct stage your organisation has followed in response to the recession.

1. Looking Over the Precipice( aka “One Step Away From Disaster”)

Outlook :  “Battering down the hatches and weathering the storm as best we can”. Being forced to deal with the here and now, given that the future is likely to remain unclear for quite some time.
Sentiment : Loss of confidence
Financial : Collapsing share price
Workforce : Aggressive cost cutting

2. Middle Ground

Outlook : Anticipating Impact.
Sentiment : Reducing exposure to the downturn.
Financial : Managing situation very carefully
Workforce : Reducing personnel in line with turn over

3. Coming Out ( Of Recession)

Outlook : Still growing, but monitoring situation very closely. Have  a sense of energy and excitement and a core ability to manage creative change and innovation.
Sentiment: Doing ok, understand the risk. Have developed a number of scenarios and will react accordingly.
Financial : See some profitable opportunity in medium term.
Workforce : Cautious, gradual hiring. Strong investment in talent management, redeploying staff to other parts of the business during attrition cycles.

Batten Down the Hatches
With most organisations seeing a strong decline in revenues, the natural tendency has been to ride out the storm and preserve life at all costs.

Unfortunately, each successive wave has depleted the organisation of the very budget and headcount that is needs to bring reposition itself out of recession.

In this environment, the standard organisational response has been to bury its head in the sand and stop innovating.

This could n’t be further from the truth of what the organisation should be doing to maintain its market share and migrate to the “Coming Out” of recession stage.

You have to assume that everyone else is innovating period. You can only survive by innovating, else risk losing market share.

How Will Innovation Help Me ?
Innovation is the ability to see change as an opportunity and not a threat.

It’s all about working smarter, connecting with your customer by leveraging new channels, redesigning business processes and launching new products.

It’s about showcasing your brand and using what you have got more economically.

Only then, can you position yourself as the expert and build the opportunity, security and better future to move your organisation to the “Coming Out” phase to exit the great recession of 2009.

In my next posting “Looking Over The Precipice – PART 3″ I will explore how you can use active Risk Management to predict the future.

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Innovation | Leave a comment

Looking Over the Precipice – PART 1

Posted on December 4, 2009 by Ian

In my capacity as an Innovation expert, I was recently asked to present to the CIO Executive council on the role that Innovation plays in a global down turn market.

Key to the presentation was a recent survey from the European Financial Management and Marketing Association (EFMMA) that identified :-

9 out of 10 companies consider it VITAL to Innovate
and that
Only 37% of organisations have a clear strategy for Innovation

In other words, nearly 2/3rds of organisations have no clear strategy for innovation.

This sparked immense debate amongst the corporate audience. These statistics are surprising because we are all aware that Innovation is ever more critical in today’s economic downturn. If you are growing, you need to innovate to maintain market position. If you are shrinking, you need to innovate to stop the decline!

The killer blow from the EFMMA survey, was that “I.T. is seen as the biggest barrier to Innovation due to its inflexible systems & bottlenecks”

At this point, many in the audience of senior technology leaders were up in arms, as the results from the EFMMA paint a poor picture of the I.T. industry.

Whilst some of the sentiment of the results can be explained away due to governance tax and regulatory constraints that face the sector, 2 key points remain

(i) 2/3 of organisation’s don’t have a cohesive innovation agenda

(ii) IT is seen as restricting an organisations innovation.

In my next posting titled “Looking Over The Precipice – PART 2” I will explain how to get behind the statistics. I will also explore how you can embrace innovation to drive your organisation out of recession

If you would like to discuss this issue or provide me with your personal insight just contact me today.

IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770

Posted in Innovation | Leave a comment