Broker back-ends still outpaced by trading technology
Too many brokers are still using outdated methods such as email and telephone to confirm trade matches, undermining the advantages gleaned from high-performance trading technology, according to a new study by financial research firm Aite Group, Broker-to-Broker Matching: Plus Ça Change …
Of 46 firms surveyed by Aite, the majority (65%) send email or telephone confirmation messages to their broker counterparts and a minority send file transfer protocol files (22%) or use electronic matching technology (13%). Two of the top 10 largest institutional brokers have still not invested in connectivity to electronic trade matching platforms, although both plan to do so in the next 12 months.
The findings illustrate the stark contrast between the front-end trading desks and the mid- and back-office areas at many brokers, which typically receive less investment due to their perceived status as a pure cost centre that contributes little or no additional revenue to the business. While most brokers have developed high-tech trading tools at the front office, including algorithms, direct market access, smart order routing technology and low-latency connectivity, few have spared the same kind of expense away from the front line.
“The middle-office often gets passed over in favour of the front-office,” said Virginie O’Shea, senior analyst at Aite. “The result is an anomaly – a super-fast front end that has all the latest low-latency kit to keep up with the cheetah traders, and a slow back end that simply doesn’t have the same level of resources.”
‘Cheetah traders’ refers to the kind of latency-sensitive, high-speed market participants such as HFT prop trading firms that have come to dominate equity markets in recent years. Mid- and back-office processes cover position keeping, trade confirmation, clearing and settlement processes that take place after the trade has been matched at the market.
Mid- and small-tier brokers can be particularly reluctant to invest in the mid- and back-office, as their revenue centres have been hard-pressed by a combination of declining commission revenues and increasing regulatory burdens in recent years. The broker commission pool decreased by 29% last year, according to estimates provided by TABB Group. Meanwhile, staff cuts at many major financial institutions have further added to the difficulty of finding sufficient resources. The result, according to Aite, is a reliance on manual processes that are prone to human error.
“Staff are using spreadsheets and emails to keep track of matches,” said O’Shea. “That represents a big operational risk. Mistakes can easily creep in, while employees are being tied up in a time-consuming and inefficient process. This isn’t being looked at enough.”
Despite the warnings, the majority of respondents to the survey (53%) have experienced a decrease in spending on trade support over the last two years, with most of these reporting a moderate (20%) or significant (20%) decrease in budget on a year-over-year basis. The average estimate for overall spending on broker-to-broker trade support is between 3% and 10% of the brokerage firm’s overall annual budget, Aite found.
Just 11% of respondents have plans to adopt electronic trade confirmation processes in the next 12 months, while 9% will invest “in the near future”. Moreover, the Aite research suggests that this situation is unlikely to improve any time soon. Headcounts have shrunk and may continue to do so as the tough economic climate could compel more firms to downsize and offshore, said the report.
“The vast majority of brokerage firms have not adopted broker-to-broker electronic trade confirmation technology,” added O’Shea. “Although there could be some regulatory imperatives to invest for tier-1 firms, this lack of adoption will remain the case for the majority of the tier-2 and tier-3 market for a long time to come.”