Are you ready for next-generation market making and principal risk trading?
FUTURE-PROOF YOUR MARKET-MAKING TECHNOLOGY
WHITE PAPER
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Market Complexity
Can you outpace the markets and your competition?
Market Making and Principal Risk Trading
Market Complexity
Do More With Less
Seeking scale and profitability
Market Making and Principal Risk Trading
achieved their ROI technology targets on risk mitigation within their payments initiatives
In summary, traders are having to cover more products and markets than ever before – and to meet the demands of today’s environment, firms need innovative, flexible and robust trading solutions.
Balancing client service enhancements with rising regulatory costs has never been more challenging. As they scale their businesses, market makers are seeking more reliability, robust risk management and market surveillance, with better usability and ergonomics. At the same time, firms are also focusing on the integration of the market-making business with the rest of their capital markets business.
While there are challenges to overcome, the good news is that innovative technologies provide an opportunity for market makers to generate scale, boost market share and increase their profitability. The market-making technology of the future needs to deliver scale and performance, while supporting a cross-asset business that includes both, vanilla and structured products. Open APIs can help firms meet future demands – and firms also need to be prepared for the growing importance of technologies such as machine learning and cluster analysis.
In order to manage payments effectively, you first need a clear view of your payment activities. The better your visibility into payments, the more opportunities you will have to embrace more efficient processes and take advantage of low-cost payment channels.
In practice, visibility is often hindered by the use of disparate payment types and manual processes. But fortunately, there are many ways that payment innovation can give you more visibility over your payments, from cross-border payment tracking with SWIFT gpi to the information enabled by real-time cash reporting.
Notable initiatives include the following:
Improve Client Service
Do More With Less
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Fortune Favors the Bold.
Bold Decisions Require Innovative Technology.
Keeping costs to a minimum is a priority for companies everywhere – and payments are often more expensive than they need to be. The good news is that some payment initiatives offer new opportunities to achieve significant savings through lower cost payment methods and economies of scale. Here’s how some of the latest payment innovations can help:
Improve Client Service
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Source: FIS Readiness Report 2021
Fully stacked warehouse vs. selected inventory
ROI achievements on payment initiatives
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Source: FIS Readiness Report 2021
Real-time cash reporting allows you to access your account statements and balances in real time via APIs – so you can use that information faster and incorporate it into different business processes. For example, you might quickly identify that the balance on a particular account is zero, and that funds need to be transferred over before a particular payment can be released.
Real-time cash reporting
In this environment, market makers are feeling the need to offer better servicing by scaling their businesses to address more instruments and more geographies.
They are looking for greater reliability in terms of uptime, performance measured as ultra-low latency and throughput – as well as robust risk management and market surveillance. What’s more, they need much better usability and ergonomics to monitor, control and effectively surveil while avoiding laborious manual steps that are far from fool-proof.
Additionally, to give some examples, the market-making business needs to be integrated with the rest of their capital markets business and to interoperate fully with other departments through crossings, agency trading and lending.
Client expectations continue to rise
Central bank digital currencies, while nascent, could provide additional payment methods with central bank issued money.
Central bank digital currencies
Real-time payments are cleared within seconds, instead of minutes, hours or days – which takes the uncertainty out of the settlement process and provides instant visibility over the status of payments. Modern real-time payment schemes can also carry more remittance data than traditional payment methods, speeding up the reconciliation process.
Real-time payments
Benefits of real-time payments
35%
Improved liquidity management
Real-time view of cash position
32%
Access to transaction data
30%
Reduce costs
39%
Improve control and visibility
42%
Reduce fraud risk
44%
Drivers for increasing investment in digital tech
Business development also requires expansion across all tradable asset classes, including equities, derivatives, ETFs, fixed income, FX, structured products and crypto/digital assets.
Today, trading and market making is a cross-asset business in which both, vanilla and more structured products are represented. There are fundamental differences in how each asset class is managed from a market-making perspective and in the factors driving price and liquidity formation.
In addition, the sales and trader interaction workflow are very different between asset classes. Again, having technology that’s built for the purpose becomes key – but it’s also essential to access technology that can support variations in the management of RFQs and internal interactions.
Fully serving all these asset classes means offering technology that can handle everything, from low-touch to high-touch, and having the ability to navigate the nuances and subtleties in each of these sub-markets.
Serving multiple asset classes
Market making is a very demanding activity that has a greater need for sophisticated technology. Technology should be built for purpose with clear intent and key functions ingrained. Exception-based management, automation and control functions should be the norm, while risk management and safety rules should be key, as losses can build up quickly into mega losses, or flash crashes as we have seen from history.
Today, the market-making business is largely automated – and the level of automation continues to rise. This, together with the sheer volume of products being quoted, creates a need for more effective monitoring and controls. Where exception management is concerned, it is important to be able to respond effectively to exceptions, without disrupting the ongoing business.
Sophistication and automation
Thin applications that operate in the cloud are paramount. The technology needs to be developed for scale and performance, while all heavy lifting needs to be done server-side and often with augmented co-location. This should be part of the technology’s DNA, forming the foundation for scalability and speed.
When it comes to co-location, it is important that market-making technology can perform and distribute all the heavy calculations where they belong which is normally very close to the exchange. Optimizing calculation jobs across co-located servers and thin clients is paramount when it comes to making sure heavy lifting is not being done in the wrong place.
Thin applications and co-location
In the future, market-making technology will need to solve a multitude of challenges. Trading, market making, connectivity, risk/position management and big data all need to be connected and part of the same continuum.
Are you ready for the next 10 years?
Source: FIS Readiness Report 2021
indicate they are taking advantage of real-time payments
ROI achievements on key drivers
Are you harnessing innovation?
Innovation is currently shaping the payments landscape. The arrival of SWIFT gpi has transformed cross-border payments with features such as traceability and transparency, while central bank digital currencies (CBDCs) promise real-time money movements in central bank money. Also significant is the rise of real-time payments and real-time cash reporting – not to mention FIS® RealNet, the innovative account-to-account payments platform recently launched by FIS.
Capital markets firms are grappling with extreme trading volume and market volatility. To stay competitive, they must optimize their trading, speed and agility – fast. At the same time, new strategies are placing new strains on existing trading systems. Traders are being asked to cover more products and markets than ever before, and at greater speed.
Against this backdrop, only innovative, flexible and robust trading solutions can withstand your most acute performance demands – and advance your growth. In this white paper, we examine what traders need to do to keep pace with market demand and provide some top tips for keeping ahead of the competition.
So, what happens when we look at some of the most interesting payment innovations through each of these lenses?
Minimizing the risk of fraud is another major priority for payment professionals. Fraud risk continues to escalate, with businesses of all sizes at risk – and the pandemic has also brought new types of threat, with the adoption of remote working and hybrid working patterns creating new vulnerabilities.
While the risks are considerable, payment innovation can present new opportunities to reduce the risk of fraud. For example:
Market making and principal risk trading are two interdependent business areas, and both have been under severe regulatory stress in recent years.
With a more punitive regulatory regime, principal risk trading has fundamentally changed from a fully stacked warehouse approach to a greater focus on ‘selected inventory’.
Meanwhile, many traders that had previously retrenched from the market because of regulatory costs are now finding their way back to recoup some of the lost market opportunities. In that process, they must find a balance between the regulatory cost associated with inventory and a fully stacked warehouse, and the need to properly source liquidity and service their client base.
During this transformation, it has become much more important to run a market-making business that has reach and is able to handle a very large number of instrument types – from vanilla to complex. This enhances the service to clients, meaning that the warehouse is perceived to be fully stacked in terms of liquidity sourcing, while keeping inventory optimized.
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FIS is a leading provider of technology solutions for merchants, banks and capital markets firms globally.
Our more than 55,000 people are dedicated to advancing the way the world pays, banks and invests by applying our scale, deep expertise and data-driven insights. We help our clients use technology in innovative ways to solve business-critical challenges and deliver superior experiences for their customers. Headquartered in Jacksonville, Florida, FIS is a Fortune 500® company and is a member of Standard & Poor’s 500® Index.
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Market making is being run by increasingly fewer people: there is a clear tendency to use a smaller number of market makers to oversee a wider set of products and markets. This has created new requirements, especially in automation, exception management, oversight and operability.
Market makers have had to balance the need to provide better client service with the higher cost burden associated with keeping large inventories. They are running out of capacity to quote with current systems. For this reason, market makers have sought to investigate more innovative technologies that can help them minimize running costs and generate the scale needed to further increase market share and boost profitability.
With higher volumes, robust risk measures need to be in place from a compliance, profitability and safety rules perspective. Transparency, usability and oversight are crucial for market makers that need to be able to move quickly. Consequently, quote management and maintenance need to be efficient and ergonomic.
When it comes to quote performance and scalability, it is also important to differentiate between varying needs. Listed standard derivatives most often require ultra-low latency response times, while more complicated products, such as structured products with a broader bid-offer spread, do not require the same ultra-low latency. For the latter products, it is more important to be able to handle a wider set of products, or simply to be able to quote more products at the same time.
In other words, performance and scalability mean different things for different types of market makers operating in disparate markets. Modern technology should be able to support all these needs.
Performance and scalability
On another note, markets have also become more complex, with a high level of fragmentation. Liquidity sourcing is more difficult than ever before – especially when combined with the growth of instruments being offered through marker-making platforms.
The net result is that markets have a greater need for the latest market-making technology than ever before.
Complexity and fragmentation
“Bold and new innovative ideas are often laughed at. Until they’re not.”
Today’s environment has more than its fair share of challenges. It is characterized by extreme volatility swings, fee compression, a growing regulatory burden, cost pressure, risk management deficiencies, fierce competition from established and new entrants – and clients that simply demand better service.
In this environment, market makers are struggling with systems that were not purposefully designed in the first place, as well as legacy platforms that are now being managed in sunset mode. This brings further challenges:
A challenging world
Competition is relentless out there. Larger banks are seeking to outmaneuver smaller regional players by offering a wider set of products and better liquidity sourcing. They can compete effectively with smaller players by being able to operate at scale, keep a larger inventory, provide wholesale services and offer better prices.
At the same time, specialist firms – so-called non-bank liquidity providers and boutique-style shops – are both highly specialized and able to operate with lower regulatory costs. This means that many larger regional banks are feeling competition from both angles.
Despite this, markets are good and the need for this service is higher than ever before. Market electronification and the wider digitization trend is fueling the transition to more electronic trading, and trade sizes and volumes are growing. These trends are seen both in established markets as well as more developing.
Competitive landscape
While the quoting activity might be acceptable, many market makers suffer from poor and insufficient risk management tools. This leads to weaker regulatory compliance, as well as difficulties in optimizing cost, inventory and profitability. For more illiquid markets largely driven by RFQs (request-for-quotes), it is essential to be able to connect the sales and trader function electronically, in so-called sales-trader interaction.
To improve the business, professionals first need to know how their business is faring. As such, the use of business intelligence tools has become essential when it comes to differentiating the firm and getting a clear understanding of key performance indicators (KPIs). It’s important to understand the firm’s performance in areas such as level of profitability, transaction cost analysis (TCA), quotes being responded to and the overall health of the quote engine.
Scalable
As the trading landscape continues to evolve, it’s clear that tomorrow’s systems need to be flexible enough to adapt to new markets and trading venues, while enabling firms to maintain the necessary risk controls.
At FIS, we provide our clients with game-changing solutions that enable their growth, whatever the market demands.
For larger players, it is also vital to be able to handle crossings to cross liquidity on an internal market. In particular – it’s paramount that firms can monitor and control the entire inventory across the institution and connect the dots between principal risk trading, securities lending and agency trading.
Connecting the dots
Automated and algorithmic trading will continue to shape markets, create efficiency gains and aid market makers, with firms using algorithmic engines for standard algos, and standard APIs for a more bespoke approach.
For proprietary and self-sufficiency needs, it is essential to have open APIs that will create numerous opportunities to tune your business to meet future demands. The future will quickly move towards a greater reliance on machine learning, cluster analysis and other artificial intelligence (AI) techniques. Therefore, it is key to integrate market making activities and use big data to feed the AI engines.
Algorithmic trading, APIs and AI
Many market-making technologies have been built for a single purpose and often serve a single asset class. While this may have been sufficient in the old days, many market-making firms are now trying to broaden their offering to more asset classes – and this shoehorning is not easily done with legacy technology that was not build for purpose.
Increasingly, financial institutions are looking to use a unified front end across the asset classes that they are trading. This has many benefits, such as cost efficiency, reduction of complexity, decrease in staffing requirements, increase in staff flexibility with improved knowledge centralization.
Unified front end
To keep pace, traders need a high performance, scalable, automated system capable of spanning all markets and asset classes. In other words, millions of instruments across equities, fixed income, derivatives, structured products, digital assets and more need to be monitored, quoted and traded with minimal latency and reaction time.
To outperform, market-making systems need to do more than just connect to markets and trade. They need to act as a second set of eyes and ears, alerting the trader instantly to shocks and volatility, improving reaction times and reducing risk by spotting exposures and vulnerabilities before they occur.
Liquidity sourcing and risk
Ergonomics are essential as well – traders need precision when navigating and adjusting quotes and quoting parameters across hundreds of thousands of instruments within seconds. Kill switches, spread adjustments, quoting tiers and more need to be immediately accessible – and able to be applied to one product, groups of products or entire market segments.
Ergonomics
Lastly, a system needs to be flexible in multiple dimensions. It needs to seamlessly incorporate third-party valuation models, algorithms and business intelligence that allows firms to generate alpha. It needs to be capable of constantly expanding its scope of connectivity, as new markets and trading venues are appearing at rates never seen before.
Risk controls must be adaptable as well. Risk is not a ‘one size fits all’ requirement – firms need precise controls and channel checks to ensure that they maintain control over their trading operations, while increasing their velocity to keep pace with the markets.
“Advancing market making is increasingly seen as essential to providing better client services. As electronic trading helps market makers permeate more markets and forms part of a wider trading continuum, we are going to see a whole lot more automation, artificial intelligence and exception-based management in the near future.”
Pontus Eriksson, Strategy Director
FIS® Trading and Processing business
Flexibility
Future Proof
“Scalable,” “Future Proof,” “Dependable,” “Performant,” “Robust”
“Scalable,” “Future Proof,” “Dependable,” “Performant,” “Robust”
Robust
Performant
Dependable
Future Proof
Scalable
“Bold and new innovative ideas are often laughed at. Until they’re not.”