The future of the sell-side trading function

Published on 24 September 2020

The sell-side trading function is under considerable pressure to change, and as it does it will impact the investment banking business, its investment manager clients and technology vendors. The commercial success that banks saw from trading in volatile markets this year should not mask the longer-term trends of increased automation, lower headcount, and a more data-driven client base.

To get a considered perspective on the evolution of sell-side trading, we spoke with Mark Goodman, head of platform and execution hub at UBS; Ed Wicks, head of trading at Legal and General Investment Management, and Pontus Eriksson, head of strategy at FIS to understand the drivers for change, their visions of the future dealer, and the practical steps needed to help the sell-side move forward.

Sponsored by FIS, market data supplied by MTS.

Dan Barnes Welcome to Trader TV, I’m Dan Barnes. the sell-side trading function has been under enormous pressure this year with market volatility in March and April. We’re going to be discussing how that function might evolve in future. We’re going to have perspectives from the sell-side, the buy-side and technology vendors to get a rounded view. Today we’re speaking with Mark Goodman,

Mark Goodman Head of platform and execution help at UBS

Dan Barnes Ed Wicks, head of trading at Legal and General Investment Management, and Pontus Eriksson, head of strategy at FIS. Mark, Ed, Pontus, welcome to Trader TV

Mark Goodman Good morning.

Pontus Eriksson Thank you.

Ed Wicks Good morning.

Dan Barnes Mark. If I could start with you. What do you see as being the evolutionary pressures on sell-side trading operations today?

Mark Goodman The pressures that we’ve seen pre pandemic are the same pressures that we’re seeing post pandemic. And personally, I would argue that technology is the most significant evolutionary pressure on the trader. I imagine that’s slightly controversial. A lot of people will talk about topics such as regulation, which clearly do have an impact. But sometimes we like to discuss our industry in isolation without looking at the wider impacts of society or technology.

Pontus Eriksson I agree with Mark. I mean, financial firms such as banks, they start to see themselves as technology first and they need to go from FinTech to TechFin in their mindset that it’s going to be a competitive race that the industry never seen before in this space. And you need to talk, you know, you need to be perfecting the digital operating model in all your areas of the bank.

Dan Barnes And as a client’s bank and as a buy-side firm, what do you think the evolutionary pressures on your sell-side counterparts?

Ed Wicks Obviously technology is a clear subject to discuss. If you look across how various sell-side firms are coping with that challenge, I think we’re seeing a lot of channel compression. So we’re seeing a lot of people talk about  high touch and low touch, that’s been around for a long time, obviously. But I think we’re seeing particularly in fixed income markets a speeding up of that transition, perhaps towards low touch, and that’s something we absolutely support.

Dan Barnes And are client demands changing?

Ed Wicks We’ve always demanded consistently high trading performance from our counterparts. So that hasn’t really changed. And really the sell-side is critical in helping us achieve those aims. The other thing that we need to be very cognizant about in this environment, is being as efficient as we possibly can be. And it’s really there where we would look to partner with sell-side firms to help out in that innovation space, just to make sure that everything that we’re doing sort of got an eye on scalability. Really, really important for us.

Mark Goodman It’s interesting that Ed points out that they support electronification. That’s key for us because we can’t move faster than our customers. If we build these solutions that are based on technology, but then find that actually the demand is still to interact with a human being, then we’ve built the wrong technology. We thought about it in the wrong channel. With the buy-side, we’re seeing that whilst they want the same services, if you’re trading 50 million euro dollar, even though you may enjoy interacting with your FX salesperson, you really have a much broader range of options on your screen. You have access to instant liquidity from many more providers and you have instant fulfillment when you want to consume that.

Pontus, your thoughts?

Pontus Eriksson We have seen a bifurcation of the asset management market into the large asset gatherers such as BlackRock, State Street, LGIM, etc. And we’ve seen new active managers coming in and focusing on solutions and outcome-oriented products for their clients. And this is typically where ESG investments comes in. And then we have the squeezed middle that are trying to stay afloat. And for these players, maintaining margin means to increase the outsourcing of non-core activities to service providers and trusted partners, and the use of emerging advanced technologies to automate operations as well as generating trade ideas.

Dan Barnes Mark, how has the changing face of regulation affected the way the trading function is built today?

Mark Goodman Maybe I downplayed the impact of regulation earlier, but just on a relative basis to technology, it clearly has an impact on our business and I would probably divide that into possibly kind of two drivers. One, if we look at a lot of the regulation that came about as a result of the financial crisis, we’re looking at regulation that drove the cost of capital. And whilst that doesn’t necessarily impact the way we build our trading function, it does impact the trading functions we build and we invest in, because increases in cost of capital have a fundamental impact on the profitability of those businesses. So I think there’s one element of regulation that drives which business we want to be in and which businesses are possibly less attractive to us. The other driver of regulation, I actually think links with technology, again. If you look at a lot of the issues admittedly was trying to address at the micro-market, microstructure level, you actually see regulation that’s reacting to technology trends and trying to update regulation to reflect that, and hopefully support that evolution whilst managing the risks. And that again focuses a little bit on how we build the trading desks, but certainly it’s much more around how we build the technology and think about the technology rather than actually how we construct the trading desk itself. That is much more predicated on the influence of technology rather than regulation as a whole.

Ed Wicks Regulation has certainly contributed to a far greater use of electronic trading solutions. Certainly on the buy-side. The way that we consume liquidity has certainly changed. So as a sort of further iteration of that, we’re then able to sort of consume more data points because we’re using these electronic systems and therefore how that sort of ties in with how we construct the trading desk. We therefore need more individuals with quantitative skills that sit on the trading desks. So, for example, at LGIM, we’ve had for the last two or three years a trading research team that actually sits as part of the trading team in London and Chicago. And what they’re able to do is to assess all the data that’s coming through our trading applications and effectively help us make better trading decisions on the back of that data.

Pontus Eriksson At FIS, we did a pulse survey recently where we asked 250 senior executives across the buy- and sell-side about the areas where they see the biggest threats in terms of their growth. And it was quite clear that added regulation, post the epidemic is one of them.

Dan Barnes Mark, what’s the drive, from your perspective, to consolidate trading between asset classes or the currency profiles.

Mark Goodman Last year, we actually brought together equities and FX rates, and credit into a single construct global market. So we definitely are in line with the trend to try to bring more of these functions together. And there’s clearly a massive amount of duplication at an operational level, whether that’s technology as Pontus just highlighted, or how we respond to regulation, how we manage and run the business and the risk. So there’s many advantages to breaking down these silos and being able to run more efficiently. I think what we have to be careful of is making sure that we don’t create generalists where we need specialists. There’s a real difference between trading in equity and trading at CDS, and I’m not sure the trader exists as yet who can handle both of those. There’s a view that technology normalizes that to some extent, but I think the market factors and interactions are very different between those two. And even if we look at maybe we consolidate across a liquid end, so let’s say equities’ large cap with US Treasuries, the protocols for trading in those markets are also very different. So there’s many challenges by trying to create this hybrid individual who can just trade any asset class. The point that Pontus mentioned about how we face off to clients, I think that’s probably the key driver here.

Ed Wicks So for us at LGIM, what we’ve done, we broadly have a group of 35 traders globally at the moment, and that is, to Mark’s point, staffed by both asset class specialists as well as multi asset traders. And I think that’s very important to acknowledge that you do need both. So what we’ve done, we we’ve broken down our trading function into two core trading groups. So we have a fixed income trading group, trading credit and rates, et cetera. And then what we’ve done on the other side is bought equity and FX together, so we have an equity and FX trading group. Now, Mark touched on the protocols and we do believe that there are a lot of similarities in the direction of travel in equity and FX is somewhat similar. The other points I would also make is that it’s not just about the protocols that are similar, but for us, the technology that we use to access those markets is also similar. In fact, it’s uniform. So the execution management system we use to access equities is precisely the same as the execution management system we use to access FX markets. So it works very well for us.

Dan Barnes Pontus, do you have any thoughts?

Pontus Eriksson We need a unique sales function to service declined in a good way. We need to consolidate technology to lower cost and to lower complexity. And we need to consolidate because we need a consolidated risk view. Thirdly, I think the data integration, you have it across the board and Mark alluded to it. You have different protocols, different ways of trading these products. And that’s absolutely true. And that’s where I guess the trick comes in. How do you create this infrastructure that does everything?

Dan Barnes Let’s talk now about the vision and expectations of change on the sell-side trading function that we have. Ed, what do you think buy-side firms might ask for differently in the future from their dealers?

Ed Wicks I guess there’s a couple of things that I would really highlight. The first thing would be data. The buy-side is increasingly wanting to consume more and more data from their sale-side partners which is very important in helping us make more objective trading decisions. So the trading research team here at Legal and General, on a daily basis are consuming unique data sets from various brokers. We also have access to various models that the sale-side can help us with. So that’s very important. The other one really centers around primary markets and there’s been a lot of discussion around this in recent months, and I think this is a key area where the interactions between the buy-side and the sale-side are relatively inefficient. The process is quite manual. It’s quite laborious. And I think really for a buy-side perspective, what we want to see is the industry corralling around one of the options that’s available and really thinking about a way forward that delivers tangible benefits and scalability to the buy-side and frankly, to the sell-side.

Dan Barnes Mark, what’s your vision of the future sell-side trading function?

Mark Goodman I think it’s very tempting coming from an electronic trading background to give the response that there is no future for the trader. We’re all going to be technology in the future. And whilst I may be axed to some extent in that discussion, I simply don’t see it as realistic. If I look at the recent volatility, would we be comfortable purely running on a technology platform or is the fact that we had very experienced traders on top of that managing the risk and taking a view on the market is probably what got us through that crisis and helped us keep servicing our customers. I think what we’re going to do is we’re going to move from what’s been a very kind of individualistic-type role where a trader running a book, taking risk, taking a view on the market, to much more of a team structure. So thinking about what’s actually the mix of skills that you need in that function, because we do need that trading experience. We do need that understanding of the markets. We also need the quantitative approach of the quants on the desk. We also need to empower these people with technology. And historically, on the sell-side, that’s a very silo approach. You have a trader running a book who provides a requirement to an IT-team that often sits in a different division, and they look at their budgets and they deliberate over time. In order to be able to be an effective trading desk of the future, you need all those skills in one place as a hybrid team so that you can leverage all those different experiences at the right time and come out with the right outcome. So I see us moving very much from a kind of individual approach into a much more hybrid team approach in the trading function.

Pontus Eriksson But I think the future trader will be surrounded by they will carry a surveillance role and definitely chip in with market knowledge. But they will also be surrounded with data scientists or an army of them helping them with the machine learning and artificial intelligence. So I think there would be a greater attribution and analysis done in the bank linking the overall cost structure to the business decisions.

Dan Barnes Very good. Mark, is there anything you want to come back on that?

Mark Goodman A trader on their own is no longer going to be what we think of as running a trading book; they’re going to have input from other skill-sets. For me, what’s important and what we’ve been doing at UBS for some time is aligning those people together. It’s really important that that ownership of that trading book is not just with a trader who then relies on data scientists. It’s got to be a trading book that’s owned by the trader and the data scientists and the technologists collectively. And that sense of ownership, I think, brings much better outcomes and a much better team working atmosphere as well, because everybody’s got the same objective.

Dan Barnes Pontus, back to you. How do you see electrification and automation shaping the function of the future?

Pontus Eriksson There’s been a clear trend in the last couple of years of markets getting more and more electronified. And we’ve seen markets previously not traded like that, and they are traded electronically today. And there’s a mix of protocols and central-limit order books to do RFQ-based trading, so I think they will co-mingle and they exist and sometimes they can be automated and sometimes it’s more complicated. So I think automation is the key driver to reduce overall cost, and market electronification has been a clear trend even before the pandemic. But that’s going to be exacerbated because of the pandemic and because of the digitalization. So I think the more machine learning comes into the place and the more artificial intelligence and the more automation, the bigger the driver for electronification. So I think they are co-mingled; you can’t separate the two.

Dan Barnes Mark, you’ve given us your vision of the future. Whereabouts are there gaps in skills, functions in technology between where we are today and where we need to be?

Mark Goodman I think our quest to find the single individual who is both a trader, a quant and a technologist is struggling. And if anyone has any suggestions, we’d happily receive those CVs. So the idea of filling skill-sets is actually about bringing people together. And if you do that and you actually then have a group of people who collectively have the right combination of skill-sets that you need to deliver in this new environment, the core skill-set of every individual on that team becomes communication.

Dan Barnes Ed, coming back to you. What effect has distributed working as a result of the COVID-1 pandemic had on trading teams and your interaction with sell-side firms?

Ed Wicks The ability to continue communicating effectively with tools like MS-teams and Zoom and all the other variations that are out there, has certainly been helpful to us. It’s allowed us to conduct internal communications pretty seamlessly. And we’ve actually just completed our half-one broker reviews and those were all conducted on those types of technologies, and it worked very well. For the first half of this year, the global trading team, at Legal and General, has witnessed a huge growth in trading turnover. We’ve actually seen a 34 percent increase year-on-year in the amount of trading activity that we’ve been executing. And I think that shows that we’ve been effective in working remotely.

Dan Barnes Mark, can I bring you in on that point?

Mark Goodman Our biggest observation is communication becomes a key challenge; you’re used to communicating with people who are sat on the same row of desks as you. Equally, when you communicate to your client, you have to be cognizant that that client trader is now not no longer sat with their colleagues, that they are also distributed. So we found that there was a propensity to lean on electronic as opposed to traditional methods. And we saw that on the trading side, for example, in BondPort, where we saw a 97% uplift in volumes. We move to be a top three provider on Bloomberg broker ranking in terms of volume executed in the credit space. What we saw there was clients actually adopting electronic-means as being more efficient than voice-means due to the challenges in communication. But what’s been really interesting is that uplift has remained, so people have adopted new ways of working. And once the initial pressures have gone away and they could potentially revert back to their traditional methods of trading, they haven’t. They’ve stuck with it.

Dan Barnes Pontus, how have you seen it impact clients?

Pontus Eriksson I think the market is going to change to a more strategic reassessment of homeworking. I think there would be some kind of hybrid between home and in the office, and I think the office space and how our banks and vendors alike, how they would do it will change.

Dan Barnes In the third part of our discussion, we’re going to be looking at the practical changes needed to bring sell-side firms to that vision of the future. Mark, if I can start with you, how do you actually manage automation and high touch sales together in a single function?

Mark Goodman So all too often, automation is seen as a way to cut costs and potentially cut headcount. If you start with automation and technology, thinking about actually what is the outcome you want to achieve, how can you make things better? Then you usually get to a solution which is actually more appealing to the client. It isn’t necessarily just about cost cutting, even though that may be a secondary effect or allow you to do more with less. So I think about some of the projects that we’ve been running. Probably the one to highlight is where we looked at how we could apply machine learning to the problem of; which client to call when we have an axe on our credit trading desk. So rather than just look at how could we automate what a salesperson does, how can we just take those axes and actually distribute them out to the right customers? We set ourselves a challenge; we try to understand what is the average number of calls a salesperson makes in order to get that trade done, and that averaged out at about five, which is actually quite impressive and shows the experience that an individual can bring to this problem. What we wanted to do was build an algorithm that could actually allow us to reduce that from five to four. That’s a benefit to efficiency; it means the salesperson could be more efficient. It’s a benefit to the trading book, because we have less information leakage and is a benefit to the client because a client gets a better hit rate.

Dan Barnes Pontus, how do you see the capacity of sell-side firms to offer multilayered services to their clients?

Pontus Eriksson COVID-19 has accelerated the pace of change. It underlines that everyone needs to be more flexible. We have the rate of change in the technology space and digitalization, which calls for additional agility, and legacy technology is holding back a lot of people, a lot of sell-side firms, and they are not working with agile working methods.

Dan Barnes Mark, how do you see risk warehousing being supported going forward? Because that’s been a challenge for sell-side firms, typically.

Mark Goodman It has been a challenge and it obviously goes back to the regulation, which is increasing capital cost, but it’s still a core function that our clients require from us, so we see it as something that we will continue to provide, but we need to provide it on on a profitable basis. And one of the things that drives that is velocity of the trading book. If we take on risk from clients in order to warehouse it, how easy is it to unwind that risk in the market? If you look at the way that spreads widened during the pandemic in the spring, you see that actually the appetite to warehouse that risk, that nervousness might not be able to get out of this risk and turn it over when I need to results in wider spreads and a difficult trading environment for clients. One of the responses to that is to increase diversity in the market. If you think about credit and the traditional model of client-dealer protocols and then dealer-to-dealer to unwind it, if at the point that all clients are going in the same direction and very few dealers want to take on risk, that model breaks down very quickly. It’s a very binary type of model. The models that we saw that were successful, where the models that allowed all-to-all interaction. That allowed many more people to come into the market and not necessarily coming into warehouse risk, but act to fill that gap. So how can you bring together not just the traditional clients and the dealers, but also the new entrants, the systematic traders, the ETF players, the Treasury desks, the private clients, all into one place and actually allow the market to continue so that you have a diversity of investment objectives, and diversity reasons for either holding risk or offloading risk.

Dan Barnes Ed, how do you view risk warehousing at the moment and potentially your needs in the future?

Ed Wicks Risk warehousing, access to balance sheet is absolutely crucial, and we work very hard with our sale-side counterparts to understand how much we are actually consuming of that. And there’s a vast difference between different banks in terms of how much they can offer; it’s a key differentiator.

Dan Barnes Mark and Pontus, can I ask you how close you think we are to the needed levels of agility on the sell-side trading function today?

Pontus Eriksson We are close because I think the agility is now being forced upon us. So I think, you know, people we’re working with a lot of agile ways before. So I think it’s in a reasonably good shape.

Mark Goodman Yeah, Dan, if you’d ask me that question in January, I’d say very far away. And then two months later, the entire industry managed to move to a completely new working model in record time and continue to service clients and the market and keep things running. I think we surprised ourselves with a level of agility we had, and that’s a credit to the adaptability of the people who worked on that. We still have a large technology legacy on the sell-side and to some extent on the buy-side, but also the front to back plumbing in the industry. And so innovations are always going to be close. Innovations will always be slowed down. As we try to overcome that legacy, we have to bring that with us and that reduces the speed that we can deliver change. So I think that remains a challenge. But as I say, I think the experience of COVID-19 has shown that when we need to adapt to be agile, the industry as a whole can respond very quickly.

Dan Barnes I’d like to thank Pontus, Mark and Ed for their perspectives, FIS for supporting us, and of course you for watching. To catch up on our other shows, or to subscribe to our newsletter, go to TraderTV.NET or ETFTV.NET.