September 2011

BACK OFFICE VEW: The problem of the multi-asset wish list

Robin-StrongAs it stands, multi-asset trading is rather like doing the Christmas shopping from several websites at once.
You have several shopping carts full of presents, food and drink, and while attempting to compare the price of each, work out the postage costs and negotiate delivery times, some items will sell out, or the price will go up. To save time, and ensure you get what you want, you could stick with one site, but you’ll probably be paying over the odds and this is hard to assess until after the fact. Fortunately, asset managers – unlike Christmas shoppers – can take advantage of a multi-asset order management system (OMS). A truly multi-asset OMS can create multiple orders and send them simultaneously to multiple counterparties. However, it is not yet perfect. Even the most sophisticated OMS cannot cater for price movements and missed limits across multiple asset classes. Nor do they handle issues such as finding liquidity, collateral management or netting.  Traditionally buy-sides leave those problems with the broker, and take on the cost because the value of the trade will, hopefully, outweigh them. But the markets are even less able to handle such a transaction in an efficient manner.  Broker-dealers generally operate in traditional asset silos. The technology that is widely deployed is usually built along single asset lines, and the total cost of ownership of multiple systems makes it prohibitive for sell-sides to go beyond one or two asset specialities, except for the bulge bracket brokers. Even when a broker is capable of working several asset types, it is usually across multiple trading desks. Since exchanges, venues and clearing networks also tend to cater for a single asset class, it is easy to see why the move to a multi-asset trading desk has not yet taken off on the sell-side. This creates difficulties for the buy-side, who have to carry the transaction risks themselves. With a few exceptions, like structured products that have been specifically created, the responsibility and the liability lies solely with the asset manager.  The question is whether the buy-side can persuade the sell-side to do anything about it. The challenges are, after all, formidable. The penalties for failing to meet regulatory minimums on operational transparency raise the question of how best to manage client exposures and asset allocation across stove-piped trading desks as regulation becomes tougher and mandates more complex. Then there is the issue of reporting. Most sell-sides have extensive reporting capabilities, but daily client reports on trade confirmations and transaction cost analysis are much harder for multi-asset trading. This is both concerning and complex when dealing with bonds, as attempts by the regulators to clear the murky fixed income waters have not yet made significant progress. Any initiatives that result in spread compression will likely be resisted by the broker-dealers and market makers who benefit most from the current structure. But perhaps the biggest hurdle right now is counterparty risk. To perform valid analysis, extra information is now needed: individual trades instead of aggregated holdings; counterparties, or more particularly the legal entities and hierarchies within each counterparty; and the guarantor/obligor relationships.  If separate aspects of one complex, multi-asset trade are with different divisions within the same entity, a firm can exceed its credit limits and be in breach of internal risk parameters. Over-the-counter trades only exacerbate this problem. What’s more, when a firm has multiple counterparties, it has to post collateral for each leg of a trade. The result is inefficient use of collateral, because they may net off to a relatively low exposure profile. Multi-asset trading, by its very definition, makes this analysis of counterparty credit risk more complex, more time consuming and more inefficient.  And so we find there is a disconnect between the sell- and buy-sides. Nonetheless, if sufficient pressure is placed on the sell-side it seems likely that brokers will start to provide a more comprehensive multi-asset service. The inherent problems are not completely solvable, and the market will not achieve a state of multi-asset nirvana. However, there are moves that can be made on both sides to achieve a more equitable distribution of multi-asset capabilities – and to achieve the goals of investors. • Robin Strong is director of buy-side market strategy at Fidessa ©2011 funds europe

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