Industry research shows that buy-side trading is undergoing significant changes that warrant comprehensive overhauls of fund managers’ technology infrastructure. Nicholas Pratt talks to DnB NOR’s Johan Erikson, head of global trading, about the changes he has made
IT HAS BEEN a staple of science fiction stories for generations, and has long been a sentiment expressed in the commercial world – that technology is becoming more important than people. Now this proposition has become the main conclusion of a recent report produced by financial technology consultant Tabb Group entitled The European buy-side trader: A profile for tomorrow.
“The buy-side trader needs to be more agile than ever before, must have a greater capacity to understand new technology and appreciate the nuances and advantages of different execution venues,” concluded the report.
The move from the traditional high-touch, trader-based and broker-dependant trading channels to the low-touch world of direct market access and algorithmic trading is cited as a major factor in the demands of heads of dealing.
For a real-life example, look to Norway-based asset manager DnB NOR, where the firm’s awardwinning head of global trading, Johan Erikson, says his firm has been through an intense transformation process.
“In many ways, the changes at DnB NOR are a microcosm of what has been happening in the industry generally,” says Erikson, particularly the changing relationship between buy- and sell-side dealers and their respective use of technology. Indeed, Erikson came to DnB NOR from a sell-side broker and one of his initial impressions was the gap between the two sides in terms of technology provision and use.
“To some extent, the buy-side trading process lacked the dynamism that has earned Scandinavia its reputation for technology innovation,” says Erikson. “Manual processes were still very much in evidence, with a heavy reliance on brokers. It was still a largely phone-based culture with the result that it was difficult to control trades or measure and quantify results.”
The advantage of a trading environment so light on technology was that Erikson had a clean sheet to rethink the firm’s strategy and to choose the appropriate technology to support it, rather than be handicapped by the legacy of outdated systems on which the firm was overly dependant.
The firm’s trading goals mirrored many of those highlighted in the Tabb Group report, more effective pre- and post-trade analysis and the ability to take a more hands-on approach to its own trading. “We wanted to bring on board technology that would help us measure performance – both of our own traders and of portfolios, as well as the brokers we choose to work with. We also need to gain more control of trading activity so we could continue to compete with big companies, in big countries with big clients,” says Erikson.
The first task was to deploy a global order management system, a project that would have to cater for the after-effects of a number of mergers and acquisitions – disparate systems and a rise in trading volume. “We have trading desks in Scandinavia, as well as the US and Asia, and these needed to be coordinated and consolidated, with the ability to cover for each other to enable seamless trading across all time zones,” says Erikson. “The merger also meant that trade volumes increased dramatically, and we needed to ensure that we could handle these with no reduction in performance.”
Greater levels of straight-through processing (STP) and Financial Information eXchange (FIX) connectivity were two prerequisites that Erikson was seeking from a new order management system, insisting that it be able to link with both back office systems and portfolio modelling systems already in the front office. “Everything should be integrated so that a trade never leaves the process, data integrity can be maintained and efficiencies increase,” he says. “We envisioned an interlinked system environment with integrated algos and DMA that would add value to our trading desk by increasing productivity and results.”
The importance of FIX connectivity was in making sure that DnB NOR was able to translate sell-side practices to the buy side by ensuring that it had access to a range of liquidity sources and could connect to the various trading desks and venues of the leading brokers. “FIX connectivity also saves time after a trade is complete with FIX allocations, which gives us time to concentrate more on clients, and allow for analysis and reflection of their trading decisions made.”
The selection of an order management system (the Minerva system produced by the recently merged Fidessa LatentZero), has enabled DnB NOR to add further capabilities to its trading practices over and above the core principles of greater operational efficiency and higher volumes, such as a greater focus on best execution and performance.
Reduced trading costs
“We can classify orders by difficulty and map this into our execution strategies,” says Erikson. “We can also create audit trails and can conduct pre- and post-trade analytics to evaluate our performance and learn from it. We rank and rate trade performance and then translate this into portfolio performance. We can also track brokers and deals and rank their execution results.”
Consequently, since tracking execution back in 2005, Erikson has found the firm’s trading costs have reduced. The average transaction cost in the first quarter of 2005 was -33 basis points, but by the same point in 2006, this had reduced by 40% to -20 basis points. Furthermore, Erikson maintains that the dealing desk improved its annual portfolio performance between 2005 and 2006 by 40 basis points and also reduced the average commission cost by 33%.
Coping with MiFID
As well as the encouraging numbers, DnB NOR’s technology overhaul has also left it in a better position to cope with the imminent arrival of the Markets in Financial Instruments Directive (MiFID), due to the emphasis on transparency, execution monitoring and reporting.
Erikson talks of the new trading approach the firm has been able to adopt. “We can trade in our own way, draw clear lines between the trading and portfolio management function, and have obviously improved efficiency and performance.” Additionally, Erikson also talks about how the firm can “face the future with confidence”, highlighting the most noticeable trend in today’s fund management market – the sheer rate and scale of change.
Technology in place
The MiFID regulation has its own impact, but the market has already been growing in terms of trading volume and also shrinking in terms of players with consolidation so rife in the exchanges market particularly – indeed, Erikson mentions the potential takeover of the Swedish stock exchange (OEMX) by USbased Nasdaq as a current focus for DnB NOR. But with scalability and capacity now a prerequiste in any technology revamp, Erikson confidently predicts that “whatever happens to our markets in the future, we know we have the technology in place that will adapt to meet it”. At least for now.
© fe November 2007