6 July 2007

Today's capital markets are experiencing rapid change. With the rise of electronic trading, the industry is moving faster and asset managers must continually adapt to stay ahead.

The market has, up until now, been split into five: buy-side firms, sell-side firms, exchanges, clearing houses and custody. But as the competition gets increasingly fierce, the lines are blurring. Firms are adding more and more services, all trying to get an extra share of the customer's wallet. The terms 'buy-side' and 'sell-side' are becoming less and less relevant; there is now simply a split between those who buy capital and those who use capital.

"As we blur the boundaries, there will be an increase in services," says Ian Warford, director of securities and capital markets at Microsoft. "Banks will offer market data and clearing data, buy-side firms will do research and so on. Banks will be looking to turn cost centres into profit centres through the use of Web services and non-differentiating activity will be outsourced."

There are three main areas of focus that have brought about these changes in capital markets, the first being regulatory reforms. "The Markets in Financial Instruments Directive (MiFID) regulations are going to have a major impact in Europe, accelerating industry changes further by giving customers better pricing and transparency," says Warford. "Larger players will benefit, seeing an opportunity to make a lot of money by internalising trade and offering services to the smaller outfits. Smaller banks, however, are set to struggle. Unable to compete with the industry leaders, they will be forced to outsource services and differentiate themselves by having a very focused strategy. The next five to ten years will see a big shake-up of smaller firms."

There is an increasing need for a compliance service to deal with the pre- trade and post-trade obligations imposed by MiFID coming into force later this year. According to Ralph Silva, senior analyst at TowerGroup in his paper 'MiFID – Forcing standards into the European markets,' there would indeed now seem to be a convergence toward the Financial Information eXchange (FIX) standard, and in particular the FIX Adapted for Streaming (FIX FAST) standard which addresses the need for efficient compression of messages in the interest of improved latency (the time taken to get information about trades published to the market). This has been achieved through a collaborative effort in 2005, involving several of the world's leading exchanges and sponsored by Microsoft.

Combine this convergence toward a standard for representing trades with the broad adoption of SWIFT standards for back-office settlement messaging, and add in additional efforts on the standards dealing with identity (TWIST initiative), reference data (RDUG initiative), market data (MDDL) and the description of complex products (FpML), and one of the fundamental enablers for the orchestration of services – standard business vocabularies – now seems within reach.

So what is Microsoft doing to further accelerate this growing consensus? "Based on positive experience in the insurance industry around the ACORD standard and the Insurance Value Chain initiatives in the US and UK, the Microsoft Financial Services Industry management team for EMEA is exploring the possibility of adopting a similar approach for capital markets," says Koen Van den Brande, Microsoft's chief technology officer for financial services across the EMEA region.

"The recent launch of an initiative around MiFID brought together a significant number of Microsoft partners, which together make up the Microsoft capital markets ecosystem. If it were possible to achieve a broad consensus between these partners and leading firms about the key services to be found in an industry application reference architecture (IARA) for the capital markets industry, this consensus could form the basis of much improved collaboration between individual ISVs in the interest of providing customers with pre-integrated capabilities based on industry standards."

Such a consensus is essential to making it possible to sustain the trend away from third-party or in-house built end-to-end solutions, toward composite applications bringing together specialised service applications within overall solutions.

"Key new Microsoft technologies, such as the server-side Excel Services which address the need for central control over spreadsheet-based calculation services, and the highly scalable and sophisticated OLAP capabilities of SQL Server's Analysis Services, also support this trend," says Van den Brande.

Algorithmic trading is also an area of focus for capital markets. Quantitative trading strategies have emerged as the next generation of solutions in electronic trading. The popularity of quantitative trading is driven more by the changing structure of the market than by the revolutionary capabilities of algorithmic trading. Fragmentation in the market and lower commission price points have driven the buy side to use algorithms. At the same time, institutional brokers use algorithms to lower their own trading costs. In doing so, they support low commission price points.

"This practice has spawned a race toward algorithms among brokers eager to provide more value to their customers and to gain mind and market share in the quantitative trading space," says Warford. "It has also changed the role of technology in capital markets. To achieve the best algorithmic trading results, companies must have immediate access to high volumes of market data, sound mathematical models to analyse that data and the capacity to execute trades in a timely manner." "The move toward algorithmic trading has put a significant pressure on technology providers to reduce latency," says Richard Gissing, chief technology officer at Gissing Software. "A few years ago capital markets firms would be happy to use a consolidated feed. Now, however, they want direct feeds from the exchange. This has had a big impact on vendors such as Reuters who are now supplying direct feeds."

The third area of focus for capital markets is in derivatives. TowerGroup believes the derivatives market is currently at the tipping point, on its way to coming into its own as an asset class. Over the next three years, TowerGroup expects buy-side derivatives usage to explode, bolstered by the shift to electronic trading, search for alpha, and more accommodating regulations which allow derivatives usage in pension funds and institutional money management.

"We are seeing enormous demand for derivatives from the buy-side, particularly relative to hedge funds, following the relaxation of restrictions on using derivatives for managing money," says Dushyant Shahrawat, research area director of the Securities and Capital Markets research service at TowerGroup. "Yet, for many, the derivatives market remains an enigma that is overly-complex and difficult to grasp."

"The complexity of derivatives data and the innovation associated with getting new products to market is challenging for many systems, particularly where buy-side focused systems may have only supported cash, equities and futures," says Brian Sentance, CEO of Xenomorph. "Even trading and risk management systems coming from the sell side may only support 20 types of asset class, leaving clients to fit a square peg in a round hole when it comes to supporting a new product type. A new type of data model is needed that allows clients to add whatever instrument they want, of whatever complexity, and to be able to link the instrument data to a pricing model with the minimum of effort."

In order for capital markets firms to focus on these key areas, there is a need for fast, reliable technology centred on agility. "Technology has to accommodate the requirements of traders in a world where better access to multiple information sources or the ability to conclude trades faster have translated into immediate competitive advantage," says Van den Brande. Microsoft and its partners recognise that customer, employee, and operations experience must be central to any technology solution developed to meet the demands of today's sophisticated investor. As the markets continue to consolidate and commoditise, legacy infrastructure has become a financial burden that hinders growth, constricts business agility and increases customer attrition. Knowing that technology deployed today may remain in operation for years, the industry is looking for adaptable architecture and better operations experience that will support future businesses whose structure is currently unknown.

"Microsoft's experience initiative is the binding element that unifies the vast amount of client and partner Microsoft .NET development that has occurred over the past four years," says Warford. "Our partners and clients have helped shape it, through their own innovation, using our tools and platforms."

Companies implementing Microsoft-based solutions for capital markets experience benefits including maximised value from technology investments. Partner solutions based on the .NET Framework and SOA are designed for easy integration with existing infrastructures, enabling firms to get maximum value from their investments. The Microsoft platform provides an adaptable architecture that can support the needs of capital markets firms, while providing the agility to meet unforeseen future requirements.

"By enabling disparate systems and applications to talk to each other through service oriented architecture (SOA), the Microsoft platform helps firms to realise an immediate impact on their operational efficiency," says Warford. "Companies that have started the switch to SOA are seeing increases in productivity and their ability to handle trading volumes, while reducing their cost per transaction."

Today, the growing momentum behind the adoption of SOA in the financial services industry as a whole provides an opportunity for capital market firms to leverage the historical ecosystem of smaller and highly specialised software vendors by applying the lessons in agility learned a long time ago, on the trader's desktop.

"SOA, correctly implemented, allows very simple concepts and components to be built into large and complex systems that can be expanded, reshaped and enhanced without risk of upsetting existing functionality," says Andrew Miller, managing director of Arcontech. "Typical systems in the capital markets have tended to be monolithic, with long timescales and high risk attached to change. Firms must be increasingly fleet of foot, and SOA is a significant part of the solution."

Enhanced employee productivity and satisfaction are further benefits of an SOA approach. Many institutions are currently unable to provide integrated customer information, which hinders employee productivity and morale. By linking their previously siloed applications, firms transform the employee experience by giving instant access to complete customer data. Employees can then deliver quicker, more accurate customer service, leading to greater satisfaction and productivity.

So what does the future hold for technology in this industry? "Future trading strategies will be increasingly cross-asset, multi-market and automated," says Sentance of Xenomorph. "Traders need technology that is able to deal with any kind of asset class, data type, analysis or pricing model, allowing the trader to spend more time trading and less time dealing with data and system issues. The ability to deal with more data, more quickly, combined with the ability to deal with more complex data, more easily, will be the key enablers of future success in the market."

"By far the biggest issue at hand is the long-term impact of globalisation," says Marc Alvarez, vice president of products at TAPMaster. "As the world's capital markets become more integrated and more transparent, they all become more liquid. Expect new tier 1 players from emerging markets like Brazil, China or India. These firms will present a formidable threat to the traditional way of doing business as their cost bases and their cost of capital are already outsourced and aggressively managed. However, the greatest returns are coming from much smaller entities like hedge funds. In an increasingly globalised world, we are only witnessing the beginning. In ten years, the cross-section of firms making up the industry is going be more numerous and more diverse, and performing a wider range of business than ever. All these developments are going to require some novel thinking in the areas of technology and services. It's not just financial firms that will be impacted, but the entire industry. We can expect a competitive and fast-paced environment for all players - it will be anything but dull."