Buy-Side Technology Trends:
As Economic Fears Change IT Spending Patterns Some See Opportunity for Strategic Differentiation
Originally published February 16, 2009
NEW YORK — Securities and investment firms may confront a Catch-22 dilemma under the current economic squeeze. Outwardly the environment suggests an emphasis on cost cutting, but deeper forces of change underscore the need to accelerate investment in both technology and talent, across the enterprise.
Future business growth will rest on proactively strengthening support infrastructures today, despite the credit crisis and loss of investor confidence in the marketplace. In trading, the kind of high-touch, manual handling of securities trades that had been the forte of full-service brokerage firms will become much more necessary and in greater demand to transact institutional orders. On the other hand, the same economic pressures make it more difficult for many firms to maintain the staff that can provide such services.
In the face of volatility, in fact, high-touch trading showed signs of a comeback in 2008 while low-touch dropped off, points out Laurie Berke, Senior Consultant at The Tabb Group.“Low touch had captured a greater percentage of order flow in 2007,” adds Berke. “We define low touch as direct market access [DMA], algorithms and electronic crossing, [which] in 2008 [accounted for] 44 percent of order flow — down from 51 percent the previous year.”
In 2007, low touch trading had hit a milestone and for the first time represented over half of traditional buy-side trading. “Over the past four to five years, as low touch took over, resulting in lower commission rates, sell-side firms definitely cut back on their human capital on the trading desk,” points out Berke.
Conventional high-touch services include order-management support from sales traders and a sell-side program trading desk. “Buy-side firms have been complaining about the cutbacks [on the sell side],” she adds. “They say those who are left don’t have the experience, insight or expertise to act as really helpful partners and advisors in trading. In [our] 2007 study, that was a big deal.”
Tabb Group posed buy-side firms the question: What is the most frustrating thing about trading today? Most frequently, the top answer was “lousy sell-side sales trading coverage,” explains Berke.
The lack of revenue also squeezes the operations and technology budget itself, observes Adam Schneider, Principal at Deloitte Consulting. “The first round of change is project deferrals, elimination of new capabilities, and getting rid of the discretionary spending,” he says. “The second round has been the capacity of layoffs — losing 10 percent here, 20 percent there. The third round has been more structural change.”
The securities and investment industry has made great investment in IT in the past, but it is still challenged to deliver the promised benefits, according to Matthew Nelson, Director of Market Intelligence at Omgeo, a prominent industry provider of trade processing, risk mitigation and operational services.
“There is a great push-pull going on right now with cost-cutting at one end, which lends itself to doing more with less and doing more with technology,” he says. “There’s certainly been large investment in technology and IT in the past few years, the good years, prior to the last 12 months. There’s definitely a call for firms putting that into action more and executing on the automation and benefits that the technology promised. We’re seeing a lot of staffing cuts. In most of these layoffs, operations and technology are in there somewhere, which means this push-pull will exist. As a result, firms have to achieve higher levels of automation, because you have fewer people around. They will be trying to do more with less.”
Automation is not yet feasible for some asset classes, such as OTC products, according to Nelson, yet some tools and automation techniques are being developed that may eventually make that possible. “That’s a positive trend,” he says. “Those who have been at Omgeo since it began are now able to sell the same day affirmation (SDA) [case] we were [presenting] in 2001-02. It’s resounding now. People are absolutely concerned with achieving the benefits of STP [straight-through processing], SDA and higher levels of automation in general.”
Automation is most useful in risk management and mitigation, according to Nelson, and conversely, removing manual processing mitigates risk. “In an environment like we’re in now, where everyone’s extremely risk sensitive and risk averse, we’re looking at more levels of regulation coming down the road. Potentially, more attention will be paid to risk management; the benefits of automation and risk management really are key.”
Capital markets firms are better able to handle exceptions in trading operations, including corporate actions, reconciliations, or missed income collection, compared to asset management firms, according to Schneider. “Capital markets people in selected products are investing for the survivors,” he says. “Flight-to quality people are investing for capacity, but the buy-side is just shell-shocked to some degree and mostly retrenching around these expenditures.”
The challenges that buy-side firms have in making decisions about spending on technology internally or on outsourcing are fueled by the industry volatility, according to Virginia Garcia, Senior Research Director at consultancy TowerGroup.
“Financial services executives struggle to balance key mandates of capital preservation in the short term against strategic differentiation in the long term,” she says. “At the same time, financial institutions must prepare for the inevitable surge in risk management and compliance requirements stemming from stricter regulatory oversight. With so much at stake, cost-cutting born of desperation today may be so deep as to cripple the IT structure permanently and thus jeopardize the business. Smarter actions to rationalize technology offer better short-term returns and also yield strategic benefits. Given that technology transformation and modernization are desperately needed to meet serious business challenges head-on, it pays to think outside the box.”
Spending on maintenance of technology will decline by 7.5 percent in 2009, TowerGroup estimates. Although there will be a gradual increase in spending for maintenance of technology by 2012, that will be because replacement technology investments now surging will shift to the maintenance category, according to Garcia. The crisis is changing IT spending patterns, she adds. “The higher stakes coupled with the power of specialized pools have given technology executives a (seat) at the business table,” she says. “Planning a business case for technology investments, while not easy, is certainly elevated in the organization. Rather than waiting for further wake-up calls, financial institutions are taking charge proactively and pursuing the business benefits of IT transformation for transparency, better customer relationship management and, importantly, risk management.”
Technology and operations projects offering more cost-savings are being ignored at buy-side firms, according to Schneider. “The projects are ending as opposed to firms automating to save money,” he says. “The financial community that helps administer the firms has great skepticism over IT ‘saving money in the short term.’ Automation offers increased capability, increased process and better control, but really saving money happened a long time ago.”
Outsourcing flourishes when financial institutions are economically challenged, according to Garcia. “Outsourcing is again showing its countercyclical nature, with IT spending increasing 9.4 percent in 2009,” she says. “This positive trend will continue through 2012 when associated IT spending will reach $15.7 billion in the US. This is a compound annual growth rate of 7 percent. Contributing to this growth is outsourcing of application development functions to third parties as well as large global institutions selling off captive offshore centers and distributing the functions and associated spending to third parties.”
Interest in “emergency outsourcing” is increasing, according to Schneider. “This applies to functions that people knew were available [to be outsourced], but are not necessarily easy to [outsource],” he says. “In the short-term interest, they become very timely. These include middle-office, back-office and asset value calculation — all tasks that can be done competently in the marketplace pretty quickly, with the goal of reducing fixed technology and operations expenses.”
Globalization is also driving the transformation of technology in operations, according to Garcia. “The downside of global integration, macro-economically speaking, is that a loud financial hiccup in one country echoes around the world,” she says. “The upside is the hiccupping country’s symptoms are alleviated by many nations around the world, reining in the risk and providing a rapid injection of capital to the markets.” Those seeking to reform financial industry regulation should consider this kind of global interdependence, cautions Garcia.
“They have to foster increased global coordination or risk failing to achieve true reform and stability,” she says. “Regulation is going to get a lot more teeth in 2009. It’s potentially a terrific opportunity for technology vendors.”
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