Brokers' lack of capital commitment and declining investment in technology will cause buy-side firms – particularly hedge funds – to change the way they manage orders, according to Ali Pichvai, CEO of trading technology provider Quod Financial.
The disintegration of major prime brokerage firms Bear Stearns and Lehman Brothers – and a notable drawing in of horns by surviving Wall Street firms – means hedge funds can no longer rely on prime brokers for easy leverage. “The changes to the trading landscape are drastic,” said Pichvai. “We are in the midst of a systemic shock which has propagated from the sell- to buy-side, and as such, there is a flight to quality away from the investment banks to the safer, less risky firms.”
Pichvai also notes that, until recently, hedge funds typically sourced their technology and back-office requirements, such as reporting, fund administration and custodian services, via just one prime broker. In the current environment, the dissolution of once-tight relationships means hedge funds need systems that are independent from their brokers, but with the ability to provide the same functionality.
The changing technology requirements of hedge funds have led to the development of Quod’s new product, BASOR – Buy-side Adaptive Smart Order Router.
“Once the investment strategy is translated into an execution strategy, BASOR can take the incoming orders and make a decision on which broker to use, which broker algos will be most effective and which alternative venues can provide the most value,” said Pichvai. “Hedge funds face the most challenged at the moment, but all buy-side firms can benefit from this product.”
In an environment where traders favour immediate and aggressive trading strategies to cope with large swings in stock valuations, advances and innovation in technology will still prove to be crucial, according to Pichvai. “Speed and capacity performance are important in determining who will grab liquidity first,” he said. “Older systems will not be able to cope with this kind of environment.”
But Pichvai also perceives a longer-term shift in the relation between the buy- and sell-side relationship as the latter take greater control of execution by means of electronic tools. “There is a disenfranchising of the sell side. The buy-side is becoming less dependent on sell-side technology,” says Pichvai. “Prime brokerage firms are turning more into execution providers. Profit isn’t made through lending, research fees and capital raising anymore.”
However, to take full advantage of their new-found technological independence, buy-side firms will still have to look to sell-side firms for guidance. “In terms of intelligence and advanced, adaptive trading techniques, the buy-side still needs to be educated and become better equipped to deal with the current environment,” said Pichvai.