Where are banks and asset managers in terms of developing new business models that address the changes in regulation and market structure?
UBS got an earlier start than most banks, and many of our clients have made good progress. But there’s still much work to be done. Significant regulatory initiatives continue to play out. Many institutions are just beginning to adjust their strategies, processes and workflow to the realities of a changed market structure and risk environment. Complicating the job is the uncertainty around economic and monetary policy.
What’s the core challenge they face?
They confront a significantly more diverse, complex liquidity landscape in the post-credit crisis era. Institutions can no longer count on a limited number of bilateral dealer relationships to meet 100% of their needs. Instead, they’re finding liquidity more dispersed and more difficult to access.
This is true even in asset categories that have been historically among the most liquid. In the US treasury market, for example, proprietary traders account for 50% of volume, according to regulators’ estimates.
In corporate bonds and municipal bonds, SIFMA has counted 15 alternative electronic platforms in operation, and four others planning to launch. These platforms use over 40 different trading protocols. Adding to the complexities are new platforms and exchange-traded products in the interest-rate and credit derivatives markets, where central clearing has created a new trading and settlement model.
What are the strategic implications for asset managers?
The strategic challenges are far ranging – from cost structure to risk management to governance. Establishing and maintaining access to these diverse pools of liquidity has significant potential costs in terms of infrastructure, compliance support and administrative burden. Each of the alternative platforms has its own rulebook, protocols and underlying technology. Then you have the question of which platforms will ultimately be successful and survive.
In this environment, institutions are asking themselves fundamental questions about their business models. How can I access the liquidity I need to implement my strategy? How can I have confidence that I’m receiving quality execution of my trades? How can I achieve those objectives at a cost that lets me deliver competitive investment returns to my clients and profits to my owners?
How is this changing the role of banks?
The most successful banks going forward will be those who simplify and streamline client access to these diverse pools of liquidity. Certainly our approach is to reduce the complexity so our clients can focus on their strategy rather than have to build and support an unwieldy, costly operational and administrative infrastructure.
What will be the winning formula for banks in the years ahead?
Clearly, the winning formula for banks will be one that directly addresses clients’ strategic challenges. From the UBS perspective, that means delivering cost-efficient, dynamic access to a global network that encompasses all the pools of liquidity relevant to clients’ needs. Principal trading will continue to be part of the banks’ capability, but a major objective will be to bring clients opportunities to interact with the appropriate types of liquidity they need to execute their strategies.
A critical part of that approach is providing quality execution in ways that are verifiable and transparent to clients. To that end, an important role for the banks is the systematic monitoring and analysis required to improve trading outcomes and make the adjustments needed to be successful in changing market environments.
What pressures does the growing electronification of the markets create?
Broadly speaking, electronic trading is on a path to capture a more significant share of trading in asset categories such as credit, where adoption rates have historically lagged. Other categories are already at substantial levels of electronification. So electronic trading is at the heart of the capabilities needed to navigate the new market structure.
Because electronic trading is inherently more efficient than traditional voice, this trend is changing the cost structure of trading operations. That puts pressure on market participants to automate their workflow, develop new skill sets and take a look at their organizational structure. For that reason, clients are looking at expertise in electronic trading as a critical factor of their relationship with banks.
How comfortable are investors with the electronic trading techniques needed to tap these alternative liquidity sources?
They’re growing more so. An important area of our work with clients is advising on electronic trading techniques and tools – which approach may work most effectively in given market conditions or venues. Overall, we’re finding that clients come to value the increased control over their orders that electronic trading brings.
It’s worth noting the emergence of the role of the electronic sales trader as a sign of the changing approach. Rather than owning the order, the electronic sales trader’s role is to help the client use the right algorithm in the right venues to maximize the trade’s outcome. In some areas, such as in credit, we also see clients more open to placing passive orders on alternative venues as well as actively taking liquidity.
Do you see institutions accelerating the pace at which they’re adjusting to the changes in market structures?
Yes, the early adopters are benefiting from the changes they’ve made, and that’s stimulated others to rethink their models. Challenges abound, but we see an abundance of opportunities for clients seeking to maximize their access to liquidity options and improve the quality of execution.
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