Role of Technology in Institutional Brokerages – Interview of Samir Jayaswal, SVP & Head of Operations, Prism Cybersoftadmin
Role of Technology in Institutional Brokerages – Interview of Samir Jayaswal, SVP & Head of Operations, Prism Cybersoft
What is an institutional Brokerage firm?
An institutional brokerage is a brokerage firm which has institutions as its clients. Examples include pension funds, mutual funds, hedge funds, insurance companies and banks. Most brokerages in India do either retail business or proprietary business but there are several brokerages that have both retail and institutional clients and few that are only institutional clients.
What is the difference between retail focused brokerage firm and an institutional focused brokerage firm?
Apart from the business and revenue models, the whole orientation of brokerages serving institutions is very different from brokerages serving retail customers.
In retail business, brokerage rate is low, typically 3 to 4 basis points. The risks that brokerages have to face for this income are enormous. Whole effort of such brokerages is in the area of containment of credit risk and in setting up distribution machinery. Institutional brokerages in contrast earn better brokerage while being exposed to very less credit risk. They also invest lesser in distribution network. Perception is that institutional brokerage is an easier format of brokerage when compared to retail.
How about service standards and how is technology used to deliver service?
It is widely believed that institutions, by virtue of being better informed can protect their interests better than retail investors. Retail investors faced adversities earlier but exchanges and regulators have actively ensured that both retail and institutional client’s interests are now very well protected. Brokerages aspire to give best of service to both types of clients. For both, they are dependent on technology to a large extent. Issues like real time risk management for retail and post trade reporting for institution becomes critical and these require good technology support.
What drives technology in Institutional Brokerages?
The service delivery demanded by institutions is of a higher standard than demanded by retail customers. Their preference for speed, service quality and post trade support is of a different order. This determines the choice of technology.
Let’s talk of some specific examples. Speed is of essence to all customers. However, some amount of latency may go un-noticed by retail customers. Institutions on the other hand, demand ultra low latency. They just don’t accept any latency above what their peers are enjoying. A lot of their trading strategy is dependent upon high speed access.
Institutions are also very particular about how their order is handled within the dealing room. They see what kind of technology is used to avoid front running and how sophisticated is the mechanism used to fill their orders. Any price away from the market VWAP is negative for the dealer and the broker. Of course there is a lot of human element here but good technology can solve a lot of problems.
Institutions also demand a lot of customization in service. The way in which one institution needs execution reporting, contracts, brokerage calculation etc could be very different from their peers. Brokers need to have adequate technology to meet such customization. These days apart from contract note, most institutional clients need their executed trades to be reported in their proprietary formats. Brokerages are finding it difficult to customize the output according to each client. Good technology can take away a lot of these challenges.
How has technology helped this segment of the market till now?
If there is one driver that has improved operations significantly in this segment, it is adoption of technology. Direct Market Access (DMA) has taken away fear of front running completely.
There used to be days not very long ago where operations in this entire segment were complex and fraught with a lot of risks and rejections. It was very normal to see institutional trades resulting in hand delivery because custodians use to reject it because the trade parameters were different from the mandate or contracts didn’t reach on time etc. Thanks to technology, all that is history now. With better technology and automated STP, the entire industry has gained enormously. Not only has operations risk come down significantly, there is all round efficiency. Capital which was once blocked to take care of operations risk is now freed up for more productive use.
What are the current pain areas of institutional brokerages?
Institutional brokerages are facing several pain areas. Some of these are –
- High technology spending if they want to remove latency, adopt sophisticated algos and sign up for co-location
- High client customization and meeting individual client needs
- Increasing regulatory and compliance costsHow is technology helping them solve these pain areas?
Technology is playing a key role in solving pain areas. DMA has ensured that client has become self sufficient in order execution. For orders where value addition is needed, by using technology, institutional brokerages are able to receive mandates better and are able to execute them better and closer to client’s expectations. Post trade reporting, contracting and client support has also become better using tools like automation. Brokerages are able to complete the entire cycle of affirmation-confirmation, sending of contract notes and shifting their obligations to custodians seamlessly, without any manual intervention.
How will technology help in client acquisition and client retention?
It is widely noticed that Institutional clients have stickiness with brokerages that use technology extensively. In fact this is one of the rare segments where clients demand more technology than what is available with service providers. In fact, the next war of competitiveness amongst brokerages will be fought using technology. Those brokerages who understand client’s algos better and can handshake with their client’s systems better will take a larger share of business.
Is ability to provide Algos also a reasonable differentiator amongst brokerages?
Although this was earlier thought to be a critical factor, it has not turned out to be one. This is because most brokerages use the same trading applications hence have access to same or similar kind of algos.
It is important to understand that most buy side clients want to keep a tight control of what algos they use. Hence they want these algos to reside at their end. Only the ones that are not very sophisticated want to use the algos provided by their brokers. Globally, most buy side brokerages use their algos and send the resultant orders for execution through their brokers. The only value addition the broker does is they provide these clients market access.
How can technology help in upgrading the risk management process in institutional brokerages?
Technology can be very well used to calculate risk and this is an urgent need too. A couple of years ago, a trader erroneously entered a very large order which in turn was allowed to go through without accurate risk checks because the order belonged to an institutional client. While risk checks are done stringently on orders belonging to retail clients, generally they are relaxed with institutional clients. This has to change and technology must be leveraged to calculate risk exactly as it emanates. Apart from this, technology can help in deconstructing risks arising from complex algos. It is very important for brokerages and custodians to understand what risks they are running because of the trades arising from their clients.
How are compliance requirements are handled with technology?
Compliance is one of the fastest changing areas these days. Regulators, depositories, exchanges etc. have their own compliance requirements. Apart from these there are global compliance requirements like Anti Money Laundering and Foreign Account Tax Compliance Act (FATCA). Compliance to these are mandatory if brokerage wants to remain in business and solicit institutional business. Technology obviously plays the central role in helping brokers comply with such requirements.