Follow up to High-Frequency Trading

It appears the SEC has issued fines against the NYSE. As previously discussed, regulators should look the markets as a whole when issuing punishment. Though participants should not be given carte blanche, participants simply use tools provided by the markets themselves. Exchanges should be treated as a regulated entity instead of a self-regulated entity.

If one takes a look at recent history of insider trading they will see that agents acted on material non-public information to take advantage of markets before information was publicly released. Should not our exchanges be subject to the same scrutiny? If they have information regarding positions that could potentially change the 'tides' of a security and this information is being released to certain individuals/entities as opposed to all individuals/entities (if such information is even allowed to be released), then doesn't this look, smell, and feel like insider trading? Thankfully legal entities and people are starting to act.

Speculation would expect greater scrutiny to financial firms regarding the purchase and use of information technology. Company equity value--in the most basic sense--is an accounting plug. Assets minus liabilities equal shareholders equity. Further, cash flows from assets need to be greater than liabilities or encumbrances to those assets to generate positive equity value (where equity value is a moving target). The equity value should not be at the behest of functions and pitfalls of exchanges. As long as the markets that allow such equity to become liquid are in a state of uncertainty and their integrity is compromised (though one could argue the public markets have never been strong in the integrity category since inception), then companies, shareholders and stakeholders, and banks all lose hedonic value in markets. We should strive for security value based on fundamental analysis, not security value based on manipulation of platforms and broken market function.

- Nile C.
5/2/14 4:30pmEST

Challenges and Opportunities for Wealth Management

Wealth Management is a retail fiduciary function that combines financial advisory, estate planning, and ad hoc advice. Wealth Management can be profitable. Since most managers take a percent of AUM, as AUM grows, so does take home wealth manager pay. There are, however, significant challenges facing wealth management when it comes to information and technology. As a fee based--over commission based--business, wealth management is growing in the US and abroad. Barron's typically ranks Wealth Managers and ranking generally depends on earned revenues and managed assets. Thus, firms are seeking to increase top line by hiring more fee based advisors to capture more accounts and subsequently increasing firm revenues. They may also be looking to offset the costs due to increased regulation.

Solutions and Discussion
Services like FIS seek to increase transparency between wealth managers and their clients. It acts as a 'hub' of sorts to provide both parties with information regarding managed accounts. Such technology allows the Wealth Manager to focus on managing and advising over administrative tasks. Instead of spending time calculating NAV and putting together documentation, managers can work on Front Office activity. This is especially important for smaller shops where managers work on administration to sales to advising. Even more important is transparency increases legitimacy and trust. KPMG has written extensively on the need for Wealth Managers to focus on trust with clients, but is confident that if certain conditions are met the market could flourish as private wealth will reach ~150trillion (led mainly by ultra high net worths). Capturing a fraction of a percent could result in attractive yearly income. Even accounting firms like Ernest & Young have entered the space. Would expect more firms to enter this space over the next 5 years.

- Nile C.
5/1/14 4:40pmEST

Information Technology Equity Discussion

Have noticed a recent upward trend in the Information Technology Sector in the United States. Over the course of about a year (4/29/13-4/03/14), the one year % change TTM in the SPLRCT  is +23.48% . This S&P Sector has outperformed, though granted it is highly correlated with, the DJIA and S&P 500

Source: CNBC.com

In terms of peer industries, Information Tech is a leader, but not at the front of the pack.

Source: Fidelity.com

Speculation: Information Technology Sector's revenues appear to stem from cash available to firms that utilize these services. Thus, in a contracting market, the Information Tech Sector appears vulnerable as it will be at the behest of buyers' ability to pay for services. Typically, tech is the most volatile sector. Would imagine as this sector moves into the mature stage of the industry life-cycle that growth will stagnate and earnings will decrease at an increasing rate.

- Nile C.
4/29/14 10:54amEST

Traders and Communication

In light of Michael Lewis's new book, "Flash Boys: A Wall Street Revolt", and the overwhelming response, ranging from regulatory and critical, it may be important to review the sector and how information technology has impacted the space.

High-frequency trading ("HFT") utilizes computer programs, algorithms, 'black box', and equivalent  to execute trades at high speed. In this space, profits are positively correlated with time to trade execution. HFT may track the speed at which an asset's price is going up or down or the delta of an order book or may look at technical trading indicators like MACD or Bollinger bands for example. Traders are not executing large block orders, but are entering/exiting smaller positions to capture pennies. In a sense, they are 'sweeping' nominal capital left on the table during a trade (or potentially many, many trades).

How a 'Flash Order' using HFT works

Source: Wikinvest

In terms of pros and cons to the market as a whole, advocates mainly point to market liquidity and lower fees, while critics point to market manipulation as HFT engages in 'scalping' markets or may even place orders it never intends to make or may artificially inflate asset prices (much like the FED. But that's another conversation all together).

Regardless of which side of the fence you are on (or even if you straddle), HFT comprises of ~70% of market volume. Yet is HFT doing anything that market participants haven't been doing before technology allowed HFT to flourish? Doesn't the market seek to react as fast as possible when new information is presented? Let's assume HFT has early access to info. How are HFTs getting information early and other participants not? That seems challenging to believe when position alpha is decided by milliseconds. Meaning, we could argue HFT and other participants have access to the same non-material and non-insider because HFT trade value vanishes in a fraction of a second. But is it hard to believe when market subscription services exist?

Pay for Play?
CME-NASDAQ has a subscription service to get data fast. The file seems to suggest that a subscriber is linked directly to market data centers allowing for one-way speeds of ~4.25 milliseconds. There are even works for a laser network between the NYSE and NASDAQ. As long as the subscription service is cost efficient for the HFT, then anything that improves speed--even if by a time so nominal it would seem logically irrelevant--will have value. But what about to a pension fund manager? Mutual fund? Or an individual RIA? It seems hard to believe they would view such technology as valuable to their business. But is their lack of participation in this tech allowing HFT to capitalize on their trades?

Level Playing Field
Would be interesting to see how long HFT could last if all participants had access to the same data services. If anything, such a level information field could potentially justify HFT as they are just the first to the table and the most sophisticated when data arises. Yet, this seems too optimistic. As HFT seems reactionary to market activity. Also, given the large amount of volume, who would receive priority from an executing broker? A mutual fund that trades once a month or an HFT that trades 1000s of times a day? It seems if the broker is motivated by commissions, then the HFT is the preferred client. This could potentially allow HFT firms's orders to be placed ahead of other clients. Such discrepancies make the idea of efficient markets outdated. Instead of fundamentals, participants seek to trade off the mechanisms of the market where no matter the movement, the trader first to the plate makes money in the trade. As regulators continue to navigate through these 'dark pools' they would probably be doing themselves a disservice if they overlooked the market's (from auction to ECN to OTC) themselves and just focused on firms that react to inefficiencies that the markets--not participants--create.

- Nile C.
4/28/14 2:39pmEST

Private Placement Solutions

It would be rare to find a sell-side banker that hasn't engaged in a private placement. A private placement is simply an offering made to select parties and does not require registration with the SEC. These can come in the form of RegD 504, 505, 506 or 147, for example. The benefits are apparent; no need for public registration, lower hurdles for disclosed information, and--normally--the waiver of a prospectus that can be costly and timely especially if 3rd party legal eagles get involved. The drawbacks are few, but we will focus on a particularly challenging drawback. Placing the deal.

Larger firms (bulge-bracket) normally have a pool of investors that they can tap for these types of transactions. Qualified institutional buyers (QIBs) and high net worth individuals (HNWIs). Smaller firms (boutiques), however, can have issues placing as they do not have the established network. Further boutiques play in the same sandbox as the bulge-brackets. Meaning, boutiques show product to the same investors as bulge-brackets and occasionally compete for clients. Investors are more inclined to go with the larger firms due to reputation and to maintain goodwill. Another problem is smaller firms do not have the bandwidth to do primaries and secondaries, and mostly focus on niche M&A. Even then, boutiques don't have the balance sheet to withstand a firm commitment and typically act on a best efforts basis. All these factors can scare off clients. The investment banking industry is saturated and fees are dropping. Boutiques need a better way of reaching new investors and corporate clients. Information technology can assist. 

Solutions or more noise? Sites like Axial.net provide a platform for members to post deals and review deals. Ideally, a banker will upload a transaction and an investor will see it, pursue the deal, and then get connected with the banker. This--in theory--allows the banker to cast a wider net on the distribution end and test the market for investor interest. What could end up happening, however, is unlicensed business brokers dilute the market place with deals that they may--or may not--have mandate to represent. Brokers may end up pursuing other brokers' deals. Such 'broker chains' could scare investors away from the platform. Instead of offering a platform for boutiques to get noticed, the site may become overrun with brokers. 

How can information and communications technology help private placements? Like public markets, the more information available, the more efficient the market becomes and investors dictate the price. Online platforms to post securities deals seem to be the next logical step in the sell-side space. If a group can create a platform where securities deals are offered through auction, then I believe that platform will be incredibly valuable. Such a platform could take a % of each deal for providing the service. Such platform will most likely have to be a registered broker/dealer and subject to FINRA/SIPC/SEC as the platform will be offering securities to investors and creating markets (Regulation M as firm will be a market maker). On the positive end, the platform could require only registered firms/individuals have access to such tools. Investors would have to prove that they are QIBs or HNWIs to join. This could streamline deal flow and create a new digital market for privates.

The hurdles appear to be mainly regulatory. Would be hard to monitor a private--yet public--type market. Would broker/dealers still have protection from RegD/144a/147/etc. or would securities have to be registered, thereby handicapping some of the benefits to these transactions? Would investors demand more information on deals before bidding? How do you limit saturation of the market by brokers? What if the broker is working on best efforts and only half the deal gets placed? If a platform can wrap their head's around the front-office capital markets distribution end and handle the back office compliance, then they may have a handle on a new market for initial private offerings over electronic networks.

Nile C.
4/9/14 8:38pmEST

Compliance and Information Technology

In September 2013, JPM announced a plan to spend $4 billion and hire 5,000 specifically in compliance. A reported 40% of financial services firms IT budgets are spent to help achieve regulatory compliance in 2014. Regulatory compliance could consist of Dodd-Frank, SOX, Basel, FINRA, and SEC. Violation of such regulation has obvious consequences ranging from fines to imprisonment. Such risks increase in decentralized and fragmented firms. Firms are exposed to greater regulatory risk if they engage in multiple business lines. Especially if interaction between various lines could cause conflicts of interest. For example, what if a firm's investment banker talks to the firm's equity research analyst about a company that the analyst covers that happens to be a client of the investment banker who is conveniently is doing a secondary offering for the company and needs a favorable report? Maybe a trader goes rogue and takes a position that exposes the whole book? Perhaps someone in Back Office document review sends a trade confirm of a client to a competitor? A broker at the wealth management arm sends an email to a client guaranteeing the return of investment on an instrument the broker is selling? Firms are seeking to limit such risks.

Information Technology firms response is to capitalize on this market. A compliance officer can only monitor so much until he or she is over-utilized and backlogged. Groups like Global-Relay can capture emails and Control Solutions can provide audits. The technology allows automation and monitoring of administrative tasks which can then be used as proof that a firm is compliant. Such innovations have become successful from a sales standpoint. Other than 3rd party providers, firm's are utilizing the cloud to capture and share information. If I were to speculate, any information technology provider that could preempt regulatory events for firms through monitoring electronic activity could prove a powerful market entrant.

- Nile C.

4/4/14 4:19pmEST

An introduction

It is hard to find a sector with more colorful characters than financial services. It is equally, if not more so, challenging to find someone in the general public that understands the mechanisms of the sector. To outsiders, Alpha, Delta, Gamma define an early 20s collegiate member with a penchant for low cost alcohol. To insiders, Greeks bring fortune, chaos, and--for the lucky--both. With the rise of information and market participants, so shrinks Alpha. Can we, however, profit from the increase in information? What impact has information technology had?

We will seek to shine a light into the darker cubby holes of the sector. 

- Nile C.

4/4/14 3:45pmEST