Keep Calm and Route Order Flow

If only we'd played in the first half like we did in the second...

Talk about snatching defeat from the jaws of victory. Our American readers will, of course, only be concerned with one sporting result this weekend: Seattle’s thrashing of Denver in New Jersey last night. For those of us on this side of the Atlantic, England’s painful loss to France in the opening games of the Six Nations tournament is still a bit raw. Unless you’re French, like my colleague Marina Daras, or a self-avowed supporter of Les Bleus, like my treacherous editor-in-chief.

Our Irish readers should be encouraged by their side's win as well, although Welsh ones may want to be a little hesitant to pop the cork, given their grinding victory over the Azzurri (which also means ‘The Blues', imaginatively) on Saturday. But at least, they'll say, at least we're not Broncos fans. Oh dear.

What relevance does this have to capital markets, I hear you ask? Not a great deal, I just wanted to shoot the breeze about the weekend pig skin. Very tangentially, though, I've been having a lot of conversations about electronic derivatives trading over the past week, and its implications for the sell side.

Market Reform
The common consensus is that, as with all things, change is afoot. This isn't just changes to the way in which trading is performed, but the very role of the sell side itself. Banks don't have the same balance sheet that they used to, essentially, and as such, the role of liquidity provision will fall to the buy side.

But what does this mean for sell-side institutions? Well, clearly, it means that the days of warehousing instruments will be over. But it also means a high degree of technology provision, with these buy-side shops and prop houses looking to connect to multiple swap execution facilities (Sefs) and, eventually, organized trading facilities (OTFs).

The buy side is, of course, notoriously leery about spending vast sums on technology, with even compliance becoming a critical factor for technology spend over the next few years, let alone taking on connectivity and market-making as well. As such, the sell side will step into the breach, many say, routing that liquidity and aiding with the tech aspects of buy-side flow.

Banks don't have the same balance sheet that they used to, essentially, and as such, the role of liquidity provision will fall to the buy side. But what does this mean for sell-side institutions?

It's a sentiment I've heard a few times, and it makes sense to an extent. I don't think it means the total exit of the sell side from fixed-income trading, but as we all know, it's a risky business. When it works, it powers the firm's quarterly reports. When it doesn't, wow, it really doesn't. The exit of some firms from fixed-income trading, the outsourcing of platforms and the like would all point towards this gradual wind down, too. And with OTFs inbound, those firms that shifted their desks to Europe in order to avoid US rules on electronic trading now have a sword of Damocles hanging over their heads.

Crystal Balls
But that's all in the future, and that particular future is particularly hard to quantify at the moment, given that so much is in flux. I suspect that the European Securities and Markets Authority (Esma) is the key here. Strange really, given its traditional role as the political whipping boy of financial-market regulators, that it's likely become the single most powerful entity in derivatives trading at the moment.

The direction it gives the technical implementation of the Markets in Financial Instruments Directive will, undoubtedly, set the course of market future on a global basis. For the sell side, that's critically important.

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