With the emphasis on managing risk at an all-time high, spending on equity analytics by global sell-side firms will rise at a compound annual growth rate (CAGR) of five per cent through to 2012, says a new Tabb Group report.
The Tabb report - which focuses on the increasing need for sell-side firms to mitigate 'execution risk' - predicts spending on technology relating to algorithms, smart routers and analytics will hit $157 million in 2008 alone.
Cutthroat competition and an increasing dependency on automation has turned US equity execution into a "complex science" for sell-side firms, making the real-time management of risk crucial, says Miranda Mizen, senior consultant and author of the research report.
Sell-side firms are now racing to develop strategies and tools that allow them to improve, measure, monitor and control the execution process and reduce execution risk. Those that do not control execution risk will see their opportunities limited and their organisation exposed, she warns.
Mizen says global expansion is accelerating four types of execution risks for sell-side firms - trading automation within asset classes, cross-asset class investment strategies, market structure changes and increasing product complexity.
"The combined effect of these four forces happening at once is serving to create a perfect storm for managing risk across the desk in real time," she adds.
Mizen says the growth of automated trading in the US equity market across the country and to other continents means "the potential for the failure of any one of these moving parts is enormous". She warns that real-time risk cannot be monitored in silos and has to incorporate much wider, cross-organisational, enterprise-wide views to have any effect.
The recent overhaul of equity trading by the Securities and Exchange Commission (SEC) - Regulation National Market Structure (Reg NMS) - broke the stranglehold held by exchanges and changed the competitive landscape, says the report.
"In a little over a year, US equity execution has evolved into a more complex science, as Regulation NMS requires that the best displayed prices be respected, leading to the rise and importance of smart order routing," says Mizen.
Sell-side firms have reacted by rushing to develop strategies and tools that allow them to improve, measure, monitor and control the execution process and reduce risk. Firms that fail to control execution risk will lose out on trading opportunities to rivals, warns Mizen.
Tabb founder Larry Tabb adds that enterprise risk management is already on everyone's radar, but in these fast-moving, high-volume, global markets, execution-time risk needs to be developed, broadened and redefined.
"Global expansion will escalate the stakes, which are already high and getting higher, as automation grips every asset class and each continent, accelerating the gap between the winners who maximize their ability to manage risk profitably and the others, who might just risk losing their shirts," says Tabb.