Legacy infrastructure cannot keep pace with the continuous automation, changing regulatory demands, dynamic market conditions and growing customer expectations in the financial services industry today, particularly in capital markets. Firms have started to realise the opportunities that come with cloud, redesigning operating models and implementing cost-saving measures to increase efficiency.
Capital markets firms are intensifying their focus from the transformation of infrastructure to investing time and resources into innovation, scaling capacity to bring new services and tools faster to market and providing customers with a continuous evolution of features and enhancements. All of these activities must be done with an eye for increased efficiency in risk management.
As a result, capital markets firms are adopting the AWS cloud in order to discover new opportunities, re-think and re-design how technology operates within an organisation, and implement cost-saving measures that increase efficiency.
Finextra Research spoke to Abhay Pradhan, chief technology officer, financial risk analytics and Mark Findlay, vice president and head of financial risk analytics at IHS Markit, an AWS APN Advanced Technology Partner about their recent report ‘Migrating capital markets applications and data to cloud in uncertain times,’ which highlights how cloud can help simplify processes and identify risk.
Finextra also spoke to James Corcoran, chief technology officer, financial services at Kx, a division of First Derivatives and an AWS APN Advanced Technology Partner, about how cloud can support mission-critical time series data across front, middle and back office and Sandeep Kurne, FS market development at Capgemini, an AWS APN Premier Consulting Partner, about trends powering fundamental operations like investment strategies, risk assessments and fraud detection to be processed in the cloud.
How is risk driving capital markets firms to migrate to the cloud today?
Capital markets firms want to continue conducting analysis on market risk and counterparty risk without exposing assets and the balance sheet to additional stresses or additional intraday calculations.
Findlay highlights this and says that they are “seeing that a given few can scale up and others are in discussion with cloud services providers to help support them in this process.”
Pradhan adds: “When markets are volatile, capital markets firms need to know what is happening on a day-to-day basis in case ad hoc runs or stress runs are needed. What the cloud provides is like a tap: it provides the ability to turn on and run large or specific calculations, which makes it easier for technology to deliver value for the business.”
By deploying on the AWS Cloud, firms no longer have to manage underlying infrastructure and can refocus on investing time and resources in innovation. They can provision the resources they actually need, knowing they can scale up or down, reducing costs and improving their ability to meet customer expectations.
While this evolution is gradually occurring, it is evident that the capital markets is a largely continuing operating business, as Corcoran states: “systems are still running, data is still flowing, businesses are still operating and the cloud gives financial institutions the flexibility to move applications and scale them where required to handle the extra load that may not have been anticipated.”
Kurne explains that institutional clients who previously “concentrated their business relationships with one single broker dealer for pricing and exotic product strategies are now:
• Diversifying their relationships for risk diversification
• Being more demanding of Front to Back (F2B) client experience and
• Demanding digital capabilities for smarter and efficient interactions.”
He adds that large broker dealers, that used to derive revenue from a list of large institutional asset managers with large trading volumes, are now being challenged to expand to non-regulated clients such as hedge funds, quant funds and RIAs.
Furthermore, broker dealers are also shifting their business models in new directions after the emergence of electronic trading put pressure on pricing strategies and traditionally fat margins, as Kurne explains.
Digitisation is occurring now that “large broker dealers that traditionally relied on client relationships exclusively through their trading desks, and investment bankers are quickly recognising their vulnerability to retain clients and the need to institutionalise these relationships with the firm.”
How can capital markets firms manage risk management and compliance?
The new shift has forced sell-side firms to manage risk in an increasingly efficient manner with the realisation that migrating to the cloud can help simplify and speed up processes and improve flexibility when attempting to run additional risk exposures and calculations on an intraday basis. This, in turn, hastens the analysis of market risk and counterparty risk at a rapid rate across various time dimensions.
The current low interest environment, narrow margins and rise of leverage levels propping up the market have increased firms’ exposure to corporate debt, sensitivity to single counterparty risk and the emergence of securitisation backed by illiquid assets, as Kurne says.
“Relative to the 2008 financial crisis, firms today have more access to balance sheet data across lines of business, transparency into golden sources of data, quality of data and processes to measure risk, report and hedge positions” he adds. Regardless, players in capital markets continue to miss the mark with scale, speed, compute and analytical engines that are capable to reacting to market shocks,” according to Kurne.
However, this should be viewed as an opportunity. “Volatility in the markets driven by recent macro-economic conditions, creates a significant opportunity for capital markets firms to evolve and target functions such as reference data management, product pricing, regulatory risk reporting (LCR, NSFR, CCAR, FRTB), non-financial reporting (LOPR, OATS, TRACE) to the cloud environment to optimise margins.”
Seemingly a more attractive driver is the massive operational cost reduction that is involved in migrating to the cloud. Findlay says this is “going to result in a race to get on the cloud, obtain increased compute power, scale up when required and downgrade when not.”
On the point of regulation, Findlay highlights recent developments with SOC 2 Type 1 and Type 2 and how the cloud can support certification across the entire technology stack and subsequent infosecurity requirements.
This can potentially be a sticking point for some financial institutions due to multiple moving parts as well as several vendors and in-house systems to manage, but this model provides “a sort of enablement to be able to trust more applications and data to the cloud.”
Doubt persists and some capital markets firms prefer to host some applications and data on-premises, but a trend is emerging where more and more firms are starting to accept and implement risk-as-a-service platforms that are being offered with cloud providers, such as AWS.
How are capital markets firms harnessing critical data?
Time series data is often looked at like the lifeblood of financial services firms, powering fundamental operations like investment strategies, risk assessments and fraud detection. Moreover, most firms have considered time series data to be their intellectual property (IP) leveraged for revenue generation by making multi-million-dollar trading calls.
Database restrictions have also hampered the speed at which firms move to the cloud and this is where time series databases (TSDBs) can help. Time series data - data that collectively represents how behaviour, processes and systems change over time - is critical to capital market firms because data recorded to the nanosecond can be analysed and applied to the behaviour of interest rates, stock prices and exchange rates, for example.
Unlike relational and NoSQL databases, TSDBs in the cloud are optimised to handle large datasets, transparent querying of the complete dataset at high speed and low latency, as well as detect trader activity and potential market anomalies.
Kurne believes that the trending behaviours of these firms will be divided into two categories. 20% of firms have “meticulously harvested and harnessed this time series data for over 30 years and invested in infrastructure, proprietary code and analytical engines.
“These time series data initiatives have traditionally always been well funded by the desk and will have no incentives to take advantage of cloud’s scale and compute efficiency. Capex is already a sunk cost; depreciation of custom code is a benefit, operational expenses being a fraction of revenue they generate.”
The other 80% will have more of an incentive to take advantage of the scale, efficiency, compute and analytical engine capabilities provided by the cloud. “Some firms are considering partnership operating models where they can take non-proprietary or commoditised data, migrate them to a cloud environment and leverage managed services to achieve cost optimisation.”
As mentioned earlier, different firms will utilise the cloud in different ways; while some will migrate to cloud infrastructure completely, others will maintain applications and data on-premises, taking a hybrid approach. Corcoran speaks of his organisation’s own TSDB and explains that while they tend to capture vast quantities of granular data, or tick by tick data, their in-house technology can still underpin and run analytics against it.
Managed services from cloud providers such as AWS make it easy to load, store and analyse time series datasets as they offer storage that can handle transaction-intensive workloads, tools for real-time analysis and data streaming capabilities to capture events as they occur.
Pradhan also makes an interesting point where firms consider migration in terms of scale and cost; a large financial institution may have millions to spend on building a private cloud infrastructure from within, but a smaller player may make a conscious decision to outsource to a public cloud provider.
However, with the hybrid option, an opportunity emerges with “resource allocation and at times, it may be required to burst up for client or regulators, running large scale regressions or performance.” It is evident that the client on boarding operating model is in dire need of a redesign, especially if firms want to retain trading volumes across an expanded set client base, including hedge funds and quant funds.
How can the cloud support line of business transformation strategies at capital markets firms?
Innovating in the space in which the most complicated calculations and operations for derivative products reside can be the catalyst for digital transformation across the institution. Pradhan describes how with increased compute capability, innovation and implementation of new technology in the front office means that “the same technology is being pushed out from the front to the back.”
Findlay adds that “capital management used to be a further downstream finance function, where you would find out about capital provisions based off how well the risk was run. It’s the complete reverse now and several capital markets firms are now setting the agenda of capital provision.
“That then informs how well and advanced they need to implement risk modelling, risk capabilities, keener pricing and better optimisation of trading books and trading desks. This is music to the regulators’ ears because firms are offering a controlled perspective and a more prudent joined up view.”
Corcoran provides a concluding comment on this and states that “capital markets departments in banks are often on the bleeding edge of new technical innovation, but at the same time they’re very well used to engineering systems to comply with regulatory frameworks, and hence when it comes to technology and infrastructure, they have stringent requirements when it comes to things such as access management, segregation of duties, permissioning data sets and long-term storage of log files and audit trails.”
Once built into the application stack, the cloud makes it easy to deploy technology at scale to other parts of the organisation.”
As Kurne explains, “organisational silos between trading desks, unlimited technology budgets, attraction of top technology talent and information security of the IP has traditionally been significant impediments to cloud adoption.”
However, over the past decade, “the relevance of these factors have been eroded at a velocity never witnessed before and simultaneously, cloud technologies have quickly adopted and matured their security to gain confidence of financial services clients.”
In a concluding statement, Kurne states that fintech firms with modular architecture will continue to disrupt the B2B business model with new products, platform functionalities, market data packages and of course, cutting prices and improving execution speed.
“Traditional large capital markets firms with monolithic and legacy architectures today have the option to compete, maintain client stickiness and adapt to client’s digital preferences only if they aggressively take advantage of legacy modernisation technologies and transition to a micro-services API driven architecture,” Kurne says.
He adds: “Capital markets firms looking to stay relevant should as a start re-evaluate the fundamental needs of their clients, digital preferences to identify, prioritise opportunities that drive revenue enablement and optimise margins without compromising their IP.”
Click here to read 'Migrating Capital Markets Applications and Data to Cloud in Uncertain Times'.