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Aiming to Capitalize on a Shifting Liquidity Landscape? Think About Your Platform

Traders Magazine Online News, February 6, 2019

Gerry Turner

Financial market participants, it appears, are getting more intrepid by the day.

In search of fertile new trading environments, many firms are looking further afield than ever before and entering markets that only a few years ago would not have seemed feasible. From Asia to the Americas, buy-side and sell-side institutions are eyeing opportunities for proprietary trading, market-making, broking and other activities. Highlighting the trend, the Bank for International Settlements, in a recent report, said trading activity in fast-paced electronic markets was becoming increasingly fragmented across new venues.[1]

This fragmentation of liquidity is having a profound effect on business models for firms in the derivatives markets as an example. One of the most notable changes is that a new breed of intermediaries, mostly made up of principal trading firms (PTFs), have sprung up. “In recent years, a number of PTFs have moved from high-speed trading on an anonymous basis … to the direct, disclosed provision of liquidity to a network of clients,” the BIS report said.

The new breed, as well as more established players, are justifiably focused on the potential revenue and margins they may be able to achieve with a successful business strategy. However, in a fiercely competitive market place, this is also dependent on them having the right technology and platform strategy.

A firm’s platform strategy can play an outsized role in determining everything from the scope for flexibility to the health of its bottom line. And what not every company realizes is the degree to which technological change and outsourcing trends have opened up new possibilities, allowing firms to be more agile, quickly validate new markets and strategies (fail fast) and focus their limited resources on building their businesses’ unique selling points. Platform-as-a-service (PaaS) used to be a buzzword, now it’s a sensible strategy for ambitious trading firms looking to differentiate their offering and increase their profitability.

Trading trends and the bottom line

The growth of direct market access (DMA) provision has allowed PTFs to proliferate. Trading directly with an order book has become commonplace, even for buy-side firms that rely on brokers for clearing. But as these firms look to capitalize on a quickly shifting liquidity landscape, they need to be mindful of the business challenges that becoming a liquidity provider in electronic markets presents.

Liquidity provision is all about volume. The margins are thin, so firms looking to make money this way need either consistently robust volumes or the requisite flexibility and agility to enable them to scale their businesses accordingly based on internal and external factors such as a shifting regulatory, commercial and macro-economic landscape. 

With regards to the first condition, volumes in many markets have been falling. Global trading as measured by total rate, currency and equity-linked contracts outstanding has fallen by nearly 50 percent to around $11 trillion during the space of two years.[2]

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