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December 1, 2000

The Tech-Services Match

By Fred Graboyes

Technology is often thought of as the way to get trading done faster, cheaper and better, and that's correct. In fact, rapid changes in the structure of the securities markets have necessitated large-scale systems expenditures on the Street. They are the ones you would expect: T1 communication lines, virtual private networks, high-end trading and portfolio management software.

But technology alone is not the silver bullet of successful trading. Even more important is the building of a strategic fit between trading firms' technological products and services.

An important step is a team of traders and technologists committed to a level of service that meets or exceeds clients' expectations.

With technological advancements, execution-focused firms have been able to expand their businesses, and provide more value to clients with quantitative and other pre-trade analytics. These include compliance and advanced portfolio management tools that make the buy-side trading experience a successful one.

Consider, for example, the impact of decimalization on market dynamics, especially in program trading. Decimalization has made spreads more volatile and reduced the information value of published quotes.

With this new pressure for real price discovery, limit order strategies are more difficult to develop. The proliferation of electronic communication networks and the recent frenzy of acquisitions within the financial community has fragmented liquidity. The technical burden of observing trading activity has been increased. The importance of upstairs trading and dealing desks in the price discovery process will grow as market participants look to move large amounts of capital in and out of the marketplace.

Technology works with these market dynamics. For example, BNY ESI's volume-weighted average price (VWAP) auto-execution engine uses expected order size to determine the frequency in which orders are sent to the market. That replaces a set time interval (such as 13 30-minute periods or 26 15-minute periods). Pre-trade analytics provide traders with the insight on recent market conditions, but our intuitive market sense, when combined with this technology, informs us on current market conditions and where to send an order.

Knowing when to send an order to a market maker, or ECN, if necessary, and when to send it to the floor is not a best-guess effort. It is a pre-set strategy based on numerous factors, including size, liquidity and clients' goals.

This combination of technology and trading enables firms to improvise and add value to straight-through processing products and services, instead of having to initiate new solutions from scratch.

For instance, BNY ESI's exchange-traded funds program links with the Bank of New York, our custodian and trustee. The product is completely automated and paperless. The Bank of New York manages the traded fund's accounting and composition; BNY ESI executes for the fund using our numerous best-execution liquidity points. We record the appropriate time and order of the trades, then return the complete, packaged results to the client. Additionally, the Bank of New York manages the money market funds for these and other accounts, making the funds rebalancing and distribution function an automated and integral process to the trading.

Creating a culture of trading technology, of course, is not simply about investing in technology to solve problems. It is about expert and creative people solving problems with the innovative use of technology. We are, for instance, in the process of reengineering not only our systems, but also the way people work. Our software developers are actively involved with our traders, with their work areas right on the trading desk. Instead of taking requests and queuing them up as projects, our software engineers interact with our traders to build solutions, often on the spot.

Industry initiatives like T+1, decimalization and the challenges that come with mergers and acquisitions require an informed, strategic response.

The best way to prepare for these oncoming changes is to have in place both the technical infrastructure and the creative resources to deploy them in a way that empowers clients to enjoy the technological advantages that will set them apart in the marketplace.

Fred Graboyes is senior vice president and head of quantitative equity trading at BNY ESI in New York.