Momtchil Pojarliev
Traders Magazine Online News

Some Like It Hedged

BNP Asset Management's Pojarliev discusses a variety of options to address foreign currency exposures. Although there is no single best-practice solution for addressing foreign currency exposures, institutional investors have three main choices, he says.

Traders Poll

Amid changes in builder, do you think the CAT project will be completed by 2020?

Free Site Registration

May 31, 2002

Risk Management Solution

By Joseph Cammarata

Managing broker dealer risk is critical to remaining competitive in a fast-moving marketplace - a marketplace in which regulation is suddenly more important.

Institutions must have access to special electronic trading systems as decimalization and millisecond executions exacerbate the potential risk of violating SEC regulations. These systems provide compliance software and programmable risk management tools at the frontend.

To achieve best execution and maintain critical trading functionality, many institutions are choosing direct access technology. A technology initially developed for individual professional traders, direct access now has Wall Street's attention.

The industry responded with products tailored to institutional needs, combining in a single platform, basket trading, smart order routing, built-in risk management tools, Web-based data reporting, FIX API (Application Programming Interface) connections and desk support.

Wall Street firms - from the sellside to the buyside, bankers to asset managers - are seeing the efficiencies that the technology makes possible in a market changed by decimal pricing, Nasdaq's SuperSOES and the highly-anticipated SuperMontage. Institutions save money by eliminating redundant direct lines to each liquidity pool.

The cost of point-to-point T-1 lines between a broker dealer and various ECNs, as well as between a broker dealer and Nasdaq, typically run between $100,000 and $300,000 per month. This cost disappears when a firm leverages the communications infrastructure of its direct access provider.

Institutional trading firms thus significantly reduce the need to buy and maintain an in-house server farm and related equipment. Providers, however, must respond quickly, creating flexible yet reliable solutions that meet the heightened demands of institutional users. One size does not fit all. It has been my experience that each institutional trading firm has its own methodologies and nuances that require system flexibility and some degree of customization.

Thus, direct access companies accustomed to the traditionally smaller orders and softer regulatory mandates of active traders, must also become proficient in the workflow process and trading constraints of an institutional client. This is where direct access firms are making progress.

A case in point: Risk management issues assume greater importance as direct access is used by a trading population less accustomed to the high-speed execution enabled by this technology. For example, a stock trading on an uptick can potentially be executed a fraction of a second later on a downtick, violating short sell rules (the Securities and Exchange Commission's uptick rule and NASD's bid-tick rule).

As providers receive direct quotes from ECNs and exchanges, it is imperative that such compliance functions as short selling, buying power and trade size restrictions, along with customizable risk features, reside within the direct access system.

Additionally, increased fragmentation in the midst of erratic market conditions has added to the burden of risk management systems and of backoffice compliance personnel.

Direct access providers offering risk management tools (such as full portfolio management and trade summary details that complement existing institutional risk technology) eliminate much of the burden on compliance and backoffice staff caused by new trading regulations.

Ultimately, by providing technology that bundles liquidity pools, smart order routing, compliance functionality and risk management tools, the value-added efficiencies created by direct access will improve a firm's bottom line.

By selecting a direct access provider with built-in compliance that can be integrated with existing operations, institutions will not only decrease exposure, but receive added benefits. These benefits include speed of execution, reduced backoffice expenditures and enhanced frontoffice to backoffice efficiencies.

Joseph Cammarata is a managing director of Sonic Trading in New York City.