How Digital Is Your Bond Desk?
By Tom Healey, Founder-Director, FINXIS LLC
Digital transformation is at the top of every bank’s strategic agenda as possibly the most important initiative necessary to remain competitive and drive future value. According to an Accenture Survey (1) of investment banks, 60% believe that in three years technology will have a significant impact on trading and that data analytics is the technology that will have the greatest impact. The opportunity is reflected in the continued growth in IT spending on new technologies and the talent required to develop it. Boston-based research and advisory company Celent, projects global bank IT spending to reach $309b in 2022 (2), and much of that spending is going to new and disruptive technologies. But there are many questions that management must address about what a digital transformation strategy means and how to ensure the results generate real value.
In the fixed-income markets a recent industry report estimated that just 19% of U.S. investment-grade corporate bond trading was electronically facilitated, mostly through requests for quotations (RFQs) (3) transmitted to established dealers. Integrating multiple venues, platforms and protocols is a complex technology problem which is why traders are focused on execution management systems (EMS) as the cornerstone of their technology strategy but a digitalization strategy goes much further than a single platform.
Digitalization has the capability to impact performance across every segment of the trader’s workflow and to significantly improve the tasks that traders care about the most. Both the sell-side and the buy-side have a lot of motivation to digitize their business and much of that is coming from the regulators that are pushing digitalization for many of the same reasons. In the U.S., the SEC’s focus on digitalization has focused on regulatory reform to support investor protection of digital assets and to promote innovation. The Bank for International Settlements has established a growing global network of their Innovation Hub, headed by Benoît Cœuré. FINRA has quickly moved forward with a digitalization initiative, DXT: “The Digital Experience Transformation is a multi-year effort to integrate and simplify brokerage firms’ digital interactions with FINRA.” In Europe, ESMA has noted the benefits of digitalization, citing “increased speed, efficiency, convenience and greater economies of scale as well as automated tools that help firms and authorities detect cases of poor conduct.”
As a McKinsey (6) study highlights, “To determine which route is right for them, banks need to begin with an assessment of their current franchise. On the product side, banks with significant exposure to products (equities, FX, treasuries, vanilla IRS) that have moved or are likely to move toward electronic trading have little choice but to invest significantly in digital capabilities. In contrast, banks with franchises weighted toward asset classes less likely to electronify (loans, high-yield bonds, emerging markets, securitized products) can pick and choose where to digitize. In many cases, it will be in their interest to preserve the relatively higher margins in certain areas.” This means that trading desks, like all other businesses, should, according to McKinsey (4), focus on the benefits of digitalization by expanding their products, broadening their ecosystem infrastructure, monetizing data and becoming “a product- or infrastructure-sourcing factory” for their clients and smaller institutions.
Launching full-scale digitalization projects in trading is not easy due to high costs to upgrade many systems, from front-office to back-office. According to Accenture, “capital markets firms struggle with digital innovation more than companies in other industry segments. Perhaps more ominously, many capital markets firms suffer from a pervasive lack of buy-in for digital transformation. More than a quarter (27%) say lack of executive support stands in the way of technology innovation—vs. just 17% for retail banks.”
So how should management think about digitalization? Digitalization of a business has come to mean digital transformation of its assets and workflows, and new metric models are being developed to measure just how digitally mature a business is. In “How digital are we? Maturity models for the assessment of a company’s status in the digital transformation” (5), the authors note that digital transformation “goes much further and describes the process of change due to an increased use of IT.”
There are no standards on Digital Maturity Models (DMMs) but there are two widely used models, one developed by the MIT Center for Digital Business and Capgemini Consulting (2011, 2012), and the IWI-HSG and Crosswalk model. The IWI-HSG is more granular and is good for developing roadmaps as it defines nine categories of analysis and five levels of maturity, ranging from testing to optimizing. Business units can use this framework to build their own model specific to their needs.
A DMM for a bond trading desk may look like the one below (only levels 1 and 5 are shown for simplicity, but levels 2, 3 and 4 are necessary to fully evaluate a business).
| Criteria | Level 1 – Less Mature Testing Stage | Level 5 – Mature Optimizing Stage |
| Customer Experience | Interaction with clients is still limited to emails and message platforms to transmit offerings, news and trading strategies. | The desk enhances its interaction with clients by providing client-facing applications with tailored and actionable strategies, products and post-trade services. Uses portfolio and market data driven by advanced digitalization methods. |
| Product Innovation | The desk’s products and strategies are less customized for individual clients. The desk is not yet using analytics to develop client strategies. | The desk develops new products using advanced analytical strategies from a broad range of client and market data. |
| Strategy | Digitalization is not a priority when making decisions on products, services, projects and resources. | When making decisions on products, markets and clients the desk uses advanced segmenting and optimization methods that maximize profitability and liquidity. |
| Organization | There is no strategic and operational team in place to access the impact of digitalization. | The desk has structured its business, teams and workflow around its use of digitalization methods and IT. |
| Process Digitization | The desk has a significant number of manual processes and workflows that are disconnected and cannot share common data. | The desk has adopted digitalization methods of data capture, aggregation and analysis throughout the pricing and execution cycle. |
| Collaboration | Traders, sales and clients use basic communication tools like email and messaging but have not advanced to interactive tools that work across the firm. | Traders and sales are able to collaborate, share and interact using digital tools. Traders and sales are evaluated on their ability to innovate and utilize technology when interacting with clients and other employees. |
| ICT Operations & Development | The desk looks for point solutions but may not broadly assess the technology capabilities of the desk. | The desk performs reviews and analysis of digital workflows across client services, pricing, execution and post-trade. |
| Culture & Expertise | The desk is beginning to hire technologists as part of the strategic team. | The desk has acquired the necessary expertise and resources to develop new digital technologies across its workflows and has launch incubators for developing new solutions. |
| Transformation Management | Top management is beginning to work with IT and vendors to expand business and products. | The desk’s management team is part of the firm’s overall digital strategy and operational plans, and has metric models in place to measure ROI on its digital initiatives. |
Each DMM category can be broken down further to better understand the maturity of a specific are of the business. Of all the categories across the digitalization spectrum, most trading desks are mostly concerned with Process Digitization, e.g. transactional processes from issuance and trading, to settlement and clearing.
To break down the process further and focus on order flow and trading process maturity, metrics may look like those in this table:
| Process | Level 1 – Less Mature Testing Stage | Level 5 – Mature Optimizing Stage |
| Client Trading Strategies | The desk provides generic strategies to clients and lacks the tools and data necessary to customize client portfolio strategies. | Products and strategies are generated from client portfolio data, transactions and behavior analytics. |
| Primary Issuance | The desk’s issuance, syndication and negotiation processes involve many manual steps and physical documents. | The desk has digitalized its processes for distribution, negotiation, allocation and settlement. |
| Secondary Market Trading | The desk’s lacks the ability to aggregate and distribute quotes across multiple platforms and protocols. There are few pre-trade analytics that sales and traders can use to assess execution likelihood. | The desk has an EMS that uses advanced analytics to source liquidity and analyze client trading behavior for quoting, pricing, routing and execution across the best performing algorithms. |
| Pricing | The desk posts its quotes to the market and on client orders by hand or uses models based on a static set of rules. | Pricing is generated or augmented using client analytics, best execution rules and market scenarios. |
| Order Routing | Traders are manually aggregating and routing orders using messaging, email and manual RFQ protocols. | Orders are aggregated and automatically routed to the best execution venue for lowest cost and highest profitability. |
Does your firm have the ability to issue, execute and settle a digital bond?
Digital securities may not be a trader’s biggest concern when they are still focused on which EMS gives them the access to the most liquidity, but before firms are able to complete digitalization of their existing products they may be faced with the next wave of digitalization in the bond markets. Digital bonds have already been issued by the World Bank, Daimler AG, Russian Sberbank, the Austrian Government, BBVA (partner with MUFG & BNP Paribus), Société Générale SFH, Santander and others. Issuance, trading and settlement of digital bonds will require workflows and new systems.
Digitalization is not just about electronification, it’s about ensuring critical data is captured and analyzed effectively to create new products, engage with clients and drive decisions. For digitalization initiatives to be successful, trading desks must be able to prove the value from the investment in systems and resources which makes the selection of digitalization strategy of paramount importance. A DMM is one tool a firm can use to communicate across the organization in a structured and consistent approach so stakeholders are engaged and committed to its success.
FINXIS LLC is a New York-based boutique consulting firm focused on developing advanced digitalization strategies for financial services firms. Tom Healey can be reached at thealey@finxissolutions.com.
Article References:
- 1) “Capital Markets. The Digital Opportunity for Improved Competitiveness,” Accenture Financial Services and Oxford Economics, https://www.accenture.com/_acnmedia/PDF-92/Accenture-Capital-Markets-Digital-Opportunity-for-Improved-Competitiveness.pdf, 2019.
- “Global Tech Spending Forecast: Banking Edition, 2019.” Celent, https://www.celent.com/insights/964486482.
- “A Survey of the Microstructure of Fixed-Income Markets,” Hendrik Bessembinder, Chester Spatt, and Kumar Venkataraman, Journal of Financial and Quantitative Analysis, 55(1), https://ssrn.com/abstract=3307502, Feb. 2020.
- “Six Digital Growth Strategies for Banks,” Somesh Khanna and Heitor Martins, McKinsey.com, https://www.mckinsey.com/business-functions/mckinsey-digital/our-insights/six-digital-growth-strategies-for-banks, April 13, 2018.
- “How Digital Are We? Maturity models for the assessment of a company’s status in the digital transformation.” Simon Chanias, Thomas Hess, https://www.wim.bwl.uni-muenchen.de/download/epub/mreport_2016_2.pdf, 2016.
- “Two Routes to Digital Success In Capital Markets.” McKinsey Working Papers on Corporate & Investment Banking, No. 10, https://www.mckinsey.com/industries/financial-services/our-insights/two-routes-to-digital-success-in-capital-markets, 2015.
