Evolving Risk Management Tools in Online Trading

We’re now entering a new phase of the industry, one where brokerages are starting to look beyond the usual suspects.

New Traders, Evolving Demands

As the industry continues to grow, so do the demands that traders place on the risk management capabilities of brokerages.

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Since the early 2000s we have seen brokers go from offering single asset classes with B-book only risk management, through to multi-asset brokerage, A-book, and on to hybrid risk management strategies and business models.

These developments have taken place in response to changing trader demands and unforeseen market events. For example, in the 2010s traders began favouring STP and A-book business models. Then, the SNB black swan event highlighted the vulnerabilities of A-book only, forcing many brokers to explore other options.

This evolution has taken place against a backdrop of slow-moving incumbents, the growth of agile third parties, and a broker-side culture of using innovative workarounds to push legacy platforms to perform many roles that they were not originally intended for.

The Rise of Third-Parties

As the industry grew, the default risk management tools offered by platform providers came to be stretched to their limits.

These tools were eventually unable to handle the demands of growing client bases, multiple servers and a rapidly changing regulatory environment.

A cottage industry of third-party risk management tools and plugins emerged to serve this need, offering everything from relatively simple dealer plugins for swap and margin management, to bridges conferring STP functionality on platforms that weren’t created for that business model.

It became a game of cat and mouse between platform providers and third-party vendors. The agility of the latter allowed them to rapidly develop solutions that the legacy platforms lacked, while the former were then able to produce their own official versions of these solutions.

It revealed the precarious nature of relying on platforms pushed by third-party solutions beyond their original functionality and having entire segments of the industry depending on the situation being allowed to continue.

Parallel to the rise of third-party software solutions we also saw the rise of third-party risk management services.

These businesses allowed new entrants to the space to focus their energies on building their customer bases, while allowing risk management duties to be outsourced to them.

“Boutique” Solutions

Another interesting development in the space saw a new breed of Fintech business emerging to fill the gap between the prime brokers and smaller startup brokerages.

These outfits popularised “prime-of-prime,” “boutique,” and “bespoke” liquidity provision services and risk management solutions.

With the capitalisation requirements of the prime brokers being way out of reach for many smaller brokerages, these new boutique providers empowered smaller businesses to access liquidity as well as a host of other business critical services.

Turnkey, end-to-end, brokerage-in-a-box solutions became all the rage. Every facet of a modern brokerage (or a pick ‘n’ mix selection of key components) could be purchased off-the-shelf, or customised to play nicely with a brokerage’s existing infrastructure.

However, while the trend allowed for many more entrants to the space, the third-party vendors were largely unable to disrupt the legacy platform providers.

The New Generation

We’re now entering a new phase of the industry, one where brokerages are starting to look beyond the usual suspects. This is partly because the industry’s client base is rapidly changing.

Demographics are shifting away from Gen-X, which the industry was so heavily dependant upon in previous decades and towards millennial traders.

Aside from being a much larger group than their predecessors, they are also entering their prime spending years and now hold the largest spending power in history.

This leaves the industry ripe for a shake-up as far as what the new platforms of choice could be. It’s a very interesting time as we are seeing pressure for change building on both sides of the fence.

On the back end, brokerages now require much more in terms of the asset types, liquidity venues, processing bandwidth, risk management strategies, as well as the customisability of their reporting infrastructure in an ever-changing regulatory landscape.

On the front end, younger traders have vastly different requirements. What worked in the early 2000s cannot be patched-up, given a facelift and passed off today.

The legacy platforms of our industry do not have the same brand cachet for this new generation. They are the reason that UX development has been honed to a precise science over the past decade or so.

They are not desktop users. They are cloud-based consumers. App development cannot be an afterthought in attracting and retaining them.

They are also spoiled for choice and are quick to delete and move on when they find an interface wanting

Time for Change

The present moment provides an opportunity for brokerages to not only solve their risk management pain points, but to provide a user experience that new traders are increasingly demanding.

It’s time to resolve the perennial back- and front-end issues that the industry has been plagued with by moving to next-generation trading platforms.

Platforms that allow dealing staff to manage risk and order flow efficiently by segmenting traders on a per group, instrument, or even a client-by-client basis, using combinations of A, B and C-Book strategies that can be updated on the fly. All while offering a user experience that looks and feels like something that belongs to the 2020s.

This article was written by Conor O’Driscoll, VP of OTC Platform at Devexperts

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