We are living in extraordinary times. In the past six months, the U.S. came perilously close to technical default, the U.S. dollar has been downgraded, and the Euro's existential crisis is causing central banks and national treasuries to think the unthinkable. Major stock indices represent an Alpine landscape of vertiginous highs and death-defying lows.
This is the age of extreme volatility, where once-in-a-lifetime risk events now take place on a monthly basis. No wonder the VIX volatility index came dangerously close to the 50-point mark in August this year.
For those on the front line, increased volatility means more rapidly changing price points, which in turn means more data to access, analyze and act upon. For those who wish to take advantage of the opportunities that volatility offers, this data-handling capability is critical -- and not just for day traders and high-frequency market makers. Even those whose strategy is simply to stay out of trouble need the ability to respond rapidly to accurate, fast-changing data.
This is a problem for many firms. Volatility has added significantly to trade volumes that already were ballooning. A steady increase in interrelationships among global events; greater use of multiple asset classes and their derivatives; and the technology that has enabled capital and trading to flow quickly across those asset classes, borders and venues all have played their parts.
Liquidity has become fragmented across venues. The Internet has freed information from traditional channels and made it more readily available and transmittable. Trade sizes have shrunk, producing many more small orders at the expense of large blocks. And trading is now a 24/7 business, leaving firms with vastly shortened windows for processing, pricing and reconciliation.
A 'Virtuous' Cycle?
Of course, all these issues have helped increase the volatility levels, too, creating a vicious -- or virtuous -- cycle, depending on your risk appetite.
Anyone who thinks this is a sell-side-only problem is missing the point. Buy-side firms -- with their multibroker strategies and their own alphabet soup of TCA, DMA, EMS and ECNs -- have been getting closer to the trade for years. What's more, no regulator, auditor, investor or custodian is going to fall for the "broker ate my homework" excuse -- even as once copper-bottomed assets lose their Triple-A status and render compliance with client mandates that much harder.
Fund managers, like everyone else, need to make sense of and meaningfully use the increased information available to them and understand the impact of volatility on the shape of their portfolios -- if only to make sensible decisions about which brokers are delivering alpha and which are relying on the reputation of their star traders. In these volatile times that show no respect for traditional institutions, counterparty risk stalks the markets and renders vulnerable everyone who does not have an accurate and immediate handle on the state of play.
The problem is that investment in technology to automate the front office has far outweighed the investment in middle- and back-office infrastructure to source, process, and manage the risks and operational processes necessary to keep up. These systems and processes were designed around clearly demarcated markets and the siloed business structures of the past.
The Genie Is Out of the Bottle
But this particular genie is out of the bottle. There will be no returning to that homogenous world where a narrow focus on asset class and geography could deliver alpha and where manual processes could effectively handle any issues that arose.
So the investment focus needs to change to center on obtaining accurate, available and actionable data, and managing it as a discrete and fundamental process across the firm, separate from -- but interoperable with -- the applications that rely on it to perform their functions. The alternative of having data sourced individually by each system only leads to chaos, duplication, inefficiency, obscurity and cost.
Indeed, most firms have multiple business units, product lines and investment strategies -- all of which require different data sets that will be used in different ways. Compliance and risk management will need different data sets for fund managers; operations want data on actual holdings; and analysts use it for modeling, stress-testing and "what if" scenarios. Clearly there's no single solution for these distinct requirements.
It's time for buy-side firms to examine how data works for them -- and not just from a risk and compliance perspective but in terms of gaining a competitive edge, too. If they don't, and their course is anything but smooth sailing, investors and regulators will no doubt be queuing up to find out.
The truth is that automation of the middle and back office is the only way to deal with the increased amount of information and processing within the tighter timeframes produced by volatile markets. There is no more time; this is not a problem that can be ignored any longer.
Phil Lynch is CEO of Asset Control, a market data management firm. Lynch is highly experienced in the strategic growth and transformation of financial services, technology and media businesses into customer-focused organizations.