Imported from previous forum
About 10 years ago I joined a firm that was able to deliver FIX connectivity to just about any destination – a feature that put us ahead of the game at the time. This firm’s ability to identify and fix operational inefficiencies enabled other firms, both large and small, to benefit.
Since then, much of the industry has matured. Almost every broker offers algorithms, most of which are no longer a differentiator but rather a requirement. Unfortunately, in recent years, trading volumes as well as commission rates are down, requiring firms to do more with less. While the times have changed, the principle of staying ahead of the game has not: identifying and eliminating inefficiencies from your operations gives you a competitive advantage to mitigate risk, decrease time to revenue, and stand apart from other firms.
Today’s Technology
In today’s industry, using technology to streamline trading, order management, and operations is essential. Yet countless inefficiencies, when not addressed by firms, reduce their operational alpha. In many instances, firms do not realize that manual tasks can be replaced with more efficient automated processes. Manual tasks for certification, such as scheduling, time zone management, configuration and setup of test environments, are just a few examples of inefficient business practices. Manually handling processes is not only costing firms time to revenue, but it’s also putting them and their systems at risk. Lacking automation in operations is not an optimal or scalable business model.
Introducing automation into the electronic trading life cycle provides an element of operational alpha for those firms; a competitive advantage resulting from the ability to ensure efficient business practices through flexible test scheduling, reduced resource requirements, and comprehensive testing capabilities.
Operational Alpha is proposed as a measure of the contribution of operational efficiency to overall firm financial performance.
The Real Cost
We all know that being “open for business” is essential. What’s the cost of having your trading system go down as a result of a code drop that inadvertently affects an untested FIX tag? Often times changes to a trading system occur with limited or no testing. The best way to test a system is by simulating a live trading scenario, but not all firms have a sophisticated market data simulator to do this. Instead, they rely on canned data or nothing at all. There is a high probability that the lack of thorough testing will lead to unhappy customers from the inevitable system failure. Any firm will tell you that this is not an option for them, yet many firms have not taken the steps to reduce the inefficiencies in their operations that allows this mistake to happen.
How often are changes not re-tested due to the difficulty and time involved in performing the test? What risks is your firm exposed to as a result of non-testing or inadequate testing?
How long does it take your firm to deploy an updated or new algorithm? Manual testing can take many times longer than automated regression testing, and still may not catch all errors. The value of being able to quickly and confidently deploy changes shows your firm’s level of investment in the infrastructure required to provide your clients with a competitive advantage.
What about your trade allocation process? Most firms have a process that is somewhat bifurcated, when really it could be streamlined using FIX. One firm has built a post trade system that can reduce costs, mitigate risk, and boost efficiencies.
There’s another benefit to adding allocation details to a FIX message: TCA can now be performed with the same file. Current processes use a file extract that combines trade details with the allocation details. Having all of the information in one place – the FIX log – provides the opportunity to generate operational alpha by reducing a number of steps and counterparties involved in these disparate processes.
What are your all in costs of operations? Including software licensing and maintenance fees, the cost of manual processing steps, these costs, especially if they are not leading to improved efficiencies and faster time to revenue, are negative operational alpha.
A neglected aspect of our operational alpha concept is time to revenue. Time to revenue is the time from when a deal is closed, such as sales trader obtains business with a buy side, until actual trading occurs. Up until the time actual trading begins, the relationship is still greatly at risk. Reducing time to revenue by improving operational efficiencies is a critical success factor for your business.
There are limits to tech budgets so more time should be spent on those projects that help drive operational alpha. Too much of the certification process is still manual because that’s just the way it’s been done. If your firm is in this camp I would suggest taking a leading role to drive efficiencies in your business or you will be doing certifications with your counterparties automated tool.
Automation reduces the time to revenue and improves the value and return on existing human capital.
As we all know, the use of technology is expanding to every facet of the trading business pushing QA resources to their limit. QA teams need the tools to help them reduce the backlog that most have. Best customers get priority and others are left in the que. Shouldn’t every customer feel that they are our number priority? Isn’t that what we sold them at the onset of the relationship? Having operational alpha will not only help the bottom line but will also improve a firm’s standing with its customers.
Conclusion
Inefficient business practices can have a chronic impact on a firm’s performance. We refer to this impact as negative operational alpha. Improving your firm’s operational alpha will likely lead to improved profitability by reducing overall transaction costs and improving time to revenue when bringing on new trading partners.
Additionally, focusing on operational alpha also has the intrinsic benefit of reducing various risks, especially operational risk.
Over the next few months we are continuing to define and develop and quantify Operational Alpha for the benefit of the overall investment community, be it buy-sides, sell-sides, and market infrastructure providers.