A streamlined back and middle office will allow more cost-efficient price provision to clients.

Changes in front office operations rest upon the efficiency, reliability, and scalability of the middle and back office. For example, with the right systems in place, banks can take advantage of client appetite for streamed price data in risky and illiquid assets, by delivering real-time risk calculations to support rapid pricing of over-the-counter (OTC) products.

Having fewer systems, covering a wider range of assets, allows a bank to optimise its return on client relationships while reducing its total cost of ownership for back-office IT and supporting it in scaling up the business.

That increase in margins and lowering of costs has a material effect. Within certain markets, notably FX, margins for large banks trading on multi-dealer platforms (MDPs) are near or at zero, according to recent research by Greenwich Associates. Similarly, trading fees for fixed income assets has increased on MDPs over the past 24 months. If prices are provided anonymously via a trading platform, the bank is not able to tailor the price to suit the specific risk profile of the client, or to engage without fear of information leakage.

This has driven many sell-side firms to assess direct connectivity to clients, in order to stream executable prices to them, and to invest in the systems to enable them.

Within this process, a fundamental evolution is that of the risk, collateral and cross-asset tools that enable the bank to measure its positions and the costs of managing those positions.

The cost of connecting

The most obvious challenge is building direct connectivity, however technically this is not the greatest issue. Linking to clients requires a pipe that can feed price data efficiently to them either via an application programming interface (API) or into an order or execution management system (O/EMS). APIs costs are falling every year, so the expenditure needed is lessening as a barrier.

A less obvious but more significant challenge occurs in the middle office and back office capabilities. Pricing any OTC instrument for individual customers creates a real bottleneck if the risk systems being used by a bank are under-resourced, too linear in their processing model, and too old and clunky to handle real-time processing. A cloud deployed and resourced platform can process in parallel and scale up when under pressure. This helps to expand the volume of prices being provided and potentially the trades being processed.

Another challenge in the middle and back office is the internal connectivity provided by systems. It is difficult to negotiate around systems which are connected with the IT equivalent of string. If a bank is trying to push data from one platform to another, when the two platforms do not naturally communicate or interface, it is very hard to build a price for a specific trade in a timely manner. Anything more complex, such as a two-way price, can become impossible and these are increasingly asked for under the ‘request-for-market’ (RFM) protocol, which began in FX and is becoming more common in fixed income.

Clients also need to be supported on trades with multiple legs, whether that be an FX component or a hedge. For streamed prices, the bank must be able to price these parts if the client confirms they want to trade – a lag on the FX component can be costly.

Building back to front

Legacy technology in the back office will hamstring efforts to expand front office capabilities. The front office has increasingly become a multi-asset agile function. Yet the data that feeds its decision making can be rooted in siloed post-trade systems that have limited to no compatibility.

Modular technology that can handle multi-asset trading is therefore needed to underpin this direct-to-client offering, as it creates a reliable and efficient service for buy-side customers. Siloed back-office technology will be a barrier to service offerings, particularly if those systems are segregated by asset class.

The back-office will need the capacity to scale in its processing power and speed, to maximise service quality, which is contingent upon access to cloud storage and delivery. Making the right investment in the middle and back office today can put a bank in the driving seat of this transformative industry change. It will lower the total cost of ownership and lower transaction costs, improving both the top and bottom line for sell-side firms.