The Speed vs. Intelligence Dilemma in Building Order Management Systems
By Dr. Ashok Hegde, MindTree
The race to win a customer base has become more intense among competing market players, and is changing the very nature of the business process. Even in the investment banking space, execution is becoming a commodity service. Over the past few years we have seen significant consolidation happening in the execution service space. These changes have coupled with key industry drivers such as direct market access, smart trading based on system built algorithms, and increased IT adaptation by the buy side clients of investment banks.
Recently, the lines which separated value-add players and vanilla execution service providers have increasingly narrowed. This trend is reflecting the technology advancements happening with respect to advisory support analytics and portfolio management. These technology advancements and adaptations have changed the differentiation dynamics which existed between an investment bank and retail brokerages. In today’s context, the players’ big challenge is to keep the average cost of execution low, while pushing the volume a system can handle upwards. The cost of execution and speed seem to be important drivers, which are forcing the execution service providers to innovate. Whether they are buy side firms or SMEs (small and medium enterprises), cost and speed of execution are key points to differentiate and propel competitive advantage.
Building an order management system for the purpose of trading is a task easier said than done. One needs to conceptualize how an order gets captured, how it is validated, and how it ought to be sent to the execution venue. In most cases, a java front end, a core processing engine with a three-tier architecture, and a quality database would be sufficient to build and deploy such a system. But the key question on which industry players spend millions of dollars every year to answer is – how do we create an order management system that will drive competitive advantage?
Increasing volume, and the need for better analytics and tighter integration to middle and back offices all have been forcing a significant shift in the way order management systems are built. Compromising on the speed is not a popular option, yet there is a daunting task to create IT infrastructures that handle all the above objectives, while bringing down the average cost while catering to the future potential of the business.
Over the years, the method of placing an order at the exchange has been radically redefined by taking advantage of technology advancements and availability. In addition, to reduce process bottlenecks, investment banks have often installed the front end of the order management system at the Asset Manager’s cabin – thereby making manual order ticket generation redundant. Faster computing and processing systems fueled the ambition of investment bankers as well as that of IT managers to aspire for quicker order execution, fractions of milliseconds faster than their nearest competitor. In a world where access to information is of principal importance, the ability to execute orders quickly when information becomes available is imperative. In that context, latency of a system is a critical consideration.
The following figure details key building blocks of an order management system
Fig 1 Key Functional Block of an Order Management System
At a foundation level, functionalities have remained in the respective classifications of front, middle and back office. No significant changes to these blocks have been witnessed either at a business process level or in the way IT supports the securities trading segment. However, significant developments have taken place in a way that these blocks are structured and communicated using a middle layer technology piece. Key mid-layer technology service providers such as MQ series, Tibco and Vitria all have reconfigured their message busses to ensure the performance remains at high levels. Components are built in a way to enhance the communication effectiveness.
From a technology perspective, constants of an order management system include:
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Fault tolerance and uptime availability – 100 percent uptime availability is key for any order management product’s success. Increasing pressure are regulatory requirements. Some of the developments envisioned in Europe (like MiFID and SEPA) will further change the dynamics of the way securities trading organizations operate and conceptualize their IT needs. It is also true that often front office applications are changed to reflect the changes in external environments. The Direct Access rule in the USA and MiFID in Europe are a couple of prominent examples of how regulation is forcing traders to adapt their system to a new reality. SEC and FSA directives on storing the execution details for five to seven years, bench marking the internal matching to the available price information and ensuring orders have executed at a fair price point, though appear simple tasks, have great impact on the system. These changes also impact the way in which order routing algorithms are built.
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Scalability – In order to meet the ever increasing service demand and increased volumes, it is clear that developed systems need to be scaleable and inter- operable. Though scalability is often over looked, it has the potential to become a critical bottleneck for meeting the future demand, if not addressed in the beginning.
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Flexibility – Availability of multiple channels to access the trading venues from anywhere and at any time, along with the ability to deal with multi products and markets, and the ability to receive real time updates on the positions as well as market movements, are still the basic expectations from the end users, irrespective of retail or investment banking clients.
The unanimous conclusion of players the world over is that it is the time taken to reach the execution venue that decides the winner and loser. As always, the winner is declared on arrival by stamping by an exchange or ECN system. Though connectivity into the exchange is well established and stable, the same cannot be said of ECNs. Venues such as OTCs have added complexities due to the structural difference in the way a deal is processed and closed.
With the relentless pursuit of efficiency and muscle building to run faster to reach the exchange, what is increasingly being forgotten is the need for tighter coupling of order management systems to decision support systems such as analytical systems. Though this initiative has the risk of slowing down the process of shooting an order, better in-sight into markets will certainly reduce the chances of loss. Taking this logic further in this scenario, insights into market depth becomes a necessary condition rather than a nice-to-have function. Market risk calculation is often considered a middle office function, but this can be a serious limitation. An order management system should address the following critical success factors in addition to their ability to provide insight into market depth and possible price impact.
Fig 2. Critical Success Factors and Key Challenges
Critical Success factors |
Key challenges |
Risk Priority |
High throughput of transactions |
Speed of execution, total time delay in processing basic validation |
High |
Accuracy and timely synchronization of suitability check |
Linking reference data and KYC systems. Building client profile which guides the frame work for suitability check |
Medium |
Collateral valuation and MTM check |
How to integrate with risk system which may not have the capability of valuing the collateral on a real time basis in addition to building common symbology and information architecture for the instrument referred in risk system to avoid mapping delay |
Medium |
Seamless integration with execution service providers, ECNs, Exchange and Markets place |
What messaging standards to be adapted and deployed. How to handle new product introductions and make the changes to the integration layers as and when external environments gets changed |
High |
Branch, Voice and Call center interface |
Implementation of front end of order management at branch, call center, and at branch level. Centrally retaining process control for the validation, risk measurement and mitigation and decision support systems |
High |
Providing easy integration to back office functionality and certain middle office processes such as trade message flow, allocation, trade enrichment, and reconciliations needs to be taken into consideration. Though achieving speed and functionality will offer significant advantages to an investment bank, a second look into how an order management system needs to be perceived and built may help to increase a sustainable competitive advantage.
For gaining competitive edge, the order management application will need to offer the best possible combination of all of the above. It is imperative that the solution be based on a deep understanding of the securities trading process from the front, middle, and back office. A litmus test for any successful order management system is how quickly it provides depth of insight into market dynamics and moving tickers without a significant compromise on the speed in which it moves between components – internal and external.
Dr. Ashok Hegde is the head of the Capital Markets business practice at MindTree. He has more than 16 years of experience in the Banking and Securities Industry space. His experience includes providing high end consulting services to global Investment Banks and Investment Management firms. Over his career, Ashok has been extensively involved in system development related to Order Management, Risk Managemen,t and Custody applications, and has managed business transformation projects and engagements supporting outsourcing initiatives of large banks. He was principal advisor for a risk system implementation for a large private bank and also worked with the ‘Equity Research’ team for an international investment banking company covering the emerging market desks. Ashok has been associated with financial systems development for clients across geographies and specialized in front and middle office application suits. Ashok has an MBA in investment banking and PhD in economics. He can be reached at ashok_hegde@mindtree.com
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