New products for new markets

Spend $4 million on trade-capture and processing software? Tight-wad hedge funds would never consider it. Or would they? The number of firms looking to software vendors for trading systems is increasing, and the growth of credit derivatives is the big factor persuading the buy side to get serious about their operating infrastructure. We look at what is available

are good times to be a trading systems software vendor. Trading, risk and trade processing systems continue to attract significant investment from sell-side institutions. Some of that IT expenditure is going into proprietary systems development, but the drive to modernise also continues to provide good business for software vendors.

Meanwhile, the emergence of large, multi-strategy fund managers is contributing to buy-side demand for vendor-provided trading and risk systems. Traditional asset management firms that have moved into new product areas are also increasingly turning to vendors to expand their operations infrastructure.

Credit derivatives trading is accounting for a good portion of the new business. "There are some big projects out there," says Paul Ronan, managing practitioner at trading systems consultancy City Practitioners. Such projects include the purchase of vendor systems by sell-side firms for the flow side of their credit derivatives business, says Ronan. There are also some large initiatives under way on the buy side, he says, particularly in the credit derivatives space.

"Credit derivative trading volumes were up substantially in 2005," says Pontus Eriksson, product manager for credit and interest rate derivatives at trading systems provider Front Arena. "All market volumes have been exploding and most of the big players made money. There are decent IT budgets."

Around half-a-dozen firms make up the bulk of the trading, risk and trade processing software vendor market. The best-known names include Application Networks (which has recently been acquired by Reuters), Calypso, SunGard-owned Front Arena, Misys Summit, Murex and Sophis.

Each of these firms today provides integrated platforms for cross-asset trading, risk management and trade processing, along with individual systems for the different derivatives markets - interest rates, FX, equities and credit. Systems for all or some of the cash equity, fixed income, commodities and structured finance markets, together with money markets and treasury round out the overall package.

The credit derivatives market continues to be an area of huge focus for vendors - not surprisingly, given the market's rapid growth, along with its heavy requirement for systems support. Moreover, for most vendors, it has simply been a matter of wanting to pursue clients into new areas of business.

For vendors with established systems for equity derivatives, interest rate derivatives or fixed income, that has meant pursuing clients into the credit derivatives market. From there, the introduction of integrated cross-asset systems has been the next obvious step.

"It's very rare for a customer to opt for just one asset class," says Eriksson at Front Arena. "For hedge funds it might be equity coupled with credit, or for a bank it might be credit and rates. Single silo solutions are today unusual."

"We have spent the majority of the past three years investing in the development of a seamless cross--derivatives platform," he adds.

Meanwhile, IT projects on the buy side include some heavy expenditure on trading and risk systems by large credit correlation fund managers, according to bankers. "Hedge funds are not used to buying from the software vendors," notes one trading systems specialist. "But there is some spend going on, particularly in North America."

However, it is not only the larger structured credit hedge fund managers that are turning to vendors. Hosted solutions are being rolled out to attract smaller-sized hedge funds - particularly funds that require systems support for more complex strategies, such as structured credit.

For example, software system vendor Calypso recently announced a partnership with hosted trading infrastructure provider, Sky Road. Calypso's trading toolkit forms the foundation for the Sky Road platform, which is a front-to-back office cross-asset trading, risk and processing system.

Mas Nakachi, senior business analyst at Calypso, says the partnership is aimed at smaller-size funds or start-up funds that require sophisticated systems support for complex trading strategies.

"A $300 million to $500 million hedge fund that is very actively trading products such as credit derivatives expects a level of sophistication in support," he says. "Historically such products have needed huge systems support, but using the Sky Road platform, the fund does not have to invest in large IT infrastructure."

As well as targeting funds that are involved in credit and structured debt, the platform is aimed at managers running cross-asset trading strategies, such as global macro funds.

Sky Road, which is based in Downers Grove, Illinois, was established in 2005 by John Borse and Joe Clifford - previously colleagues at Ritchie Capital Management, and before that at Citadel Investment Group.

Hosted solutions certainly look attractive for smaller-size funds when the cost of buying and installing systems is totted up. The cost grows as more and more asset classes - or 'modules' in systems support-speak - are added. According to Ronan at City Practitioners, the cost for a multi-strategy fund manager looking for systems support in different asset classes can potentially top $4 million. "Large multi-strategy funds are doing a bit of everything and need depth and quality of operational systems, but are not doing massive volume. To an extent, that is a problem for them, as big technical spend is needed."

Meanwhile, traditional asset management firms that are turning to vendor solutions to support their move into long-short trading strategies include Barclays Global Investors. The firm, which has moved into credit hedge fund management and is currently planning a synthetic ABS investment fund, has bought products from Calypso and Misys Summit.

"General institutional asset managers are an interesting new area of activity," says Nakachi at Calypso. "That has been a big part of our business over the last six months to a year. The IT infrastructure at these firms has been cash systems, effectively, but many firms are making increasing use of credit derivative products."

Besides helping to keep diaries full with beauty parades, the credit derivatives market is keeping vendors busy on product development, as trading in new products grows. For example, systems have been responding to the development of liquid trading in options on credit derivative indices.

"We have seen a stream of requests in relation to CDS options," says Emmanuel Fruchard, head of the credit professional services unit at financial software company Sophis. "That is clearly a new feature coming into the system and has involved adding analytics and front-to-back functionality."

Other projects at Sophis, which has its headquarters in Paris, have included partnering with application infrastructure provider DataSynapse to offer an enhanced grid computing service. "We have internal tools for grid computing and can take advantage of the architecture we have developed for equity derivatives desks," notes Fruchard. "For larger market players we have partnered up with DataSynapse to distribute on even more machines."

Adds Fruchard: "A few years ago volumes were generally not large enough to require grid computing. Today people can have open positions on several thousand swaps which is a bit demanding. Clients want to see the underlying market risk analytics, refreshed up to 100 times a day, so all the ingredients are there for grid computing." Sophis distributes its own tools to small and medium size clients that run up to 100 machines on a grid.

Meanwhile, trading in credit derivatives on asset-backed securities is the latest product success that vendors are working on integrating into their systems. For example, Calypso says it is working with a consortium of dealers, including Bear Stearns, in the ABS credit derivatives area. The initiative relates to trading in ABS credit derivatives using the North American pay-as-you-go standard.

"We were approached last year by a dealer consortium and are working to build out functionality," says Nakachi at Calypso. "Credit events are more binary in the corporate market, so the systems requirements are very different.

"With PAUG you are dealing with 'soft' credit events that can occur on a monthly basis. It is a question of how to manage and process that. In addition, credit events are bi-directional - sometimes the protection seller is receiving payments based on reimbursements. We are in beta testing at present."

Exotics and hybrids are other areas that present challenges. "Some banks see flow and exotics sitting in different lines as a problem," says James Kemp, managing director at financial markets technology consultancy Stentra. "But understanding how to get it to work in a single system can be difficult."

Sell-side and buy-side firms that are looking to buy a vendor system will obviously have a keen eye for the respective strengths and weaknesses of each offering. One quality that is often used to distinguish different systems is whether the system is a toolkit - allowing the user to build from the ground up - or whether it is more of an off-the-shelf product, but with the flexibility to extend and modify.

However, consultancy firms say that such differences should not be taken too literally. For example, according to one consultant, Murex is often perceived to be more of a black box compared with a system like Calypso, which is sold as a toolkit. But the reality is somewhat different. "In fact, Murex has a very good XML workflow engine and a lot of clients do a lot of API [computer system interface] work with Murex inside the package," he says.

He adds that systems can go in and out of fashion, depending on where the system is in its product cycle. "At Summit there is a bit of regrowth and rebirth going on," he says. "Packages have a lifetime and at the beginning they solve everything. But then the client appetite changes."

Summit was established in 1990, and offers systems across fixed income, treasury, derivatives and commercial lending. Recent initiatives include integrating credit derivative consultancy Reoch Credit Partners' valuation model into the Summit system.

The systems consultant adds that the vendors he sees most often in the market are Calypso, Front Arena and Summit. "It's Calypso, Summit to a degree, and Front, especially if you are interested in a wide spread across treasury as well," he says. "Sophis is also there, particularly for equity derivatives. Sophis has very good analytics and quite a bit of penetration with hedge funds."

Front Arena, which was established in 1987, offers an integrated system combined with an extension framework. "People are starting with the core foundation framework and have the Arena Extension Framework on top," says Eriksson at Front Arena. "It's a product with the flexibility of a toolkit. You can plug-and-play but you can extend as well."

Front Arena recently announced the release of the latest version of its cross-asset trading platform, Front Arena version 2.2. A new feature launched with the release is an enterprise service bus, which enables "instant plug-in" of specific services, such as pricing services, as well as integration with legacy systems.

The service bus API is available in a range of different programme languages, allowing users to integrate components irrespective of the different internal technologies and architectures.

The service bus is being shared with other business units in SunGard as part of the company's so-called common services architecture (CSA) initiative.

The aim of the initiative is to foster collaboration between SunGard's business units, using a common set of technology standards. "For customers, CSA will result in both SunGard systems and other vendor solutions working together more cost effectively, easily and quickly," says Peter Banham, global head of product groups for Front Arena.

Meanwhile, Front Arena's Eriksson says Front's new architecture will help trading firms reduce total cost of ownership, by helping lower running costs, integration costs and operational risk. "It is based on the concept of a service-oriented architecture," he notes. "Front Arena versions 2.2 offers more integrated workflows across product lines and value chains."

Trading systems software vendors

Application Networks
Palo Alto, California; founded 1998
Product: JRisk: derivatives, fixed income, market risk, structured/ hybrid products, treasury/FX

Calypso
San Francisco; founded 1997
Product: Calypso: derivatives, fixed income, equities, FX, money market, treasury, commodities, exotic structured products

Sungard Front Arena
Stockholm; founded 1987
Product: Front Arena: derivatives, fixed income & repo, equities, treasury, FX/money markets

Misys Summit
New York; founded 1990
Product: Misys Summit: derivatives, fixed income, treasury, commercial lending

Murex
Paris; founded 1992
Product: MX: derivatives, FX, equities, commodities, hybrids

Sophis
Paris; founded 1985
Product: Risque (sell-side), Value (buy-side): derivatives, equities, fixed income, structures & hybrids

What is a trading system?

Trading systems vendors provide front office-to-back office software systems for trading, risk and processing. These systems are designed to capture, store and process data - trades - and allow that data to be subjected to various kinds of analysis, accessed through user-friendly interfaces and passed around the organisation efficiently. Trading systems are not designed primarily to price derivatives - that is a separate large area of technological spending. However, many systems include pricing functions, or are designed to work with certain pricing models.

Trades are captured in the front office, and here staff can use various functions such as product structuring, analytics and position management.

Risk components typically include "what if" analysis, VaR analysis, P&L analysis, limit management and hedge recommendations.

The other part of a trading system is workflow management between front and back office, and between back office and external parties for confirmation, payments and settlement. Accounting functions also form part of a trading system.

Trading systems come with development tools and programming interfaces allowing modifications and extensions, often using C/C++ or Java APIs, or through COM or CORBA interfaces. Alternatively, systems can be supplied with built-in scripting engines and extension tools.