David Donovan at TabbFORUM panel interviewed by Greg Crawford

Greg Crawford, editor of TabbFORUM, the online global capital markets thought leadership community, interviews David K. Donovan after the panel on Equity Market Structure Regulation: Will it Happen? Is it Needed?

Finding a Balance in Market Structure (Sapient Global Markets, David K. Donovan, Vice President, Managing Director)

Prior to the opening of the SIFMA Financial Services Technology Leaders Forum and Expo 2011, I was honored to take part in a TABBForum panel that discussed the very timely topic of “Equity Market Structure Regulation: Will it Happen?  Is it Needed?”  Needless to say, the crowd was standing room only.

Moderated by Larry Tabb, founder of the TABB Group, I was joined on the panel by:

• Bill Neuberger, Global Co-Head of Electronic Trading, Morgan Stanley
• Claude Courbois, Vice President, Managing Economist, NASDAQ OMX
• Dave Johnsen, Head of U.S. Liquidity Strategy, Goldman Sachs Electronic Trading
• Charlie Susi, Co-Head of Global Electronic Trading, UBS

It was really fascinating to hear their insights and to add my own as a former top trader at Fidelity Investments and in my present role as a VP at Sapient Global Markets.  One area that I touched upon was the explosive growth of high-frequency trading firms (HFTs) and their competitive advantage.  HFTs, for example, “co-locate” by placing large server farms right next to exchanges so they can get faster data feeds.  This faster access to data gives them the edge to make huge profits; the scientific term used to describe the HFT front running is “latency arbitrage.”  The latency being arbitraged is the speed of data sent to computer terminals.

We must continue to stress the need for fair and organized markets in order to restore public confidence.  This includes introducing rules and technology that make the markets fair and balanced.  RBC, for example, has the THOR algorithm, a patent-pending smart order routing technology is designed to minimize latency arbitrage, improve execution quality and control trading costs.  THOR cuts this very slight time differential down to zero so data arrives at that various exchanges at the same time, making the market fair and balanced for all parties.  RBC has actually tweaked it recently and is now moved from 25% to 100% fill rates.

I’ll have more insights on market regulation and how it has impacted both the buy- and sell-side of the market in upcoming blogs.

Investment banks are now exploring nearshoring (or “nearshore outsourcing”) as a necessary option because front office operations are becoming increasingly complex and it’s now more vital than ever before to support and develop applications in real time that are mission critical to business success. Today, investment banks are eyeing nearshoring because they understand the importance of having essential applications — like those that calculate risk, profit and loss, Value at Risk and collateral management — in the same time zone as the businesses that rely on that information to make immediate and informed decisions — and that means nearshoring.

What a different perspective from what’s happened in the last decade when banks moved business processes like information technology, business processes and software development to far away and lower-wage foreign countries, mostly in the Far East, like India, Pakistan and The Philippines.

Nearshoring is gaining traction because it reduces the complexity and risk inherent in traditional offshore outsourcing.  It puts everyone in the same time zone, reduces language barriers and cultural issues, promotes closer collaboration between teams, bolsters process and data security and provides intellectual property protection under U.S. trade agreements.

Investment banks are now starting nearshoring operations right here in the U.S. in places like Texas, Florida, North Carolina and the Southwest, keeping jobs in the U.S.  Canada is also becoming another nearshore outsourcing location.  The key drivers here are access to quality talent through top local universities and lower costs of living, like housing and energy, which can be met by lower salaries.  The large salary advantages that offshore outsourcing once offered have largely gone away.  Also, many states are now making themselves more attractive to business in order to grow their local labor forces.

However, capital markets firms must understand that they need to establish an “IT portfolio strategy” — the most efficient IT strategy for their front office (order management, analytics, risk), middle office (collateral management, margining, some P/L) and back office operations (confirmations and settlements of trades, reconciliations).  The best “IT portfolio strategy” involves leveraging and balancing both nearshore and offshore outsourcing to maximize their individual advantages and create the most effective global strategy for their businesses.

Disclaimer: The views and opinions expressed here are those of David Donovan, a former top trader at Fidelity Investments, and do not necessarily reflect the views and opinions of Sapient Global Markets or any other company.