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"Liquidity management is the science of automatically managing order flow with limited human interaction," explains Larry Tabb, CEO and founder of TABB Group, in "Liquidity Management: Pushing Automated Trading Beyond Agency Brokerage," a report published a year ago when the phenomenon was first taking hold in the equities space. "Liquidity management is simply how brokers handle customer orders and their decision process behind how and when to provide liquidity."
Today, the practice is well developed in the U.S. equity markets, in which brokers use low-touch technologies such as direct market access (DMA) and algorithms to route agency flows and search for hidden liquidity in dark pools rather than pay the exchange fees at Nasdaq or the New York Stock Exchange. But in the fixed-income and OTC derivatives markets, in which dealers risk their own capital as the source of price formation and maintain two-sided markets, the process is more complex. Still, firms such as HSBC are looking to expand liquidity management to structured products.
HSBC Gets FIERCE With Liquidity Management
With the goal of streamlining its transaction process and migrating it across asset classes, HSBC is developing a set of technologies for pricing, executing and hedging the components of structured products. The multiyear project -- known as Finance Instrument Enterprise Resources for Consolidation and Execution (FIERCE) -- began in 2005 and involves building a liquidity management system (LMS) for complex financial products so that multileg trades can be priced, executed and hedged electronically. A multileg transaction is a trade with two or more instruments that are bought/and or sold simultaneously to achieve a certain investment goal. Traders can capitalize on multi-leg trading strategies to express a view on the market which is either bullish, neutral or bearish.
The liquidity management solution encompasses smart order routing, internalization, matching of customer and proprietary flows, and hedging with multileg transactions, according to Ken Yeadon, CEO of Yeadon Financial Concepts and chief enterprise e-trading strategist for HSBC. "Our objective is to minimize execution slippage," he emphasizes. Slippage occurs when the trader executes one leg of the trade but the price moves in the market before the trader has a chance to put on the other legs. "If you can eliminate any slippage in hedging, you can either support a tighter market or you can make more money in the same one," Yeadon explains.
By internally crossing the orders, HSBC has the ability to guarantee the automatic execution of the trades and the hedges that are based on the same internal prices. "An internal price can always be relied upon because we control the match," says Yeadon, a 17-year veteran of HSBC who previously held roles as head of trading in fixed-income and interest-rate derivatives for Asia Pacific and head of e-commerce for Asia Pacific. "But the minute the matching process is referred externally, you can no longer have a guaranteed outcome. You can only have a statistically optimized outcome," continues Yeadon, who currently is a consultant to HSBC and is managing the technology build for the liquidity management project.
To revamp its execution process, HSBC is working with Paris-based Smart Trade Technologies, whose liquidity management platform aggregates liquidity sources into a consolidated order book whether they reside on an internal engine or an external destination.. With Smart Trade as the "core internal market component," Yeadon says, HSBC is able to create an internal market model into which it registers its own liquidity pools and that serves as a proxy for external liquidity pools.
"What you are basically doing is building an integration point for each external liquidity pool that normalizes it into a common representation of an order," says Yeadon, who explains that internally, all the liquidity pools are represented in a common data structure. HSBC is using application programming interfaces (APIs) from ION Trading Systems as an integration framework to connect directly with electronic fixed-income markets, Yeadon adds.
Externally, HSBC is connected to two interdealer broker channels -- Brokertec and eSpeed -- that bring streaming prices into the virtual order books and Liquidity Hub, which offers a request-for-stream model in which the supplier streams the rates for a certain time period. In addition, HSBC is hooked into MTS, the major European government debt-trading platform, and it's in the process of connecting to external futures markets, including CME, CBOT and Eurex. Customer orders come into HSBC via Bloomberg Electronic Trading and TradeWeb, as well as by interacting with the bank's own APIs. Clients also phone sales traders who manually enter trades.
