Recent global events have led to a surge in the popularity of online trading, with many brokers reporting increased trading volumes. However, it’s important to note that recent growth is riding an already well-established trend of interest in retail trading. From budding crypto enthusiasts and Millennial wealth management app users, to new generations of technical and fundamental analysts learning how to trade through YouTube and other social media platforms.
This increase in interest has taken place in parallel to financial markets becoming more accessible. The Great Financial Crisis of 2008, followed closely by the birth of the cryptocurrency industry, have also greatly contributed to improved general awareness of markets and how they work. Both have engendered a D.I.Y ethos where the public is now much more comfortable with the notion of taking control of their own finances and distributing their wealth across a variety of asset classes. A decade ago it was difficult to find a layperson who understood quantitative easing. Now it seems as though everyone has an opinion on the state of the global economy, central bank largesse, expanding balance sheets, and the role of gold and crypto in such a climate.
Veterans of the industry can congratulate themselves for having been well ahead of the curve. They were among the first voices to spread the message of financial inclusion, accessibility and the retail trading industry as an avenue for taking control of your personal finances. They were also the ones who took the first steps to educating retail traders via the then burgeoning information technologies.
But as the online trading industry continues to grow, so do the demands that traders place on the risk management capabilities of brokerages. Since the early 2000s, we have seen brokers go from offering single asset classes with B-book only risk management, through to multi-asset brokerage, A-book, and on to complex hybrid risk management strategies and business models. These developments have been informed by and have occurred in response to changing trader demands (in the 2010s traders began favouring STP and A-book business models), as well as unforeseen market events (the sudden removal of the Swiss franc’s peg to the euro in 2015 highlighted the vulnerabilities of A-book business models).
This evolution has taken place against a backdrop of slow-moving incumbents, the growth of agile third parties, and a broker-side culture of using innovative workarounds to push legacy platforms to perform many roles that they were not initially intended for. This reliance on workarounds has a great deal to do with the first-mover advantage of a lot of legacy platform providers, their brand recognition among traders and brokers alike, as well as a pervasive culture in the industry of “if it ain’t broke, don’t fix it.”
The rise of 3rd Party vendors
Anyone who has worked behind the scenes at a brokerage will tell you how quickly the default risk management tools offered by the legacy platform providers came to be stretched to their very limits. These tools were rudimentary at best and were eventually unable to handle the demands of growing client bases, increased numbers of servers and a rapidly evolving regulatory environment. This led to a cottage industry of third-party risk management tools and plugins favoured by dealers for simply and efficiently allowing them to manage risk across their client bases and adding absent functionality. This involved everything from relatively simple dealer plugins for managing swaps and margin levels, to bridges offering STP trading on platforms that weren’t intended for that specific business model.
Building a business on top of another platform comes with many pitfalls. And as with everything in the world of tech, it became something of a game of cat and mouse between platform providers and third-party vendors, whose agility and expertise in certain niche areas allowed them to rapidly develop solutions to extend the functionality of legacy platforms. In some ways, these third parties performed the role of research and development for the big platform providers, who were then able to produce their own official versions of some of these third-party solutions. If anything, this situation revealed the risk to both third parties and brokers of relying on souped-up platforms pushed beyond their original functionality and having entire segments of the industry depending on this situation being allowed to continue.
Parallel to the rise of third-party software solutions to be licensed and used in-house by brokerage dealing room staff, we also saw the rise of third-party risk management services that took this aspect of the brokerage business entirely off the shoulders of smaller (particularly white label) brokerages. These services allowed new entrants the space to focus their energies on branding and on the growth of their customer bases while allowing risk management duties to be delegated to others.
Another intriguing development in the space saw a new breed of Fintech businesses emerging to fill the growing gap between the large liquidity providers and the influx of smaller startup brokerages to the space. These businesses popularised terms such as “prime-of-prime,” as well as “boutique,” or “bespoke” liquidity provision services and risk management solutions. With the capitalisation requirements of the prime brokers, particularly in the wake of the 2008 crisis, being way out of reach for many smaller brokerages, these new boutique liquidity providers enabled smaller businesses to access liquidity as well as a host of other services including risk management, reporting and CRM suites.
Turnkey, end-to-end, brokerage-in-a-box solutions became popular. Every piece of a modern brokerage (or a pick ‘n’ mix selection of key components) could be purchased off-the-shelf, or alternatively customised to be compatible with a brokerage’s existing infrastructure. What was particularly interesting about this trend, is that while it allowed many more entrants to set up their own brokerage businesses, these third-party vendors were largely unable to disrupt the legacy platform providers. The reason for this is debatable. Some were more experienced in building bridging solutions and CRM modules than front-facing trading platforms and thus found it difficult to compete with existing platforms. In other cases, the legacy platform providers were often still favoured for their brand recognition and market share.
The next generation
We’re now entering a new phase of the industry, one where brokerages are starting to look beyond the incumbents. This is partly because their client base is rapidly changing. The demographics have massively shifted in recent years towards Millennial traders and away from the Generation-Xers that the industry was so heavily dependant upon in previous decades. The Millennials have a lot going for them as a potential customer base. Aside from being a much larger group than their Gen-X predecessors, they are also entering their prime spending years and are now the generation with the largest spending power in history. Having been the generation most affected by the previous crisis, they are also much more likely to take matters into their own hands and use the tools at their disposal to learn something as initially forbidding as how to trade.
This leaves the industry ripe for a shake-up as far as what the new platforms of choice ought to be. It’s a very interesting time as we are seeing pressure for change building on both sides of the fence. On the back end, brokerages need much more in terms of the assets they can offer and the venues they can source liquidity from, the trades they are able to simultaneously process, the risk management strategies they are able to deploy and combine, as well as the customisability and ease of use of their reporting infrastructure in an ever-changing regulatory landscape.
On the front end, the prospective traders they are trying to attract have vastly different requirements compared to previous generations. What worked in the early 2000s cannot be patched-up, given a facelift and passed off today. The legacy platforms of our industry do not have the same brand cachet for this new generation of traders. This generation is accustomed to conducting every aspect of their lives online. They are the reason why UX development has been honed to a precise science over the past decade or so. They are not desktop users. They are cloud-based consumers. App development cannot be an afterthought if you hope to attract and retain them. They are also very quick to delete and move on when they find the interface they have recently downloaded wanting.
Two birds, one stone?
What’s so intriguing about the present moment is that it provides enough motivation for brokerages that wish to remain relevant in the years to come (particularly with an even more uncompromising Gen-Z coming of age), to opt for new platform providers whose products not only solve their pain points where risk management is concerned, but that can also provide the user experience that new traders are increasingly demanding.
It was inevitable that there would only be so far the industry could go by adding third-party functionality to old, tried and tested platforms. It’s time to resolve the perennial back- and front-end issues that the industry has been plagued with by moving to next-generation trading platforms. Platforms that allow dealing staff to manage risk and order flow efficiently by segmenting traders on a group, instrument, or even client-by-client basis, using combinations of A, B and C-Book strategies that can be updated on the fly. All while offering the end trader an interface and user experience that looks and feels like something that belongs to the 2020s.