The Future of Broking

The likelihood is that the global economy will continue to be sluggish, even without further global-scale disasters, as the lag effect of the recent gaggle of black swan events takes its toll. To enhance their resilience, banks must ascertain whether they have staff with the necessary skills and experience to understand the implications of climate change and the geopolitical turmoil on their businesses. The insights gleaned from detailed scenario testing must become embedded into business strategy and should flow into risk divisions to enhance the management of both new and established risks.

Regulators, whose role it is to maintain the integrity of the financial system under their jurisdiction, are ‘upping their game’ both in terms of the technology they utilise and the way they analyse broker data and, as a consequence, will be pushing for more accurate reporting. Banks must garner a better grip on their data, so that they can report more accurately to regulators. In the UK, the Financial Conduct Authority (FCA) created the Senior Managers Regime (SMR) in order to unequivocally identify those responsible for complying with its rules. The FCA appears to be encouraging brokers to utilise their own data to better locate and remediate their own compliance issues, enabling them to report the remediated issue to the regulator before the un-remediated issue comes to the FCA’s attention by other means.

Brokers are also challenged by potentially disruptive technologies that are being increasingly talked about in the financial services space and beyond. The opportunity for artificial intelligence (AI) – in all its forms – to make workflows more efficient is becoming ever clearer, and many look on this as a positive development. However, not only do the proponents of AI face a reluctance to engage with the technologies from those who predict widespread redundancies (as is the case for almost any technological leap forward), but they must also overcome opposition those who fear that the AI will not be controllable – or that it will be given too much control – and that humans will ‘dumb down’ in response.

Brokers have the opportunity to incorporate other advanced technologies – perhaps less hysteria-generating but still potentially very disruptive – into their firms. Blockchain falls into this category. The technology is both an enabler of digital (or crypto) assets and a disruptive technology in its own right, particularly in post-trade  processing. Key challenges for the broker community as a whole is to determine the extent to which traditional finance could and should be involved in the crypto asset space, and how much blockchain – or digital ledger – technology could and should be used to facilitate traditional finance workflows.

At the heart of all these challenges – whether technology- or regulation-based – lies the perennial problem of data. What data is garnered, in what format, from which sources, how it is used and how clean and accurate the data is when it is reported are ongoing concerns even today. Subsequently, how data, which has been gathered for regulatory reporting, is used within the firm and to what benefit is the question du jour. As broking becomes increasingly digitised, it may become less about business relationships and more about technology. The ongoing digital transformation of the sector is creating a downward pressure on profits as firms struggle to tidy up platform integrations, automate manual processes and rationalise data. Digitalisation has other implications for broking firms, too, as it creates more ‘attack surfaces’. This is particularly the case when a firm’s IT topology includes on-premises, in-house-developed and vendor-provided platforms as well as cloud-based platforms from multiple providers. Indeed, this describes many broking firms today – although larger broking firms tend to put policies in place that stipulate the use of one cloud provider only. That said, where cloud technology is used varies from firm to firm, but brokers continue to be cautious about allowing sensitive data to be processed or stored in the cloud.

In this report, based on the content of The Broker Club 2023 Conference, The Future of Broking, GreySpark Partners summarises the key themes discussed including regulation, UK competitiveness, crypto assets, desktop interoperability, advanced technologies and the impact of climate change on the financial services industry.

Since 2008, ongoing regulatory change has been a constant in the financial sector, as regulators struggle to put regulation in place to reduce systemic risk and protect investors. This global effort, one could argue, has been successful to an extent, and that the financial industry was more resilient going into the pandemic than it would have been had the pandemic arrived a decade earlier. The post-financial crisis swathe of regulation was mainly concerned with the ‘too big to fail’ financial institutions, as they were perceived to hold the most systemic risk. Thanks to a decade of regulatory effort, firms have tools in place to help them mitigate the systemic risk they hold within the global financial system. However, a new threat / opportunity is emerging.

In the past, the largest banks mainly utilised technology from large and established suppliers, but with the advent of potentially very disruptive technologies, borne and developed by startups and other small, specialised firms, banks can be found dipping their toes into this primordial soup, often not being completely aware of what lies beneath. This being increasingly the case, regulators are increasingly interested in broker use of the services from smaller, younger firms that could pose to banks a new, potentially high, source of risk. As their resilience will be an FCA focus in 2023, firms must fully understand the risk posed to them from all third-party service providers. This is particularly important, as cloud-based ‘As-a-Service’ technologies are increasingly utilised by financial firms.

The debate being had in some regulatory jurisdictions is whether regulators are likely to lean more heavily on regulation backed by legislative enforcement or whether they will give more latitude to firms by providing recommendations only. While there are indications that regulators across the globe are not completely aligned on this, in the UK, the FCA is becoming increasingly assertive.

While the world teeters on the brink of recession following the consequential effects of the Covid-19 pandemic, it has so far successfully avoided it. Possibly encouraged by this, regulators are looking to continue their scrutiny – but in a smarter way – taking advantage of the data and technology available. In the UK, the FCA is becoming more data focused and is putting in place technology to identify insights from within the data that will help it properly supervise firms.

The FCA had its resources depleted, to an extent, by the extensive enforcement actions it took in 2022, and so it is likely that the number of onsite audits will reduce and, instead, emails will be utilised more extensively. Those emails will contain the FCA’s demands for clarifications of reported data or explanations of absent data, and recipients will be given tight deadlines by which to respond. In all respects, the FCA is looking for firms to identify, remediate and report issues. It would reflect very poorly on firms if they did not identify and report an issue before the regulator found it.

2.1 UK Competitiveness

Since Brexit, there has been much speculation about the future direction of UK regulation; anything from continuing to mirror the regulatory landscape of the EU – much of which is already written into UK law – to retain existing business through to politicians walking back much of the ‘legacy’ EU-based legislation in a drive to garner a competitive advantage for the UK to attract new business. However, the truth is likely to be somewhere in between. New post-Brexit regulation being developed by the FCA and PRA is shown in Figure 1.

Figure 1: Timeline of Financial Conduct Authority (FCA) & Prudential Regulation Authority (PRA) Regulation
Source: The Future of Broking Conference, GreySpark analysis

(click image to enlarge)

The FCA is looking to ensure that the regulatory change it develops protects the financial services sector, does not negatively impact the UK economy as a whole and protects investors in British businesses. The protagonists of the ‘UK Divergence vs UK Convergence’ argument are diametrically opposed: Pro divergence support relies on the argument that   new business can be attracted if the UK can manufacture a competitive edge by moulding itself into a more hospitable business environment, whereas the pro convergence argument is that business will be lost by the UK if the country differs too much from the regulatory regime of our nearest and biggest regulatory jurisdiction. The cost of being compliant with both regulatory regimes may mean that brokers and others step away from the UK in favour of the EU.

His Majesty’s Treasury announced the ‘Edinburgh Reforms’, in 2022, which incorporate a set of 30 policy initiatives designed to support the UK Government’s vision for an open, sustainable, technologically advanced globally competitive financial services sector. Described as an extensive package of reform, the reforms include a series of consultations and calls for evidence (not all of which are published (at the time of writing). Highlights include a review of short selling, the long anticipated consolidated tape and an accelerated settlement period.

Figure 2: Commentary on the Chancellor’s Proposed Measures
Source: HMT, The Future of Broking 2023 conference, GreySpark analysis

(click image to enlarge)

Prior to the pandemic, firms were obliged by MiFID II to provide clients with a Best Execution report to demonstrate the quality of their executions. During the Covid emergency, ESMA encouraged national regulators not to prioritise supervisory action for firms failing to produce Best Execution reports. However, since the end pandemic, nothing has replaced these reports in the EU. The lack of this information is fuelling the drive for a consolidated tape, which will aid transparency for bonds and equities trading. In the US, firms must send US 605 and US 606 reports which provide a good overall view of what is being traded, as well as a consolidated tape for bonds and equities trading.

One of the key drivers for regulation developed in the aftermath of the financial crisis was to achieve more transparency across the financial sector. Any shortcomings are to be addressed in the next cycle of legislation. So, when UK regulators look to introduce new post-Brexit regulation, they should try to do so with the objective of improving the UK regulatory landscape rather than to gain competitive advantage. EU regulation itself is a moving target and any competitive advantage might be countered as the EU moves in the same direction. In addition, divergence will be unpopular in the short term with investors who will ultimately be asked to bear the cost of any regulatory divergence. It is unlikely that there will be any dramatic changes to be made in any case since the UK was instrumental in developing the current EU regulatory framework. As such, a ‘race to the bottom’ is highly unlikely. Some have predicted that there will be a memorandum of understanding (MoU) introduced between the EU and UK to address any disparities.

Much has been written about the growth of the equities market in Paris at the expense of the London equities market. As a consequence, there is an expectation that the UK may take action to make the listing rules in the UK more hospitable to businesses, as well as undertaking a review of taxation and the depth of the markets. The EU is not the only alternative to London for investors, however, and the UK should also look carefully at the conditions in the US and APAC before revising UK financial regulation.

2.2 MiFID II and the Impact on Liquidity

Markets were fragmented by MiFID II. The new categories of trading venues defined in the directive mean that liquidity is more difficult to find. MiFID II compliance is still a challenge as there has been very ineffective deployment of Transaction Reporting regimes by brokers. Some venues are not accessible in traditional ways and managed service providers have found their ‘sweet spot’ – helping clients to access these markets through an API, direct connectivity, cloud or cross connects.

There are some issues with the implementation of MiFID II’s RTS 25. Some brokers still find that timestamps are not consistently applied to transactions and some that timestamps have drifted away from coordinated universal time (UCT). Errors and omissions cause issues with the traceability of workflows if logs do not include an accurate and consistently created timestamp which clients must be able to access as and when they need the data. To ensure that this is in place, there must be sufficient investment in the infrastructure to allow for data to be retained for seven years, as is required by MiFID II. Tools should be made available for customers to use to extract the data that they require. However, storing the data is becoming more challenging as it is increasingly complex, and the exchange protocols and market data fields are constantly changing.

2.3 Crypto Assets

The events of the last few years in respect of crypto assets have shown the crypto asset – alternatively called ‘digital assets’ – trading to be a new ‘Wild West’ for finance. The direct involvement of consumers in this space has – possibly – led to the sentiment driven volatility that has driven even wilder speculation. Digital currencies were created to disintermediate banks and regulators – however, many banks have since stepped into the crypto asset world. Given the collapse of the FTX crypto exchange, many in the financial service and beyond now advocate regulation of this space. Regulators will never capture everything everywhere, however. Individuals and organisations involved in traditional finance can escape regulation by putting their money into the Cayman Islands, the Seychelles or any other ‘unregulated’ jurisdiction. The trade-off for those unfettered by regulation is that they are not afforded the safety net that regulation provides, so crypto investors may benefit from having the option to trade either within a regulated environment or a less regulated one depending on their risk appetite.

It appears, however, that the digital assets space is beginning to mirror that of traditional finance. Custodians are appearing with whom investors can store their digital assets. There is increasing demand for a joined-up product offering with seamless cross-margining and execution. Alongside this development, traditional finance is in turn becoming ever more interested in digital assets themselves. For instance, in 2021, ZodiaCustody, formed by SC Ventures, the ventures and innovation arm of Standard Chartered, and Northern Trust, an asset servicing provider, was registered with the FCA, and to provide commercial services to clients as a crypto asset business. In addition, Nomura is backing the crypto asset firm, Laser Digital and Bitpanda is collaborating with the Austrian bank, Raiffeisenlandesbank NÖ-Wien.

Regulators have been slow to address this space, and the FCA is focusing on the anti-money laundering (AML) aspects of digital assets, and concentrating less on market manipulation aspects, which are likely to become a more significant risk with the increasing involvement of traditional finance in this space. In Europe, text for the first piece of EU legislation for tracing transfers of crypto assets like bitcoins and electronic money tokens was provisionally agreed by the European Parliament and European Council negotiators in June 2022. Markets in Crypto Assets (MiCA) aims to ensure that crypto transfers can always be traced, and suspicious transactions blocked. How the industry will react to this new regulated crypto asset space is yet to be determined.

2.4 Financial Crime

Money laundering continues to be an issue for brokers, and this is of particular concern for regulators when the financial system is under stress. Regulators have identified that many brokers have weak systems and controls in place to counter money laundering, and in stressed markets brokers may be reluctant to turn away any customers – even those who provoke the whisper of suspicion about money laundering.

However, that may not be the only reason that brokers form financial relationships with bad actors. Brokers sometimes lack the right level of resources to responsibly onboard customers. The FCA is strengthening its commitment to enforcing good behaviour in this respect and it requires CEOs to inform the regulator of any suspicion of money laundering, market abuse or price fixing, and to put remediation in place when such suspicions arise. Practices that create risk, such as brokers paying their clients’ margin calls, should not take place at all.

2.5 Weathering the Storm

Regulators have and are continuing to put measures in place to manage the many and significant risks the financial system and investors face today. Brokers are encouraged (recommended or mandated) to step up and ‘do their bit’ – be that ensuring they follow good practice and protect against cybercrime or putting in place sufficient stress testing to remain resilient even during the downward phase of the economic cycle. Brokers must think through the impacts of their financial decisions and ensure that there is sufficient governance and reporting in place to keep them on the right side of the laws and guidelines.

Enforcement actions taken in 2022 drained FCA resources so the regulator is hiring heavily, and action is likely to be driven by analysis of big data now the regulator is investing in the technology to support it.

The Senior Managers Regime (SMR) is a significant piece of regulation for wholesale brokers in that it holds individuals accountable when things go wrong. For that reason, it is advisable for all senior managers to have a deep and comprehensive understanding of SMCR, as well as of their organisations’ processes, risks and controls.

The FCA is looking for firms to have the capacity and capability to handle incoming regulation, and brokers must demonstrate that they have regulatory change in hand. This means not only enough budget and resources, but also people equipped with the right expertise and knowledge for every piece of incoming regulation. This may be a tall order for small firms.

Some see technology as an opportunity; they relish its use in their relationship-oriented businesses. However, there are those that feel the industry may be heading in the wrong direction. That ‘brokerages are not technology firms’ is becoming somewhat of a trope. Whatever our personal preferences, however, technology is impacting almost every aspect of our working lives. The question for the industry is when, or if, the brakes need to be applied.

3.1 AI and Next Generation Technologies

Perhaps the most obvious example of unprecedented heights of technology risk is the field of artificial intelligence (AI). The recent-ish development of Generative AI – ChatGPT being an example – sucks away trust in the written word. This along with ‘deep fake’ videos mean that nothing digital can be 100% trusted.

However, by not embracing this and other advanced technologies, firms put themselves at a distinct disadvantage compared with those that do. There are many positive use cases for the technology and AI may eventually be utilised across the breadth of human experience. In the financial services, for instance, Generative AI can be used to write feed handlers in record time. Co-pilot, another generative AI tool, is to be incorporated into Microsoft Teams and will automatically record and summarise meetings for the user.

There is almost universal agreement that the technology will need to be more stringently controlled, but the precise safeguards that need to be put in place are as yet unclear. There is an understanding, however, that firms will need to have inhouse knowledge and expertise in all the advanced technologies utilised as we move into what has been hailed as a new chapter of human evolution.

3.2 Cloud Computing

The advantages of utilising cloud computing technology and third-party vendor ‘As a Service’ offerings have been talked about for many years. Indeed, it could be argued that Cloud is now a mainstream technology in the financial services. It is not always used ubiquitously across a firm’s technology landscape but can be found where the advantages it supplies are particularly obvious for a particular use case.

When determining the optimal technology to use, brokers consider service levels, availability requirements, latency needs and security concerns among many others. Of course, cost is also a big part of the decision, too, and brokers are aware that the pricing of cloud services means that there is a tipping point at which the advantages of cloud (vs physical on-site infrastructure) are negated by the cost. Low volumes of data in the cloud are typically charged at a lower rate, but as a firm becomes more reliant on the cloud and consequently adds more data and demands more compute power, the price per unit volume rises steeply.

Many brokers are moving their disaster recovery centres into the cloud, as well as some back-office operations and testing. Time constraints for the activities in these areas of the firm are measured in minutes rather than microseconds and so are well suited for hosting on distant physical infrastructure.

Factors that are negative drivers for cloud computing include the sensitivity of the data. Data that is critical for principal market makers for instance, should not be subject to risks associated with external cloud dependencies (such as cloud providers’ operational resilience and business risks). It is interesting to note that the increasing trend for traditional finance to utilise cloud computing, runs directly oppositely in the crypto asset space, where virtual assets are being stored on physical servers in custodian banks.

3.3 Screen Real Estate

For years, the mark of an important, successful trader in a brokerage was the size and number of his or her screens. Multiple applications would be open and each viewed with a flick of the eyes turn of the head. This ‘old school’ stereotype has given way to a more empirical measure; profitable compliant trading is the mark of a successful trader, today, and this can be boosted with tools that make her or him more efficient. Imagine being able to see only the metrics needed from each application and that they are not only presented together on one screen but are updated in real time. One way that this can be achieved is via desktop interoperability software.

Some traders – especially high-touch traders – require a lot of data from a variety of sources: shareholder data, CRM data and sentiment analysis data etc. They must assimilate a lot of information, the UIs for the applications from which this data is gleaned may require a very large amount of screen real estate, and traders are often required to log in and out of different applications to piece together the data they need. For a trader to be able to access the CRM, click on an order, speak to the client and have that information and communication automatically recorded and stored, would lead to significant efficiency gains, higher trade volumes and better client service.

Applications that form part of a trader’s workflow can include on-premises in-house developed software or third-party software hosted either on premises or in the cloud. The challenge of creating an interoperable desktop from all that complexity is technical and twofold:

• Decoupling data: Extracting data from the applications and presenting only the data that is needed on one screen, and
• Application communication: Enabling applications to interoperate so that the data on the screen from all the various sources is up to date.

Using the software and expertise of one of the few firms that can do this – Cosaic (formerly part of Finsemble), Glue42 and Openfin, an environment can be created on the trader’s screen displaying timely data from all relevant applications.

Decoupling Data

One of the issues with pulling data from a third-party application with a bulky user interface is that the application provider may not like its user interface being side-lined. In effect, the vendor loses control over its offering. However, there is a way around this problem.

Applications built using container technology, rather than in one long code base (monolithic application) are easier to separate up so that they can offer a modularised product to clients. As containerisation becomes an ever more popular software architecture, modularisation is likewise an increasing trend. For a containerised OMS application, it becomes feasible to create an ‘OMS Lite’.

The mini application would have just enough functionality and data to be useful to the trader but provide no view of the complexity underlying the application. Of course, the development of this sort of modular component on an interoperable desktop would require the cooperation of the third-party application providers. In fact, many vendors are beginning to realise that they need to work together, in partnership – or at least, in harmony – and be open to collaborating with their competitors to deliver the best outcome.

Application Communication

To allow the data to flow from one application to another requires the use of a specific application programming interface (API). An API translates data in the format specific to a particular application to the format specific to a second application. Essentially, each API is specific to the sending and receiving data formats.

The FDC 3 industry initiative was set up to develop a protocol that would allow the interoperability of any application with any other. However, there still appears to be some way to go before this ideal becomes a reality. In the meantime, desktop interoperability vendors are needed to create an environment on the desktop which can receive, make sense of and update the data from multiple applications.

As more younger traders are brought into institutions, expectations around technology will change. The straight-through processing of actions found in most retail technology will be demanded in the working environment. Future application usage will likely look something like the interoperable desktop with key data being shown and data flows updated in real time. The emphasis on individual applications will decrease as emphasis on visualising only relevant data and functionality increases.

3.4 Data

The financial services industry lives and dies with data. Streams of data, batches of data, the majority of it quantitative, pours through financial services systems day and night. Yet, the financial services industry has the reputation for being ‘bad with data’. Not all financial services data is badly managed – any trade lifecycle data is carefully and properly handled, analysed and stored. The challenge for financial systems lies in the sheer volume and complexity of the data running through the systems. Data that is reported to the regulators could often be of a better quality, however, and the reason for this goes to the heart of the communication problem between brokers and the regulators. As some in financial institutions see it, the data they generate, report and send to regulators is of no benefit to the firm itself, firstly. And, secondly, there is little regular feedback from the regulators to the brokers about the data. The feeling of many has been that the data they send simply falls into a big deep hole. The enforcement action taken in 2022 by the FCA may have disabused many of that notion to an extent.

Improving the quality of data is a challenge for many brokers because most firms were built by acquisition and so there can be multiple duplicative systems stitched together, many of which are based on old technologies.

Solving that particular challenge will be complex and costly, and in 2023 the industry has to carefully evaluate improvement proposals and measure the benefits against the cost. When it comes to regulatory data, brokers must understand that this is the regulators window into their firm. If the window is not kept in proper order, the regulator will dig deeper and responding to regulatory enquiries will likely divert resources away from the business.

ESG is difficult to ignore as signs of climate change are everywhere. Most of the world understands that if nothing is done then macroeconomic trends such as food insecurity and mass population movement will accelerate. High profile events – catastrophic weather events including droughts, floods and fires – will continue to plague humanity. This awareness has led to the creation of ESG funds, bought and sold across the financial sector. However, the energy crisis and inflationary pressure on the heels of a pandemic has meant that people are starting to think less about the planet and more about their pocket, and are  pulling their money out of ESG funds, which is having a stinging effect on some fund managers.

On the sell-side, brokers are struggling with the disclosure and labelling requirements for certain investment types. Firms are keen to avoid being seen to be greenwashing – working to appear more environmentally friendly than they are – and bluewashing – publishing deceptive marketing that overstates a company’s commitment to responsible social practices. The actual commitment to transforming the industrial landscape will cost trillions of pounds, and the financial services must play a central role in this transformation.

Requirements for certain firms to report their ESG status have been in place in the UK for over twenty years, and while this is a positive move, it can be a distraction from the real issues and ESG innovation – which is actually desperately needed – will suffer as a result. However, reporting is a driver to stimulate investment and innovation, which will, in turn, take the UK towards NetZero.

Today’s brokers face an onslaught of relentless disruption. While challenging economic conditions can sometimes be profitably exploited, the closely sequential economic shocks the world has faced in recent years have become draining for everyone. The issues that brokers need to focus on will first and foremost include bolstering their own operational resilience. To do this, controls must be reviewed and – most importantly – considered and maintained. Data should be of good quality and adequate tolerances set within the controls. The ability to respond to change will be critical, and this extends to scenario and stress testing. Reviewing disaster recovery plans and infrastructure is not a bad idea either.

To further bolster their operational resilience, firms need to undertake stress testing that covers an increasingly wide set of scenarios, and they must have good quality data to support the tests. Cyber attacks are an increasing concern. The financial industry is key to a strong economy and is a natural target for bad actors. The future of broking in this respect is one where cyber security teams will have a higher profile within organisations and they are likely to hold even more sway when it comes to financial technology decision-making.

Brokers should also think about the emerging – and potentially disruptive – technologies and the challenges and opportunities that they present. Crypto asset trading is increasingly becoming part of broker firm offerings. The core principles of crypto assets and those of traditional finance are diametrically opposed, yet both seem to be moving toward a middle ground. Traditional finance is increasingly utilising cloud-technology with ever more platforms and applications being hosted virtually. Meanwhile in the crypto space, some infrastructure for trading and custody is being brought on premise and into traditional finance institutions.

Controls for AI in financial institutions are mentioned in the same breath as the potential advantages, but how to effectively achieve that balance is subject to debate. When calculators first began to be used in classrooms, many feared that people would lose the ability to do basic arithmetic. In fact, the trend facilitated a step change in the speed at which children were able to move into advanced mathematics… and yet few understand how a calculator performs its functions. The same could be true for AI technology. To fully embrace what advanced technologies such as AI can do, firms must engage the proper resources to be able to understand the output from the technology in order to utilise it for their benefit and the benefit of the wider economy. New training pathways will be needed to ensure that staff stay up to date with the fast-moving technological advances.

Firms should stop focusing on reducing regulatory risk – and potential fines – but should be thinking about how they can utilise the regulatory data to shore up their firm’s resilience and even improve their business outcomes. At the heart of the FCA’s message is that firms should assume that they and their regulatory reports are squarely in the regulator’s cross hairs. Firms should consider reaching out to regulators on a regular basis, and letting the regulator get to know them. This kind of frequent contact may mean that regulators move their focus to other parts of the industry that are more opaque.

In return, regulators are engaging more with firms and the opportunity is there to deliver feedback on the direction of new regulation and supervision if firms are prepared to engage. The FCA is investing in technology to become more effective – and efficient – in how it supervises firms. Finally, members of the boards of financial firms should look at the FCA’s SMR rules. Decisions made by their subordinates may have a lasting impact on Boards of Directors as their members may be held accountable.

This means that in the future brokers must ensure that their Boards and Executives remain in the driving seat.