Indian Capital Markets: Why technology is the key

30th March 2012
Indian Capital Markets: Why technology is the key

In the capital markets business, competitive edge is directly derived from effective use of technology. In this industry the rates in many asset classes change every second or at times even faster. Equities transactions for instance are aiming at a sub-millisecond transaction window. The round trip from the trading application to the exchange and back should be executed in less than a millisecond by ultra-low latency applications. This cannot be achieved without cutting-edge technology infrastructure. 
We bring you  a  special feature by Pravin Lal, Director, Sapient Global Markets, which highlights the challenges that arise in both, the equities and debt markets while analyzing the technology adoption and trends in the Indian capital markets.

In today’s competitive world business and technology are inseparable. Better technology leads to faster business execution and higher operational efficiency. Which in-turn leads to customer retention and growth in both top line and bottom line. This is applicable to capital markets business more than any other.
In the capital markets business, competitive edge is directly derived from effective use of technology. In this industry the rates in many asset classes change every second or at times even faster. Equities transactions for instance are aiming at a sub-milli second transaction window. The round trip from the trading application to the exchange and back should be executed in less than a milli second by ultra-low latency applications. This cannot be achieved without cutting-edge technology infrastructure.
Fundamentally technologists in capital markets space are faced with the following types challenges:
1. Equities Markets: Technology challenge of developing, supporting an enhancing low latency applications. Co-location of servers for faster execution of trades and smart order routing applications (which route the order to the exchange where the probability of execution would be highest at the best price) provide a glimpse into the way technology is moving in this business.
2. Debt Markets: The challenge in debt markets is more quantitative in nature. Valuation and risk analytics applications can pose a mathematically complex challenge for technologists.
With this as the backdrop let us analyze the technology adoption and trends in the Indian capital markets.
 
In 2008,  the Securities and Exchange Board of India (SEBI) allowed brokers to offer Direct Market Access (DMA) to their institutional clients. DMA allows the clients to use the broker infrastructure to trade on the exchange order book directly. Through DMA clients can place their orders directly on the exchange without any manual intervention from the brokers. The level of adoption of DMA in India is increasing. The pressure from FIIs to adopt DMA is pushing the brokers in this direction.
Interestingly, the SEBI circular mentions “Initially, the permission is restricted to institutional clients” Will this be extended to any other client segment in future is anybody’s guess. However, this does give an indication of the trend in future.
In the year 2010, SEBI allowed smart order routing (SOR). This would allow the trader to place the order on the best possible exchange. Many scripts are listed both on BSE and NSE. SOR technology will route the prices from the stock exchanges to the trader and automatically determine the best execution venue.
Along with this co-location of trading servers has been permitted. NSE allows co-location of servers as this would reduce the time taken for the execution round trip to the exchange. Even though this fuels a debate on whether some players will have an unfair advantage or not, it still is the direction. Going by the way developed markets have moved, adoption of co-location in emerging markets is a clear direction as there is a business value in co-location.
These  form the basic building blocks for algorithmic trading. This is a form of trading which is executed without any manual intervention,where the computer algorithms trade on the exchange. Algo trading is another trend for the Indian equities market which is on the rise. Currently a small percentage of equity volumes come through algo trading in India. Going forward the following two trends are appearing in this space:
1. Algo trading volumes will increase in India. This is in lines with the way technology was deployed and used in the developed markets. There is no authentic source of actual equity trading volumes through the algorithmic route, but at this stage the algo volumes in India are much lower than in the developed markets. Potential for growth in the algo volumes is huge since the basic technology infrastructure required for algo trading is now falling in place.
2. Complexity of algorithms will increase. Currently the algorithms are largely focused on the comparison of the future price and spot price. Complexity in the form of various variables can be added. Currency markets, commodity markets, macro-economic indicators and market news together can be bundled into trading strategies.
On the debt markets front, the spot light is more on the regulations and the need to build an active corporate bond market. As the volumes of corporate bonds and securitization increases there will be a need for enhanced technology infrastructure.
Currently the securitization volumes in India are not very high. As a result many players use the bond trading application as a work-around for trading in Mortgage Backed Securities (MBS) and Asset Backed Securities (ABS). As the volumes of MBS/ABS increase there will be a need for many applications in securitization for instance structuring application for implementing complex structures, pricing application which would model the pre-payment behavior of borrowers. Since pre-payment is a risk and has an impact on the future cash-flows, predicting the pre-payment behavior of borrowers in the pool is essential for determining the right price. These pre-payment models have to be India specific. Currently the models used for projecting pre-payments in India are very rudimentary if at all. Such analytical applications are critical for performing valuations of MBS and will be in demand as the volume of securitization business increases in India.
Debt markets will also see an increase in India specific research tools which would be made available to institutional clients. These tools would be used to analyze the performance of specific Indian bonds over time and also used to perform valuations and risk for various debt market asset classes in the client portfolio.
To summarize, capital markets technology is at a very critical juncture in India where the capital markets are evolving and so is the technology shaping the future of this business. Presence of global players i.e. the FIIs and the global investment banks will make it imperative for the local players to scale up the technology to keep pace with the business requirements.

*Sapient Global Markets is the only provider in the world to offer integrated advisory, program management, analytics, technology and operations services exclusively to capital and commodity market participants and regulators. www.sapient.com