IP- enabled trading in financial services

Table of contents 1 Introduction 3 2 Background to IP turrets 4 3 Rationale for adopting IP trading turrets 5 4 Conclusion 8 Page 2 of 9

1 Introduction Trading turret technology has traditionally lagged behind that of enterprise telephony but all that is beginning to change, due to a number of key drivers. The demand for faster, more effective, transparent trading delivered in a regulatory compliant manner has encouraged the emergence and acceptance of IP-enabled trading turrets. Incumbent and challenger suppliers alike are utilising new technologies such as hosted cloud based services and content provision and collaboration tools to offer traders, market makers and other capital market professionals a new generation of trading turret solution. In addition, regulatory changes are dramatically increasing the scrutiny that trading is now under. This is particularly true in the complex asset classes that are predominantly traded via voice systems, thus increasing the importance of accountability and the ability to monitor voice traders behaviour from a risk management perspective. Risk ratios ceilings are becoming more stringent, and the time frame for current risk profiles to be calculated are shortening from end-of-day/next morning to intraday and even near-real time. Decision-making in this domain is becoming more important since this market is at a crossroads 1. On the one hand, the number of turret units installed is not growing, but the need for them is not going away. On the other, PBX vendors are increasingly capable to make a serious challenge for at least part of the business currently served by specialist systems. With capital market firms refreshing their trading estate every 7-10 years what does this mean for trading turret system owners? Above all how do they reflect the opportunities of this new technology in developing an investment case and sourcing process to procure these services? Page 3 of 9

2 Background to IP turrets Trading turret, or dealerboard, systems are highend voice telephony platforms designed specifically for capital markets sales and trading. Traditional, non-algorithmic trading relied greatly on trading turrets based upon a type of complex analogue telephony hardware. Turrets have multiple lines connected to them, including dedicated always-on lines to connect to traders most frequent counterparties. A dealerboard system consists of both the front-end turrets sitting on end user desks, and a specialised voice switch in the back-end, handling inbound and outbound connectivity for all the attached turrets. Traditional PBX architectures are typically contended systems, with more desk phones attached to the PBX than phone lines, resulting in phones potentially competing for lines, and some may be forced to wait for connectivity until somebody hangs up. Turret system environments are used constantly throughout the working day, which requires a nonblocking architecture with more lines connected to the voice switch than turrets. Traders have multiple regular phone lines attached to their turrets, as well as so-called private wires, which are always-on connections that require no dialing. The user simply hits a button and starts talking to the counterparty at the other end. Traders typically have a number of these private wires attached to their turret, connecting them with their most frequent interlocutors in the market. Another major difference is the presence of a multi-site, networked intercom capability for intra-company communications in turret systems. Current market size and location In total, there are more than 200,000 turrets servicing the needs of traders, market makers and intermediaries globally. As Ovum 2 observed, despite the growth in automated trading, particularly in cash equities, there are certain types of assets that, due to their complexity or exotic nature, can only be traded by people connected on phones. For these instruments, voice-trading systems will remain critical. Of the current addressable market; 60% is in North America, a further 30% in Europe (with the lion s share in London), and the remaining 10% elsewhere. In capital markets, the market size is affected by the advance of automated trading, which started out in cash equities where it makes up the bulk of the volume in New York and London, but is expanding into other asset classes such as foreign exchange, options, and futures, as well as into new geographies. Ovum 3 has estimated that the refresh cycle for trading turrets varies between seven and ten years, so that even while the total installed base may be at best 200,000 positions, the actual annual market is estimated by different vendors at anywhere from 14,000 to 30,000 positions. However, it has been estimated that only a very small segment of the addressable market, just three hundred or so companies, have more than one hundred trading turret positions per location. An estimate for the annual market value, including capex spend on hardware, professional services, and maintenance fees, is around 300m- 330m. Page 4 of 9

3 Rationale for adopting IP trading turrets There are a number of the change drivers that organisations considering a refresh of their turret estate should consider. Change Driver The wave of new regulations particularly in North America and Europe, the two main regions for turrets usage, is changing business requirements. Compliance and Regulation These regulations impose tougher risk management requirements on market participants. Not only are the ceilings on risk ratios more stringent, but also the time frame in which institutions need to calculate how their current risk profile is shortening from end-of-day/ next morning to intra-day and even near-real time. This is particularly critical for instruments such as asset-backed securities and credit default swaps that were regarded as major contributors to the global financial crisis. Since many of these instruments are too complex to be exchange-traded or even centrally cleared, they remain within the remit of voice trading, making it vital for that area of a firm s business to be as closely monitored for risk policy compliance as any of its automated trading systems. Cloud based services and content The majority of suppliers are using Cloud based services to enable collaboration, increase business agility, reduce costs and provide quicker access to more and richer content. IP transformation has been particularly important for voice communications, which previously required a separate dedicated network, but which is now treated as one more application on a data network, albeit one with particular characteristics in terms of sensitivity to latency and jitter, which negatively impact call quality. VoIP Maturity The market for voice communications for trading floors is no exception, though turrets have started later and taken longer on the journey to full VoIP for several reasons: First, while a number of the back-end voice switches converted to IP in the early 2000s, the protocol that communicated with individual turrets, continued to make use of pre-ip (i.e. TDM) networks. Second and more crucially, turrets have always had a second group of connections alongside the regular dial-tone ones, namely the private wires. Given the criticality of these, there was considerable resistance to trusting such links to IP, because VoIP was viewed as a cheaper, make-do technology, subject to drops in voice quality. SIP The next major technological evolution following the move to IP was the emergence of the Session Initiation Protocol (SIP), a signaling protocol designed in the mid-1990s, and now adopted by most major vendors and considered the de facto IP telephony industry standard. Richer multimedia integration The deeper integration of trader voice, trader video, future channels and support for SIP devices and clients and the potential to flex screen sizes accordingly. Emerging markets agility The need for agility with regard to emerging markets. Using the new IP services, trading operations can be set up in next to no time, and also dismantled substantially faster than traditional voice trading technology. Investment bank Green credentials The green credentials of an investment bank will be greatly enhanced through significant reduction in Data Centre power requirements. Table 1 IP Turret system change drivers Page 5 of 9

Incumbent dedicated platforms The three incumbent suppliers (BT, Orange and IPC) have been expanding their turret systems beyond voice to integrate with other communication media such as instant messaging and teleconferencing, with or without a video component. As part of their drive to add value to their platforms, these turrets have embraced the SIP standard, which enables them to integrate with applications outside of voice. In some cases these are non-voice communications methods such as instant messaging (IM), chat, and social media. In others, it extends beyond this and into compliance and risk management systems or market data delivery mechanisms. Videoconferencing has also been piloted for this purpose. Challenger IP-PBX platforms The three challenger suppliers who are making the most serious challenge within the turret market with their IP-PBX platforms are IP Trade, Wesley Clover and Speakerbus. The use of IP PBXs within capital markets, particularly within smaller trading rooms, seek to lower average costs, so provoking a paradigm shift in pricing. The standard yardstick is the so-called price per position, and anecdotal evidence has indicated that this had dropped in the past last five years, from between 7,500-10,000 to about 2,750-3,750 at start-up, and less for add-on positions once the platform has been installed. The difference in total cost of ownership compared to a traditional system may actually be even greater. System support charges are usually derived as a percentage of a manufacturer s list price, and since an IP PBX is essentially a software-based system, a lot of system changes can be done remotely via software or by the customer themselves. IP trading turret transformation opportunity Hudson & Yorke has identified that the CIOs of Capital Trading firms are facing a range of challenges: IT budgets constrained by tight market circumstances, Total cost of ownership (TCO) needs to be minimised, Return on investment (ROI) in any new infrastructure needs to be accelerated, and Wave of new regulations coming, particularly in North America and Europe. CIOs can take advantage of today s more competitive market to reduce the TCO of their turret system, even if they ultimately decide to stick with their incumbent provider. Central to the attainment of this TCO reduction is effective scenario and sourcing strategy planning. IP trading turrets investment case Investment cases need to reflect different implementation strategies. For example, RBS has outsourced its dealer board solution as part of the deal struck with Accenture in 2009. On the other hand, the Bank of Ireland committed to a more straightforward, hosted turret solution supplied by BT. IP enabled turrets facilitate enhanced market participant engagement through advanced collaboration, increased transparency, effective risk management, and better monitoring of traders. Page 6 of 9

However, the business case should quantify the wider investment case elements that offer business value: Scaling technology up and down as a cloudbased service while allowing full management control, including enhance management information and monitoring Deploying flexible cloud/data centre hybrid configuration options Ease of deployment to new locations and/or trader mobility through cloud solutions Hosted cloud-based service removes single point of failure and multi-tenant capabilities allow multiple bank locations to leverage the system whilst protecting the individual service, regulatory and security requirements of each location Providing more comprehensive business continuity and risk management options through distributed technology Adopting flexible commercial models such as pay-as-you- go based upon a price per position per month Having backwards compatibility across existing communication infrastructure, and enabling a controlled evolution and upgrade Allowing components to be localised thereby minimising voice traffic over the WAN, reducing delays, ensuring local site survivability and hosting of session managers in the cloud Reducing the data centre footprint, less power utilisation as well as non-specialist hardware implementation Leveraging opportunities to integrate with and use existing centralised telephony platforms e.g. call recording, IPT, etc making it easier to involve key people in trades, quantify risk before trade, etc. Leveraging opportunities to consolidate towards a single trading platform Page 7 of 9

4 Conclusion Many capital market firms are expected to face the decision to refresh their existing trading turret estate in the next 7-10 years. This investment decision must be made against a backdrop of new cloud-based technology, SIP protocol adoption and increased regulation change drivers. With the advent of IP-trading turrets, this decision will be more complex than in previous technology refresh cycles; as CIOs must evaluate the size of their estate, the complexity of their trading environments and whether they need a dedicated platform provided by the incumbent providers, or a standard IP-PBX solution provided by a new market entrant. To ensure that increased functionality is delivered in parallel with TCO reduction, good technology and sourcing strategy definition based upon effective scenario planning, followed by a professional sourcing process will be essential. For more information about this report, please contact us on +44 20 7947 4176, email us at enquiries@hudsonyorke.com or visit our website at. References 1.,2.,3. The Future of the Trading Turret Market Will IP PBXs muscle in on turret systems party? Rik Turner, Ovum September 2011 [Reference Code: OI00129-002] Page 8 of 9