Data Management Fuels Front/Middle Office Convergence

Risk management systems have been commonly positioned as part of the middle-office operation because they require integration with front-office trading activities and back-office settlement procedures. However, risk management and regulation have collectively been thrust into key supporting roles within the profit center of the front office. The new trading systems (which continue to evolve daily) are coalescing into a model that compresses the front and middle offices as never before.
Like many of the sea changes happening on Wall Street, the consolidation of the front and middle office stems from the 2008 financial crisis and the tremendous technological advances (ie, unprecedented speed) occurring inside Wall Street trading engines. The result is significant time compression along each and every point of the trading cycle, from pre-trade through execution.
Evolution
The longstanding convention of front and middle offices each having unique agendas, with competing functions, melted in the crucible of the financial crisis when existing risk mitigation mechanisms failed en masse. In fact, change was well underway; the financial crisis merely accelerated what had already begun. The advent of high-frequency trading technology, the failure of several mammoth financial institutions and resulting unprecedented regulatory scrutiny, combined to reset the clock, and recast ideas on how to design trading systems that can process transactions and permit accurate risk accounting from pre-trade to execution to post-trade. This new imperative calls for mission-critical trading and reference data to be increasingly leveraged outside real-time trading parameters in an enterprise-wide information eco-system. This is hastening an end to departmental silos and is also driving investment decisions concerning next-generation platforms.
Pre-Trade Dynamics
When we look at the constituent parts of pre-trade dynamics-pricing, risk monitoring, position keeping and trading-we immediately see where the new rules of the road are setting a new course:
Pricing. Price discovery in a plain-vanilla equities world has been relegated to the least complex challenge. On one hand, technology has made it possible to easily trade in virtually all asset classes, lowered transaction costs and vastly improved price discovery and liquidity. That said, with the majority of equity trading happening electronically, there are fewer designated market makers, leading to faster and lower-margin markets. This is one way by which, seemingly overnight, the risk management and oversight traditionally associated with the middle office has become an imperative in the front office.
Risk Monitoring. The need for speed brings with it a compression of trade cycle functions that is nowhere more prominent than in the area of managing traded capital. Monitoring risk now means accounting for
risk categories and valuations including mark-to-market, value-at-risk, credit risk and counterparty risk.
Position Keeping. Position keeping has become incredibly complex owing to the rapid ascent of multi-asset portfolio trading and sophisticated cross-asset hedging strategies. This is one area where the Dodd-Frank Act has flexed its muscle. The challenge is how to manage things such as liquidity and counterparty risk across a blend of instruments that span high-frequency trading partners and corporate hedges.
Trading. The task of nailing down the right sequence of market, risk and reference data to permit markets to operate at optimal speed without overrunning our capacity to monitor them has become substantially more challenging. The convergence of front and middle office is in many respects very much about the marriage of market data and risk data in ways that will improve risk-adjusted returns.
If the compression of the front and middle office into a unified entity needed a technological coup de grace to ensure its consummation, complex event processing (CEP) is it. With the opportunities to seize fleeting but fertile market opportunities more compelling than ever before, CEP provides real-time visibility into cross-border and cross-asset exposures on a day-to-day basis by performing analytics on high-speed streaming data.
Clearly, the inexorable forces driving the front and middle office together are unprecedented and unstoppable. While bolder headlines dominate the news, we will need to keep our eyes on this unfolding story.

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