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One client, two systems
Order management systems providers can handle advances like algorithmic trading. But are they forgetting their original mission?
Over the past two decades, order management systems have transformed the front-office operations of asset managers by eliminating much of the paperwork their stock trades generated. The mid-1980s invention of OMS by Seth Merrin, then a young arbitrage trader at Oppenheimer & Co., spawned a small but intensely competitive software sector that has played a key role in the securities industry's drive toward total automation of trading processes -- what is now known as straight- through processing.
Today, however, institutional trading is a very different business from the one that order management systems were initially designed to serve, and the companies that buy-side firms depend on for the latest in OMS technology find themselves at a crossroads.
Competition among these specialist vendors is fiercer than ever. About a dozen companies -- among them privately held boutiques Charles River Development, Eze Castle Software, LatentZero and Macgregor; investment systems giants Advent Software and SunGard Data Systems; and the Bloomberg and Reuters Group trading networks -- are fighting for a U.S. revenue pool that, according to Boston-based research firm Celent Communications, totaled just $90 million last year.
At the same time, these rivals must hustle to keep their systems current with the latest advances in algorithmic and program trading -- innovations that sell-side brokerages are pushing ever more aggressively while their buy-side clients concentrate increasingly on controlling their trades and associated costs.
"It's the most hypercompetitive vendor solutions market that I see," says Daniel Houlihan, who heads the Boston office of London-based investment management consulting firm Citisoft. "These companies have been making unprecedented investments to support all the changes that the trading business is going through. Whether the firms' middle and back offices can keep up with all those changes is another question."
OMS providers find themselves having to build in more advanced functionality -- going beyond basic order-entry and order-tracking tools to include transaction cost analysis and other computational features -- for budget-constrained clients on the buy side that are none too willing to boost their technology spending. In October, when St. Louisbased investment adviser Kennedy Capital Management replaced an Advent Software OMS with one from San Diegobased Indata, the decision was all about costs. "Indata offered the most comprehensive set of capabilities for the money," says Kennedy head trader John Laux.
"We look at functionality first, then pricing," adds Scott Atwell, manager of Financial Information Exchange (FIX) trading and connectivity at American Century Investments in Kansas City, Missouri, which has chosen the Bloomberg Portfolio Order Management System for fixed-income and LatentZero's Minerva for equities.
If pricing pressure is so intense, how can these technology companies generate the added revenues they need for systems enhancements and upgrades? Merrin, who now runs New Yorkbased alternative trading system Liquidnet, worries that they can't. "To support OMS properly, a typical vendor needs a revenue base that's probably five times what it has."
Vendors say they are coping -- up to a point. Thomas Driscoll, vice president of sales and marketing at Charles River in Burlington, Massachusetts, points out that the current version of his firm's Investment Management System "has over 1,000 product enhancements, and our Version Eight [due this quarter] will have even more," such as improved settlement capabilities with the TradeWeb fixed-income market and the Omgeo posttrade-processing network. Still, Charles River wasn't able to do everything it had on the drawing board: It decided, for example, to delay some tax and portfolio optimization tools for later release.
The industry doesn't lack growth opportunities. Celent projects that annual OMS revenues will climb 87 percent, to $168 million, by 2007 -- though that's a tiny fraction of the $25 billion the U.S. securities industry spends each year on technology, out of a global total of more than $70 billion.
Citisoft's Houlihan estimates that about 2,000 U.S. asset managers have order management systems. That leaves some 7,000 yet to be sold on the idea. No one is counting on a rapid take-up, however; many firms are small and still prefer to use telephones and faxes rather than invest in OMS and other components of straight-through processing.
Hedge funds are more realistic near-term prospects, though few are big enough to be likely buyers: Only 120 of the estimated 7,000 funds have more than $500 million in assets, according to Needham, Massachusettsbased research firm TowerGroup. Eze Castle, which is based in Boston and part-owned by leading prime brokerage Goldman, Sachs & Co., is tops in this segment, with 175 client firms, according to the software company's president, David Quinlan. It's being challenged by, among others, the French firm Linedata, which has struck a deal to integrate its LongView Trading OMS with UBS's prime brokerage; and San Francisco's Advent, which has tailored the latest version of its Moxy OMS, released in September, specifically for hedge funds.
Rather than wait for more institutions to come calling, OMS companies have begun working more closely with the sell side. Connectivity to brokerages has always been a critical piece of the OMS offering, and the vendors have taken that capability up a notch to accommodate algorithmic trading. For instance, LatentZero, which has dual headquarters in Boston and London and has sold its Minerva OMS to State Street Global Advisors and other top asset management firms, said in a corporate statement last month that its customers had access to nine leading algorithmic platforms, including those of Bank of America Securities, Citigroup, Credit Suisse First Boston and Goldman Sachs.
In some cases, moreover, OMS vendors are collecting revenues from the sell side to compensate for their additional work. It's a small but growing stream: Charles River, which like most of its competitors doesn't disclose earnings, says that fees from brokerages, such as connectivity charges, account for less than 5 percent of its revenue.
Although any incremental revenues should be good for the OMS industry's health, some critics warn that if the vendors become too close to or dependent on the sell side, their principal customers -- the asset managers -- may get short shrift.
Celent analyst Denise Valentine sees the makings of an identity crisis for OMS providers. "Their desire to increase both market share and profitability may encourage vendors to drift away from their core competency," she says.
Liquidnet's Merrin agrees that the question of whose interests the OMS developers are serving is a critical one, especially at a time when the relationship between the buy side and sell side is in a state of flux. "It gets dicey if you're forced to serve two masters," he asserts. "You have to figure out who the customer is and really focus on servicing that customer."
Daniel Watkins, LatentZero's CEO for North America, acknowledges that his industry is being pulled in more than one direction. However, he accepts it as a normal evolution to which OMS vendors and the securities industry as a whole are adjusting. "All of this is part of the changing face of trading between buy and sell sides," he says.
Even as LatentZero and its competitors work more closely with the sell side, Watkins says he is confident that "our [buy-side] clients will continue to exercise a very high degree of influence."
David Csiki, head of Indata, which supplies software to small and medium-size investment management firms, isn't troubled by the closer brokerage ties. He believes they could raise the level of cooperation between sometimes-feuding constituencies. "It's not often that a one-sided industry initiative in a two-sided industry would be successful," he says, citing the FIX messaging protocol as an example of a mutually beneficial technology improvement.
Vendors are simply trying to adapt to a new OMS order by staking out a middle ground, albeit a shifting one.
"Two masters is too strong a description," argues Linedata COO Jack Wiener. "At the end of the day, it is still the portfolio managers or traders at the buy-side firms who are deciding which OMS they want. We need to work together [with dealers] so that our mutual clients gain the best set of tools to do their investment management."