Real-Time Risk. Aldridge Irene

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      Irene Aldridge

      Real-Time Risk

      Real-Time Risk

       What Investors Should Know About FinTech, High-Frequency Trading, and Flash Crashes

      IRENE ALDRIDGE AND STEVE KRAWCIW

      Copyright © 2017 by Irene Aldridge and Steve Krawciw. All rights reserved.

      Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

      Published simultaneously in Canada.

      All cartoons © Irene Aldridge.

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       Library of Congress Cataloging-in-Publication Data is available:

      ISBN 9781119318965 (Hardcover)

      ISBN 9781119319061 (ePDF)

      ISBN 9781119319047 (ePub)

      Cover Design: Wiley

      Cover Image: © PM Images/Getty Images

To Henry and Rosalind

      Acknowledgments

      We would like to thank our intrepid editor Bill Falloon, and the great production team: Judy Howarth, Cheryl Ferguson, Sharmila Srinivasan, and Michael Henton for great cover design.

      CHAPTER 1

      Silicon Valley Is Coming!

      Knock‐knock.

      – Who is there?

      – Bot.

      – Bot who?

      – Bot and sold, it's a stat‐arb world.

      Do you wonder why the markets have changed so much? Where's it all heading? How will it affect you? You are not alone. Today's markets are very different from what they used to be. Technological advances morphed computers and infrastructure. Changes in regulation allowed dozens of exchanges to coexist side by side. The global nature of business has ushered in round‐the‐clock deal making. All of this has created stratospheric volumes of data. The risks that come along with automated trading in real‐time are numerous. Now, the inferences from these data allow us to go to previously untapped depths of markets and discover problems and solutions that could not even be imagined 20 years ago.

      Do you remember Bloomberg terminals? If so, you are reading this book not so long after it was written. JP Morgan's January 2016 announcement “to pull the plug” on thousands and thousands of Bloomberg terminals is a leading example of the sweeping disruption facing investment managers. Billion‐dollar hedge fund Citadel followed suit on August 16, 2016, by announcing that it was taking on Symphony messaging as Bloomberg's replacement. Symphony, who? Many still struggle to wrap their head around the situation, with social media platforms like LinkedIn buzzing with discussions about pulling the plug on traditional sources of market data. Yet, here is fact: The competition is not sleeping, but working hard. And now, the competition is so strong that Bloomberg, Thomson Reuters, and others may end up in significant financial peril if they ignore fintech. Is your company also oblivious to changes in innovation?

      The unfortunate truth is that many established firms are completely unprepared for the fast train of innovation currently passing them by. Old, manual procedures may have been fine in the past, but with innovation sweeping through, risk management executives have to be ready to see established operating models and platforms go out the door as newer, untried approaches take their place.

      Consider the investment advisory industry. Reliance on charming brokers to seduce ever‐dwindling pools of clients into paying for their commissions and overhead expenses remains the business model for some firms. At the same time, a number of well‐established startups deliver cutting‐edge portfolio‐management advice to investors right over the Internet, with some charging as little as $9.95 per month.

      Global banks like Barclay's and Credit Suisse have exited the US wealth management arena while at the same time hundreds of millions of dollars in venture funding have been channeled to fintech startups working to streamline financial advice and beyond.

      The bet has been wagered that new innovative and cost‐efficient business models are here to stay. Innovation can take the form of a completely new approach to conducting business or through advances in the information used for the existing way of conducting business. As an illustration, while many finance professionals are still debating market structure and whether a new exchange will help people avoid high‐frequency traders, companies like AbleMarkets deliver a streaming map of high‐frequency trading activity directly to subscribers' desktops, leaving nothing to chance and helping to significantly improve trading performance across all markets. Similar innovations are going on in insurance, risk management, and other aspects of financial services, and firms that are not up to par on what's going on are at a significant risk of failure.

      EVERYONE IS INTO FINTECH

      Have you ever missed opportunities in the markets because you felt you were disrupted? We have been in a unique and fortunate position to be immersed in the heart of fintech innovation and to observe first‐hand the extent of what is becoming a true disruption to businesses that, in turn, disrupted financial markets in the late 1970s and 1980s. Think of this as Finance 3.0. The possibilities are endless, and the new players are already embedded in most facets of traditional finance. These new players are not boiler rooms – most founders have advanced degrees and the most recent scientific innovations at their fingertips.

      According to the Conference Board, investment in financial technology, trendily abbreviated into fintech, grew by 201 percent in 2014 around the world. In comparison, overall venture capital investments have only grown by 63 percent. The digital revolution is well underway for banks, asset managers, and