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Automated dealing

Internet-enabled trading systems are a major innovation in the way financial markets are traded


Using the internet as a low-cost communication channel between the bank and its corporate customers and branches will prove to be as much of a revolution as the introduction of automated dealing over the last decade.

Further, this revolution is set to occur in the way the markets are traded as well as the way that banks organise their businesses internally. Behind the Euro and Y2K headlines, there have been great changes taking place in the automated global trading market. EBS and Reuters, which were the first companies to put automated FX matching services on the interbank desk, have changed the way traders trade and the way the interbank market functions. I expect the evolution of electronic trading by utilising Internet technologies will have a greater impact on the traditional corporate trading model says Debbie Fuller, of Cognotec, who have been producing automated trading systems for the foreign exchange and money markets for ten years. It is now accepted by the banking community that automated trading brings reduced costs as computing power replaces human effort, reduced levels of errors and enhanced level of connectivity between the treasury department with its internal and external customers.

However, automated dealing changed the way the interbank market functioned as well as the way that dealers did their jobs. Today, the convergence of the most cutting edge automated dealing technology and the data-delivery capacity of the Internet will do the same for the way banks access their client base - and the operation of the market as a whole.

The most important immediate effect of using Internet-based technology is to lower the cost of entry to the market. The expense involved, errors and volume constraints have hitherto hampered the development of automating dealing for many smaller banks - especially in relation to their client and branch-related activities. As a result, client dealing functions have not been fully integrated into the banks’ broader transaction environment. Consequently, efficient information gathering for client and risk management purposes, and the establishment of enterprise-wide straight through processing have been difficult to implement.

This conundrum can be solved - at a price. Many larger institutions have made the technology investment necessary to take as much human intervention as possible out of client and branch dealing transactions. One solution they have used is Cognotec's AutoDeal. AutoDeal has been successfully established as an industry standard in the provision of automated dealing technology and is in use by banks like UBS, Royal Bank of Canada and Lloyds Bank.

But AutoDeal, like its competitors, requires the installation of both hard and software on site as well as the payment of an up-front license fee and annual maintenance charge. This meant that the benefits of automation were mainly confined to larger organisations. However, the Internet allows the cost of automating to be radically reduced. A new version of the service, AutoDeal LITE, is maintained by Cognotec on a central server.

The bank has its own service on the server which is branded with the bank’s corporate identity. The bank's customers and dealers access the bank's site on the AutoDeal LITE server as if accessing the bank itself - the service therefore appears seamless to users at both ends. Instead of an up-front fee, the bank pays a monthly maintenance fee and a 'per deal' transaction charge. All requests from the bank's clients are automatically checked by the system. The request is compared against the client and currency limits set by the bank. Any request which fails a limit is automatically routed to a dealer for authorisation and pricing. If the limits are not exceeded, the rates requested can be generated automatically or referenced to a dealer who can review the price before quotation. On the client’s acceptance of the rate a unique deal number is generated and an electronic deal ticket generated which interfaces with the banks internal systems. The 'per deal' transaction fee means that the cost of using the service is directly related to the volume of business which the bank has. As the service is fully automated, the bank can transact many more deals without increasing its sales staff. One bank using the service was recently able to close one sales office and merge two others, while enjoying higher volumes of business.

The key to AutoDeal LITE's cost effectiveness is the harnessing of Internet technologies with the highest levels of security. It is now acceptable to execute millions of dollars worth of business over the internet because security standards are now so evolved. Digital certificates, encryption techniques and intranet and extranet network options have made the Internet a viable delivery channel for dealing business,asserts Fuller.

The issue of how 'safe' the Internet is has needlessly held back some organisations from fully-exploiting its capabilities as a low-cost communications channel. These concerns are natural. The concept of proof of identity is one of the pillars upon which organised society was built. Verification of identity is particularly vital in the area of commerce because it creates a foundation for reliable, trustworthy communication between buyer and seller. These principles are no less important in Internet-based transactions - where deals previously made in person are now occurring on-line.

Secure digital identification is one solution which is reliable, easily obtained and easy-to-use. Cognotec uses VeriSign, widely regarded as the world's leading Certification Authority in the Internet arena, to ensure secure access to the AutDeal LITE service. VeriSign is also the worlds most widely used security standard. For Internet-based transactions VeriSign digital certificates provide bank-level security in a number of ways. These include:

n Allowing each party to be confident of the other's identity - this applies to individual users, organisations, and providers of software and content.

n Verifying message and content integrity - a message, document, software program or content file digitally “signed” and validated with VeriSign Digital ID technology means it has not been wilfully or accidentally corrupted since it was initially signed.

n Ensuring privacy: - VeriSign Digital Ids work in conjunction with public-key encryption to encrypt a message for specific recipients.

The security package used by AutoDeal LITE comprises a global server ID - a secure sockets layer between the client's browser and the AutoDeal LITE server. This provides server authentication (that the bank's site is actually owned by the bank), client identification and data encryption. It also uses digital Certificates which the user bank issues to authenticated clients. In subsequent communications, the Certificate guarantees to the bank that the client is who they are claiming to be.

Now that security concerns have been addressed, all market participants can enjoy the internal efficiencies internet-based trading offers. A further benefit to some banks, particularly early-adopters, will be the access provided to new markets. One element of the internet-based trading system which is destined to have a considerable impact on market participants is 'liquidity Linq'.

In the current market environment of tight spreads allied with declining liquidity, a trading process which allows greater price predictability and lowers market risk is to be welcomed. Liquidity Linq achieves this by allowing banks who nominate themselves to be price makers, or liquidity providers, to make a market to other AutoDeal LITE banks. Thus price takers can offer a broader range of currency to their customers and branches without assuming market risk. However, there is no element of compulsion - each bank decides on the counterparties with which it wants to deal.

From the price makers' point of view, Liquidity Linq allows the bank to increase its market penetration by leveraging its local market knowledge and offering this expertise to other AutoDeal LITE users. The counterparty pairing is also automated through the browser-based service, saving time to both sides of the deal. It also provides a method of offsetting the market risk the price maker might be assuming in other areas of its trading activities.

From the price takers point of view, they can quote a rate to their client safe in the knowledge that the price quoted by the market maker won't change before the price taker is ready to transact the deal. This is achieved by significantly speeding up the trading process. Thus the risk assumed by the price taker is reduced and the price taker's margin is instantly more predictable. As a result, the price taker can refocus its sales technique toward enhanced customer service and more complex risk management.

Further, the price taker can use AutoDeal LITEs intelligent pricing engine to automatically quote a price to their client using the parameters specific to that client. However, again there is no compulsion, as at all stages of a trade a dealer can intervene if preferred.

Liquidity Linq will prove to be an effective market tool enabling high-volume transactions with minimal impact on short-term market prices. Not only is the quote to the end-user significantly speeded up, and therefore the banks potential turnover of business greatly enhanced, but both sides of the deal - the price maker and the price taker - are both sure of transacting their trade at the price agreed.

Internet-based trading will prove to be a significant market advantage for banks dealing in low-liquidity, high volume conditions which characterise the leading European currencies. Overall it is an example of how internet-enabled technologies - when allied with market experience and a high level of security - can enhance a bank's competitive position and broaden its universe of available currency markets and trading partners.

Brian Maccaba



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