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Investment Bank Technology Stack 101Why Grid is essential

by

John Davies

www.Grid.org.il

www.Grid.org.il

Investment Banking 101

• What is an Investment Bank?

• Different businesses within the bank

• Front, Middle & Back Office– 100,000 quotes a second to $500,000,000,000 per day

• Algo/Automated Trading– Where µ-seconds count

• Applications, Messaging & Integration

• Summary

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What do banks do?

• Very simple, banks make money– The old saying Money makes money is true

• Investment banks will trade almost anything as long as the amounts are worthwhile– Metals (Gold, Aluminium etc.)– Currencies (USD, GBP, EUR etc.)– Bonds (Government etc.)– Equities (MSFT, APLE etc.)– Commodities (rice, paper etc.)

• They also trade complex combinations of the above– Futures & Options– Derivatives

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Silos and Front / Middle / Back

• Generally banks are very silo’d, we call these silos “Lines of Business” or LoBs– F&O (Futures and Options)– EQD (Equity Derivatives)– FI (Fixed Income)– FX (Foreign Exchange)– OTC (Over The Counter)

• Each LoB has a front, middle and back office

• Depending on the instrument being traded the Front Office is very different

• The Middle Office is more similar but still differs across LoBs

• The Back Office is more similar and often a shared resource

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LoBs and Front / Middle / Back Office

• An Investment Bank in a nutshell– albeit a very rectangular nutshell

F&O FX FI OTC EQD

Front Office

Middle Office

Back Office

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How does it work then?

www.Grid.org.ilThe Dealing Room

• Simplistically the trade starts from the front office

• Welcome to the dealing room, hundreds and sometimes thousands of traders– This is the realm of the Microsoft desktop (for now)

www.Grid.org.ilThe Front Office

• The trader watches his screens (all 8 of them)

• Sees something interesting…

• And tries to trade it

www.Grid.org.ilWho’s at the other end?

•It’s exactly the same on the other side–It could be down the street–Or half way around the world

•Banking is a global business

•Before either side can start to trade, there are a few things they need to know…–Does the deal make sense?–Is it a good price?–What if we buy and the market crashes?–Can we make money from this?

www.Grid.org.ilWhat’s happening?

• The trader needs information about the bank’s “position” on the accounts he’s trading– How much of each commodity (e.g. currency, stock etc.) do the bank

own or will they own at any date in the future?

• He also needs to understand the “risk” associated with the trade– How reliable (i.e. what is the rating) of the corresponding

broker/bank?– How reliable is the exchange that’s trading the commodity?– How reliable is the country e.g. stability, laws, bureaucracy,

jurisdiction

• All this information is calculated be the middle office and provided, usually in real-time to the trader– Hence the large amount of screens

• This is what the middle office does

www.Grid.org.ilAn example

• Our client receives $60 million cash from a recent acquisition and wants it in New Israeli Shekel (NIS) in one year

– Do we change today or at the end of the year?

• Today $1 buys NIS 4.32650– At this rate $60 million today would get NIS 259,590,000

• USD interest rate is 5.43%, Shekel is 3.75%

• After one year– If we keep USD we’ll have $ 63.258 million ($8,926 per day!)– In NIS (if we convert today) we’ll have $ 62.25 million (at today’s rate)– A loss of just over $ 1million if the exchange rate doesn’t move

• What if USD/NIS moves from 4.32650 to 3.90210 (best in last 52 weeks)– Our NIS would be worth $69,020,431.3 (a profit of $ 5.76 million ), not bad!

– What would you do?

www.Grid.org.ilBig money

• One bank might offer 4.32650, another 4.32850– (This was the change as I did the calculations on the last page)– The difference is worth $ 27,723 (am I in the wrong job?)– Do we wait, what if it goes the other way?

• If the interest rates vary, we have the same issues

• In our example $60 million is an average amount in FX– Arbitrage trading trades on the differences above but with amounts

hitting over $1 billion

• Example bank A will buy at 4.3265 and bank B will sell at 4.3266– With $ 1 billion we can make $23,112.84 in under a second

www.Grid.org.ilThe Middle Office

• The job of the middle office is essentially accounting, positionkeeping and risk management

• In terms of number of applications and complexity, mathematically and algorithmically speaking, this is where it all happens

• The vast majority of banks run Java on Linux and Solaris– Many calculation engines are C or C++, some argue naively for

performance but it’s usually just legacy– PERL is a common sight, other languages are rare– Windows is very rare other than desktop workstations however some

“RAD” VB-based apps slip through from time to time– AIX and HP-UX feature strongly in a few banks

www.Grid.org.ilAutomated / Algorithmic trading

• Many of the traders are simply watching graphs and numbers looking for an opportunity

• This can be, and is, done automatically

• These engines watch market trends and trade automatically

• The risk of something going wrong is increased, millions could be lost in seconds– Clever algo-trading designers look for glitches and accidental errors

to take advantage of• It’s like programming a hacking engine, i.e. great fun

– Companies can be made bankrupt in seconds

• Grid is not just important, it’s VITAL for survival– What else can you run flexible “what if” scenarios on several

thousand commodities a second?

www.Grid.org.ilThe Latency speed limit

• The speeds are incredible, trades can be executed in millisecondtimescales– Obviously supporting applications need to reflect a similar level of

performance– Latency is critical– If one engine can execute in 10ms you need an engine faster than

10ms and/or better algorithms to make ANY money at all– Many engines are situated physically close to the exchange to reduce

the speed-of-light times

• 1 billion km/h!– Light in a vacuum travels at 299,792,458 m/s or 300 km/ms– Tel Aviv to New York is 9,000 km, about 60ms round trip (best case)– .. and there’s not much vacuum between Tel Aviv and New York– We can’t afford 60ms!

www.Grid.org.ilThe Back Office

• Settlement is the final part of the trade’s active life

• This is usually an aggregation of the day’s transactions in one payment to each account in each bank

• Amounts can be huge, it is not unusual to see $ multi-billion movements in settlements– This is the realm of SWIFT messaging

• Front Office, Middle Office and Back Office are VERY different businesses– They rarely talk to each other– Often in separate buildings– Totally separate management structure– Very different needs…

www.Grid.org.ilFront / Middle / Back

• Front Office– Very high volume ( 1000 - 100,000 / sec), usually simple messages– Latency is critical (< 1ms)– FIX, ASN1, IIOP are most common payloads– Light-weight XML only (if any)

• Middle Office– Volumes are high (up to 1000 / sec), very complex messages– Calculations are complex and grid/HPC is usually requires– FpML, Murex, SwapsWire, CSVs are most common formats– XML widely used but usually over MQ & JMS

• Back Office– Low volume (100-1000 per hour)– Very high value messages, strict compliance and validation– Proprietary networks, mostly SWIFT

www.Grid.org.ilThank you!

תודהYou now know the basics of

Investment Banking

Any Questions?