Artificial intelligence-backed trading is coming for the world’s interdealer brokers. It is going to drive prices down to a point that will likely render much of what remains of this industry unprofitable.
“Our offer has to bring costs down by at least 50% when we enter traditional markets,” said Jos Evans, founder of London-based AiX, which has just introduced the world’s first interdealer trades done via chatbot.
AiX achieved this in the world of cryptocurrencies, not traditional commodities derivatives or other niche areas where interbroker dealers thrive. AiX is still testing its chatbots, settlement infrastructure and other technologies. But Evans said the firm should be ready to enter traditional markets in the second half this year.
Not long ago, just six years back, interdealer brokering was a glamorous gig, mostly young guys wining and dining clients – themselves even younger hotshots at investment banks, broker-dealers, and other large financial institutions. Trips to the grand prix or a ski chalet were common perks, and the men at the very top got massively wealthy. The work could be interesting, digging around for juicy trading ideas, or it could be a lot of “relationship building” flimflam, with its usual nightlife accoutrements.
We have now aggregated human and digital liquidityJos Evans, AiX
Whether this was actually of value to the large financial institutions relying on these middlemen is increasingly debatable. Interdealer brokers cater to institutions in spaces where there is no formal exchange or market-maker system. Everything is over the counter, dealing in large blocks of often-illiquid securities, and therefore specialized and manual. Relationships have remained more important than electronic platforms.
These interdealer brokers came to dominate important niches, particularly in fixed income, where these players were the only recourse for interest-rate derivatives on the less liquid parts of the credit and commodity derivatives markets. Post GFC, investment banks reduced their balance sheet commitment to secondary markets in bonds, giving interdealer brokers a new lease on life.
But the post-2008 reality was also about transparency, efficiency, and regulation, not to mention reduced demand among many financial institutions. Many parts of the market that were once OTC have been commoditized and are now cleared (in what is called the futures market). This has been a gradual process, but two years ago commodity derivatives became the last type of contract to move to a clearing model.
The value-add for interdealer brokers began to disappear, so scale became critical, and those that could not scale came to rely more on exotic structures to defend their margin.
We need to ensure the linguistic kinks are worked outJos Evans, AiX
This has led to massive consolidation among interdealer brokers into a handful of giants such as TP ICAP, BGC, and Tradition, along with a handful of specialists in areas such as forex (GFI) and equity derivatives (Sunrise Brokers, Square Global Markets).
From crypto to traditional and back again
Evans launched AiX in 2017 with the view that the industry was ripe for technological disruption. Back then, he told DigFin that the company was preparing to raise up to $200 million via an initial coin offering, to build its vision of trading powered by artificial intelligence and blockchain.
The firm didn’t pull the trigger on the ICO when it couldn’t get explicit approval from British securities regulators, and at a time when the U.S. Securities and Exchange Commission was cracking down on perceived crypto trespasses.
“Doing an ICO wasn’t worth the future risk to the business,” Evans said. Since then the company has raised $8 million in seed and Series A funding – a far cry from its initial goals, but enough to maintain a team of 35 staff, of which 26 are programmers and engineers. (The firm has not disclosed its backers.)
The concept of being an A.I. broker hasn’t changed, but the team found that its easiest test case was cryptocurrencies, whose present-day inefficiencies look a lot like the commodity derivatives space just a few years ago.
Even so, it’s taken two years to develop a matching engine to automate price discovery, the chatbots to handle negotiation, execution, and settlement.
The hardest part was settlement. In the derivatives world, brokers settle contracts at a venue such as Chicago Mercantile Exchange or Singapore Stock Exchange. That clearing-house function doesn’t exist in crypto, where brokers and exchanges blur. Automating this took extra time.
“We now have aggregated digital and human liquidity, but it took ages to put in place,” Evans said.
You can swear at it, but the system won’t swear at youJos Evans, AiX
In the first week of February, AiX made its first completely automated negotiated trade, a bitcoin/USD transaction between two crypto brokers, GSR Markets and DV Chain. The trade was settled through Zero Hash, an affiliation of Chicago-based digital assets firm Seed CX. Zero Hash offers a fully regulated post-trade infrastructure in the U.S.
“Once we’ve proved and refined the concept, we will step into the traditional, regulated space,” Evans said. “The goal has always been the same: to have clients trade any asset on the system, 24/7.”
The most visible aspect of AiX’s service is the natural-language processing for its chatbots. Users won’t be speaking with a human trader. Instead they will have a conversation with a chatbot. The service is now available via Telegram and Symphony, with user IDs leading to regulated KYC steps that open an institutional portal, where they can search for AiX.
The chatbot can chase multi-party bids and offers, and negotiate prices. Right now the system is still basic, but AiX is working to make the chatbot capable of complicated discussions around complex derivative structures.
More, AiX expects its bots to be proactive with customers, and come up with trading ideas based on historical data comparisons, backtesting, and current market conditions – similar to what a human trader provides. It can even assimilate news feeds into trading ideas.
This is easy for vanilla products, but the bot isn’t ready for prime time – yet. “We need to ensure the linguistic kinks are worked out,” Evans said.
How authentic is the bot? DigFin asks if it will replicate the usual language of traders. Will it drop the F-bomb? Evans said, “You can swear at it. But the system won’t swear at you.” Perhaps an opt-in feature for the nostalgic?
The future of interdealer broking
AiX is tiny and new, and up against an oligarchy of big players with longstanding relationships and track records. Moreover, some of its competitors are tech-savvy. TC ICAP acquired NEX, a big vendor of data solutions to hedge funds and other institutions, and also makes money selling data to Refinitiv. The company was itself acquired in 2018 by CME.
AiX will need to offer compelling cost reductions. In crypto pairs, the firm is charging 5bp per side, with variations among markets. Evans didn’t comment on specific pricing for regulated derivatives markets, other than to say AiX must be at least 50% cheaper than a traditional interdealer broker.
Is there a future for interdealer brokers? The answer is yes, but it’s a small one. The big firms like ICAP have already responded to declining volumes by diversifying into buy-side trading, data, and settlement services. Evans says there will always be a niche for good human traders who are in the loop in a given industry. Derivatives are regulated, and so there is always market color to provide, particularly around information that isn’t found on a Bloomberg or Reuters news feed.
The AiX team celebrated the first A.I.-driven trade with a bottle of champagne. But in this tech-driven future, it’s the chatbots that are going to have the most fun.