AIBC 2022 Research
An Introduction to Sales & Trading (S&T)
By Glen (Geonwoo) Lee:
Aimed at those interested in a summarised and broad overview of the sales and trading division, the article provides an overview of what the division is, the types of trading, the main products traded, and the industry’s recent trends and outlook.
What is Sales and Trading (S&T)?
The Sales and Trading division, sometimes also known as the Global Markets division (depending on the bank), works closely with the investment banking division to advise and facilitate the purchase of securities between institutional clients. These clients include hedge funds, asset managers, pension funds, and mutual funds.
As its name suggests, the division comprises two sides: the sales side and the trading side. The sales side is mainly responsible for building relationships with the banks’ clients and pitching ideas and opportunities to them. Meanwhile, the trading side consists of traders who execute the orders and advise clients on when to enter and exit their financial positions.
Function of the Sales Side
Salespeople at an investment bank communicate directly with clients to deliver information about various securities. Specifically, they serve clients in three main ways: (i) salesperson reaches out to clients with trade ideas that correspond to clients’ strategy (ii) clients contact salesperson for advice on what to best put based on their market views (iii) clients know the exact trade they want to execute and contact a salesperson for a quote. While doing so, sales personnel closely monitor investment news such as quarterly earnings reports and M&A information to pitch investment opportunities to their clients.
Furthermore, when an investment bank undertakes initial public offerings (IPOs) for a firm, the sales side commits to selling a specified number of shares with a set minimum price. In this process, sales personnel take underwriting and the responsibility of selling the required number of shares to institutional or individual investors. On this note, salespeople continue to develop relationships with potential securities buyers to efficiently sell securities. While maintaining such relationships, sales personnel also work and negotiate with the traders to execute orders at desired prices.
Function of the Trading Side
Traders execute a trade of security either on behalf of their investment firm or their clients. Before making trades on behalf of their clients, traders quote bids and ask prices to clients; they provide clients with an attractive price, yet within range for traders to manage their risks and capital. Traders make a profit as they receive commissions and purchase securities at a lower price than the price quoted. It is also important to note that traders use different types of trading techniques and specialize in different financial products such as fixed-income securities, equities, commodities, foreign exchange, or derivatives.
2 Types of Trading
Within the trading side, there are two main types of trade:
(i) Flow Trading
Flow traders can simultaneously make trades on behalf of the clients and behalf of the investment firm. For instance, when the client wishes to purchase a stock that the investment firm holds, the flow trader would make use of this opportunity to offer a profitable price to generate profit for the investment firm.
Flow traders generate profit from the difference in the bid-ask spread: the difference in the price at which trader purchases securities (bid-price) and the price they are selling (ask-price). While making such a bid-ask spread, it is the responsibility of the flow trader to limit market risk and provide an attractive bid-ask spread compared to competing banks.
(ii) Agency Trading
agency traders merely execute orders on behalf of the client. When traders execute an order on the behalf of institutional clients, it is often the case that the order is in large volumes. Hence, they must strategically spread out their orders to purchase the desired number of shares at a favorable price without having their buys increase the price too much.
※ Previously, proprietary trading (executing trades on behalf of the financial firm with the firm’s securities) was considered as one of the trading types. However, in 2015, Volcker Rule was set in place as it was deemed that investments such as proprietary trading contributed to the 2008 financial crisis. Since then, to discourage banks from taking too much risk, investment banks are prohibited from engaging in proprietary trading.
5 Types of Trading Products
As mentioned earlier, traders specialize in specific financial products. Some of these include fixed-income securities, equities, commodities, foreign exchange, and derivatives.
(i) Fixed-income securities
Fixed income securities provide returns to investors in the form of periodic payments and/or repayment of principal at maturity. For instance, fixed-income securities include government bonds, corporate bonds, and other debt-related instruments. Furthermore, traders may specialize in trading securities with specific maturity ranges such as trading bonds with a maturity of 10 years or less. Since bond yields are directly impacted by interest rates, those who trade fixed-income securities closely monitor central banks’ action on interest rates.
Trading equities, which are securities that represent the ownership of companies, involves the analysis of individual companies through various financial metrics such as price-to-earnings (P/E) ratio, debt ratio, or discounted cash flow (DCF) analysis, and could involve transactions in both stocks and other equity-related products, such as convertible securities, futures, and options.
Any physical goods that can be bought or sold in the commodity market are considered commodities. They can be classified into four broad categories: metal, energy, livestock and meat, and agricultural. The most commonly known metal commodities include gold and silver, and energy commodities include oil and gas. Within each basic category, traders may also specialize in a specific market such as palladium futures or cotton futures. Many commodities trades occur in the form of derivative products and can take two forms of contracts: spot contracts, which trade at a fixed price for immediate payment and delivery, and futures contracts, which agree to transact at a fixed price at a later date.
(iv) Foreign Exchange (FX)
Currency is the most liquid asset market as the forex exchange market allows trading 5 days per week, 24 hours a day. Currency pairs have base and quote currencies, for instance, “GBP/USD” would indicate GBP is the base currency and USD is the quote currency. This ratio shows how much of the quote currency is needed to purchase one unit of the base currency. For example, GBP/USD= 1.3 would mean that 1 GBP equals $1.3USD. While it is the largest market in the world, only a small number (~20) of currency pairs make up the majority of the volume and activity of the market.
Derivatives are financial contracts made between two or more parties that derive values from underlying assets or groups of assets. Underlying assets include the aforementioned trading products: fixed-income securities, equities, commodities, and foreign exchange. Such derivatives from underlying assets have not only blurred the lines between trading products but also expanded the trading categories. For instance, futures contracts, swaps, forwards, and options are all in the subset of derivatives.
Key Trends in S&T
1. Increased use of algorithmic trading systems
Algorithmic trading, also known as automated trading or algorithmic trading, uses a computer program that follows a set of algorithms when making trades. The algorithm itself may include various factors such as timing, price, quantity, or any mathematical model to make decisions on trades. For instance, high-frequency algorithmic trading has gained significant attention for its ability to make trade orders at high speeds – milliseconds or even microseconds – and high frequency.
With reduced manual errors and automated checks, an increasing number of banks have adopted algorithmic trading systems. In the global FX market, algorithmic trading makes up to a fifth of all trading and 70 percent of all orders placed on multi-dealer currency platform EBS. For instance, UBS has been using its algorithmic trading system ORCA-direct in the FX market. Other investment banks such as Credit Suisse use Advanced Execution Services (AES), J.P. Morgan uses Aqua, and Bank of America uses Instinct FX, effectively incorporating an algorithmic trading system into their respective trading division. In 2020, more than 40% of the financial FX traders employed algorithmic trading and it is expected that the usage of FX algorithms will continue to increase.
Despite the benefits and increased usage, there are concerns regarding the potential operational failures of technological systems. For instance, between 2010 and 2014, Latour Trading, a high-frequency proprietary trading firm, erroneously allowed millions of orders amounting to approximately $116billion due to the errors in their codes and routing logic. Such an order violated the U.S. Securities and Exchange Commission regulations. On a similar note, the Central Bank of Ireland has expressed concerns over the development, testing, and risk control of implementing algorithmic trading systems. Moreover, studies show that the aforementioned algorithmic trading of ‘High-Frequency Trading’ can exacerbate price movements and exhaust available liquidity in a volatile market environment.
2. Change in skills sought after by the sales division
There has been a consensus that the skill set sought in the sales side is transforming. Now, investment banks are searching for more analytical and entrepreneurial qualities from the sales personnel. According to PwC Banking and Capital Markets Trends 2019 Report, “almost 80% of 235 Banking and Capital Markets CEOs see skills shortage as a threat to their growth prospects”. With a growing reliance on electronic execution, less emphasis is given towards relationship management and detailed product knowledge, but rather towards the ability to analyze quantitatively and technically.
Figure 1: Technology tools employed in each client segment. Source: PricewaterhouseCoopers
As shown in Figure 1, sales personnel employ technological tools in serving all client segments (serviced, managed, and customized). With such change, investment banks are trying to navigate how they would attract technically proficient graduates and how they would bridge the development gap among sales personnel.