Wednesday, September 02, 2020 / 11:50 AM / By Proshare Research / Header Image Credit: EcoGraphics

Executive Summary

"Throughout my financial career, I have continually witnessed examplesof other people that I have known being ruined by a failure to respect risk. Ifyou don't take a hard look at risk, it will take you."- Larry Hite

Thenew evolution of trading in financial markets rests on digital platforms thatenable clients and traders to develop relationships that save time, improvequality and hedge risks. Fintech institutions in Nigeria and collaboratingstockbroking companies have noted that working through new products and sharperservice delivery channels would enable greater market intimacy and provide afriendlier environment for a new generation of investors. Generation Z and Y,the new investment kids on the bloc, represent a demography that willincreasingly dominate both the equities and fixed income market as theygradually improve their financial savvy and deepen their understanding of howlocal and international capital markets work.

Theecosystem will see greater intervention by fintech companies who will likelyprovide mobile applications that will enhance trading opportunities but at thesame time provide options for the aggressive risk-taking younger generation tohedge their bets and reduce their susceptibility to 'animal spirits". The new fintech platforms that allow trading in a wide variety of asset classesmust equally have a risk-protection mechanism that ensures that youngerinvestors can buy financial assets but with a clear understanding of thedownsides making them equipped with the knowledge of how to use loss-breakersto stabilize the overall value of their portfolios.

Financialmarkets can be brutal and tormenting leaving the unblooded with deep scars, butwith CMOs using artificial intelligence (AI) to profile investors the 'hot' passions of youth can be tamed and allowed to mature into seasoneddecision-making.

Therise of AI would enable a smoother market transaction process with tradersgaining deeper insights into the requirements of their clients and the assetcombinations and risk/return expectations that fit into the preferences ofinvestors. So far technology is still fairly rudimentary as digital sandboxesare still undergoing development and testing. More sandboxes need to bedeployed to provide a richer ecosystem of alternative solutions from which thebest would be chosen.

Tobe sure, local Nigerian financial markets are steadily rising to match globalstandards. Fintech companies are putting pressure on the brick-and-mortarparadigms of classic trading platforms and raising the performance bar foryounger investors insisting on a different consumer journey from theirforbears. Indeed the new user of financial products is fixated with speed,governance, responsiveness and accuracy. Capital Market Operators (CMOs) thatcannot fit into the revised framework of client expectations have one choice,to fold up. The evolving capital market environment is gruellingly competitiveand crushingly innovative, the time for genteel paper-pushing has ended andoperating firms that do not rethink, reimagine and restrategize theirbusinesses could kiss such businesses farewell as digital innovation becomes anever more powerful force for change.

Inthe online digital trading report for 2020, analysis shows that CMOs have becomemore aware of the pressures to build robust online platforms that communicateinteractively with customers. The outbreak of the coronavirus pandemic in late2019 has made the case for remote business interface compelling. The reportnotes that the fixed income securities market is the largest and possibly themost attractive segment of financial trades. With the government increasingactivity in the treasury bill and bonds market to cope with the challenges ofwidening budget gaps, the market for public treasury instruments has grownphenomenally over the last decade 2010-2020. While the Nigerian Stock Exchange(NSE) market capitalization rose from N11.48trn in 2014 to N12.96trn in 2019,reflecting a six-year growth rate of +12.89%,the bond market saw growth from N104trn in 2014 to N232.68trn in 2019, showinga much faster-paced six-year growth rate of +123.73%.

The Digital Deal: Asset Class Spread

Despitethe faster growth in the fixed income market and the relatively larger size ofgovernment treasury trades, the digital market still favours equities. Thereport discovered that 72.90% of online trades are equity transactions, 14.18%mutual funds transactions(mainly equity), fixed income 5.29%, forex 2.19%,commodities 0.90% and others 3.35%. Investors appear be feel easier handlingtraditional equity businesses online than any other asset class. The limitednature of online trades means that the online market of asset trading inNigeria is thin and narrow, thereby representing an opportunity.

Iftraders educate their clients and show them how to make decent returns ontrading different asset classes, the volume of traded online business wouldincrease exponentially and investor portfolio diversification would improverisk/return ratios. The online financial asset trading business appearsconstrained by a lack of strategic effort at getting investors to migrate todigital mobile trading platforms. The problem appears to be a lack ofCMO-friendliness with digital technology and constraining 'muscle memory' thatcompel CMOs to revert to the comfortable and familiar. Fintech companies are,however, shaking things up.

COVID-19may have wobbled CMO perceptions and their operating preferences as remoteinteraction increasingly becomes the new normal, with clientsincreasingly expressing a preference for transaction journeys that reduce ahuman interface. Gen-Zers in particular would want the customer experience tobe plugged into a mobile digital journey similar to their daily consumer retailtransactions. To improve digital online trading, CMOs will need to rethinktheir service-delivery buckets and drive more business to digital platforms.

Eyeballing The Survey

Onreviewing the outcome of the 2020 survey that received 785 responses, the topfive fastest online platforms were:

Theseplatforms, according to the survey, provide investors with the fastest tradingjourneys but most of the experience relates to equity trades. What informs thechoice of online trading platforms? The survey result suggests that users ofonline platforms made choices based on the following considerations:

Theconsumer experience journey has shown that financial sector clients continue todiscriminate amongst online service providers for the following key reasons:

S0where do online clients desire to see improvement in service deliveryexperience? The research survey suggests that the most significant areas ofonline service improvement required by clients are in the following areas:

Thesurvey covers other areas of importance to retail and wholesale customers,building a body of information of strategic importance to CMOs who would needto Rethink, Reimagine and Restructure platform operations in a way that feedsinto a product and process value chain that fully recognizes the needs andwants of younger demography of investors.

The Wrap Up

Mostof the CMOs surveyed would need to ramp up digital service quality if they areto improve their digital conversion rates. The report shows that digitalconversion rates are still relatively low for most capital market operators.Transitioning clients from brick-and-mortar trades to digital transactions havebeen a hard long walk because most CMOs are yet to figure out the dynamics andfunctional architecture of a truly virtual trading structure. CMOs appearlocked in tradition and find it difficult to connect with emerging realitiesdespite the powerful statement on a new remote work culture dictated byexternal business shocks such as COVID-19.

Thereport wraps up with the admonition that to meet client's demand along a risingexpectations curve of wants and needs they must plug into a product and processculture driven by big data, artificial intelligence (AI), and a visceralunderstanding of generation Y and Z, anything short of this could mean thedifference between corporate survival and the other side of business daylight.

Trading Technology andThe New Digital Customer Experience: The J-Curve

Tradingasset classes on formal Exchanges are no longer matters of physical space butthat of digital cyberspace. Investors in equity and bond trades now conducttheir affairs on computer devices loaded with software that drives bid andoffer transactions.

Theconsequence of a formal format shift for the trading of traditional assetclasses has been the creation of new consumer expectations and the adoption ofrevised methods of the interface between floor traders, analysts andinvestors.  Technology is the new lifeblood of asset trading and so, beyondfundamental and technical analysis of equities and bonds, the trading platformsused to execute investor mandates have become critical as time has become acrucial variable in investor action.

Withthe timeliness of transactions becoming just as important as the particularassets traded, trading houses have had to improve the quality of theirplatforms in terms of data processing, research, customer interaction andgenerational segmentation. This has created a sort of J-Curve pattern whereservice delivery quality at the point of transition or upscaling of digitaltrading transactions shows early signs of difficulties with service qualitywhich dip briefly at the point of the first-stage implementation and thenimprove exponentially. The 2020 online ranking digital trade report suggeststhat trading houses are still located somewhere at the lower end of the risingJ-curve (see illustration 1 below).

Illustration 1 Climbing The Digital Trading Curve

Indeed,stockbrokers have improved their adoption of digital trading platforms acrossstockbroking houses, however, the customer service journey remains relativelypoor. The speed of transactions and response to customer enquiries have notimproved significantly since the last report in 2019.

Stockbrokersmay have possibly failed in providing clients with the transactional experiencethey expect in terms of allowing customers to have regular daily digitalinteraction with the market through detailed research produced in a format thatis quick and easy to interpret and represents actionable data. Nigeria'scapital market operators (CMOs) also appear to be lax to the quality of their tradeadvisory services. The lack of engaging and interactive advisory activities asexperienced by investors abroad prevents local CMOs from creating broad digitalinteraction with clients. Analysts note that the domestic trend appears to befor stockbroking firms to project their in-house research on their custom-builtwebsites, this limits the number of eyeballs that see the research andrecommendations and hurts the opportunities that exist to widen their clientbase.

Taking Action

Toimprove interactiveness between CMOs and their clients CMOs will need to showgreater presence in the digital media space, they would need to get theirresearch posted on leading business and finance websites and engage in onlinemedia conversations around the different financial markets. The supply ofqualitative market information in the popular business media would buildinvestor confidence, help in ensuring knowledge-based trade action and provideopportunities for CMOs to market their bespoke niche products and services. Thebalance would be to assess the cost of potential media partnerships with theexpected revenues that would emerge from more intensive client relationshipsand stronger brand positioning.

Upping The Strategic Push

Goingforward, CMOs will need to break into new strategic pathways where they canadopt product/service differentiation as a basis for a competitive tussle formarket share. Speed, for example, at this stage goes beyond being a feature tobeing a value promise. The commitment to speed evolves into a consciousdiscovery of ways of providing excellence within the shortest practical period.Besides speed, CMOs would review cost-to-market issues. The lower the cost ofdelivering service the better the ability of the CMO to squeeze profit marginsper trade, one clear way of reducing cost over the medium to long-term would bethe adoption of big data and artificial intelligence (AI) skills to farminformation and package it within a framework that gives both asset managersand investors strategic data in usable small-sized buckets.

Thelast arm of the CMOs digital competitive strategy would be to createservice/product niches that provide non-contested (blue ocean) marketopportunities. For example, repackaging the daily stock market report in a waythat removes inactive stocks and concentrates on active stocks with specificthreshold market capitalizations and shares price movements on a moving-averagebasis for the last 30 days. In other words, the strategic imperatives for CMOswould be; differentiation, cost and niche (seeillustration 2 below).

Illustration 2 Digital Competitive Strategy, From Old Models To New Objectives

Of Waterfalls and Monkeys

Twomodels can be used to further the digital plans of CMOs; one model is the waterfallmodel which allows the implementation to take place in one full sweep, withexecution taking place on all fronts simultaneously.

Inother words, all goals are addressed at the same time or something akin to a 'full-court press' in basketball. The alternative model is called the agilemodel which allows CMOs to take a step at a time, using each step as alearning ladder to be lined up against the next phase of digitalimplementation. This approach, bearing the agility of a monkey, reduces riskand allows for incremental reviews but may be slower than its waterfallcounterpart and lead to several realignments based on changing situations (see illustration 3 below).

Illustration 3 Adopting Different Digital Strategies could Involve Tough Choices

CMOswill have to decide which approach works for them, but whichever is chosen mustbe done with the ultimate intention of significantly improving their client'sservice/product delivery experience. The struggle for the digital market of thefuture will go beyond just understanding J-curves and classic models ofcompetition to understanding the idiosyncrasies of the emerging generation oftraders and designing services to meet the new expectations.

Online Trading: A Peep Into Tomorrow

Online trading is gradually making a shift in global importance. Theneed for AI in online trading in Nigeria has become more of a pillar than abuilding block. Artificial intelligence help brokers in getting larger tradetransactions done, ensure that the stock market works efficiently with lowervolatility for a period. AI presents grand opportunities for millennials andperhaps generation Y and Z that can get a quick run on its intricacies.

A wide variety of online trading platforms around the world are takingadvantage of AI. Companies such as Greenkey technologies in Chicagoadopted AIfor trading uses, speech recognition, and natural languageprocessing technology to save traders time searching through conversions,financial data, and notes. Artificial intelligence is also maximized by Auquancompany in U.K. Auquan's data science competition platform democratizes tradingby allowing data scientists from all backgrounds to produce algorithmic tradingstrategies that help solve investment challenges. Also, Kavout's "K-score" is aproduct of its Kai intelligence platform that processes massive diverse sets ofdata and runs a variety of predictive models to come up with a stock-rankingrating (see Illustration 4 below).

Illustration 4 AI and The Future: Surfing The Rise

Based on the current state of artificial intelligence applications instock brokerage by use-cases from companies operating in the space, artificialintelligence applications in stockbroking can be classified into three majorsegments:

• Artificial intelligence for trade executions
• Automated Trading
• Advisory Services.

In trade executions using artificial intelligence, the trade executionalgorithms are programmed. When a trader executes a buy request, stockexchanges need to match these buy orders or bids, with sell orders to executesecurities trades. Artificial intelligence uses statistical techniques to breakup trades into smaller orders to minimize the impact on the stock prices afterthe trade is executed.

Also, AI can be used for the identification of arbitrage. This is a casewhere investment managers can potentially take advantage of differing pricesfor the same assets in different markets. It can search for such arbitrageopportunities and list them out to the investor in their dashboard (see Illustration 5 below).

Illustration 5 AI King of The ArbitrageGame

The second segment in which AI can be applied is discretionary trading.Artificial intelligence can prompt traders and stockbrokers with tradingstrategies for individual stocks e.g. AI can recommend the best stocks to tradebased on the highest probability of returns the next day. This will be acertain win-win for CMOs that build business models on the customer'stransaction journey (seeIllustration 6 below).

Illustration 6 When AI Takes Discretion

Thethird segment in which AI can be applied is advisory services. Artificialintelligence can analyze financial data such as SEC filings, technicalindicators, price patterns, and sentiment analysis based on news, blogs,analyst, reports and social media feeds relevant to a particular broker'smarker interest. CMOs need to lock this part of their activities down toguarantee superior client services (seeIllustration 7 below).

Illustration 7 AI and The Beauty of Analysis

When Online Platforms Give a Boost, a Pat and a Kick

The world is becoming increasingly digitized, automated, and advanced intechnology adoption. There is a gradual shift towards the application of AI inmassive online transactions. Some online trading platforms around the globehave adopted this methodology, hence the call for Nigerian online tradingplatforms to tilt towards this direction. The speed at which such technologicaladvancement is adopted by an online trading platform will determine itscompetitive level and its survival in the nearest future.

An online trading platform quick to adopt this technology would recordan increase in its user's satisfaction, an increase in the level ofsophistication of its platform, an increase in the number of users, and also asignificant rise in its brokerage revenue. A modest approach to the adoptionwould mean that the online trading platform would record a fair increase inuser's satisfaction, continue operation in the short run to medium period, itslevel of sophistication would be intermediate, there would be the need for roomfor growth and improvement and a modest rise in brokerage revenues.

The two undesirable actions for any online trading platform would be tobe slow in the adoption of AI and not adopting AI at all. Online tradingplatforms slow to adopt artificial intelligence in the nearest future wouldrecord a significant decline in the number of users, low level ofuser-satisfaction, low level of sophistication, and significant decline inbrokerage revenue. While an online trading platform that fails to adoptartificial intelligence would lose a majority of its users, significant declinein brokerage revenue, a decline in user's satisfaction as they are likely tomigrate to more sophisticated online platforms and would be forced to upgradeits services a sophistication to ensure its survival (see Illustration 8 below).

Illustration 8  The OnlineDigital Trade, Boost, Pat and Kick

Artificial Intelligence and the Nigerian Stock Market, Navigating ABlack Box

Integrating and adopting artificial intelligence on online tradingplatforms present numerous benefits, opportunities as well as risks andchallenges.  Artificial intelligence suggests that the number of humansinvolved in trading and investment decisions decreases and this may affectmarkets and price actions.

Analysts have said that application of AI to asset trading could createefficiency with lower market volatility. Stocktraders, in turn, have arguedthat greater efficiency could come from a reduction in subjective marketdecisions based on human sentiment, thereby, cutting down on what investors call, 'white noise'. Furthermore, AI also reduces trading cost, it provides dynamicautomated modelling and rapidly and efficiently collects and analyzes far moreinformation than considered previously possible.

Despite the benefits of AI, there are still challenges associated withintegrating it as a tool to facilitate online trading. Unsupervised,self-taught AI presents the challenge that its decision-making and financialtrading processes take place in a 'black box' and they may be incomprehensibleto both users and regulators. Also, implementing AI is not easy as it isexpensive, requires sophisticated expertise. Furthermore, some of thecommercial benefits of AI are constrained by the current regulatory frameworkgoverning financial markets, there is the potential threat of a compliance armsrace as individuals and organizations try to game the system.

There are also risks associated with AI in online trading. AI programsused in trading and investing rely on third-party data sources that aresusceptible to manipulation. Also, models used in financial markets stresstesting may provide misleading results if they are given insufficient training.Furthermore, if many traders use similar AI strategies, they may pose a risk tomarket stability as different actors unwittingly act in concert (see Illustration 9 below).

Illustration 9 Inside A Black AI Box

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