The convergence of principal and agency trading technology

By Christer Wennerberg
November 1, 2016

Agency trading technology was traditionally very different from that used for principal  trading. Greatly simplified, principal trading required extreme performance, while rich features and flexibility were key in agency trading. Now, this is about to change. But before we examine what is driving the convergence, let’s take a look at what originally drove them apart.

Principal trading involves a spread and trades are executed against the firm’s own inventory. Market making and arbitrage are two examples where extreme performance in terms of latency and capacity, and powerful position monitoring were key requirements. But as low-latency infrastructures became mainstream and the profitability of just being fast decreased, the cost of generating incremental speed became prohibitive and market participants started to seek new ways to differentiate their business. As a result, extreme performance is no longer enough and a more intelligent system is required.

Agency trading involves a commission and trades are executed externally. Also called customer-driven business, agency trading was originally less speed-sensitive than principal trading. Agency trading systems were designed for high flexibility and functional richness. However, as the complexity of trade processes and market structure increases and new regulatory requirements are introduced, more powerful agency trading technology is now required not only to remain profitable, but to remain in the agency trading business.

Closing the gap between agency trading and principal trading — the drivers

Regulation is now the biggest challenge facing the financial industry in general, and trading in particular. Regulation is also the main reason why agency trading and principal trading have recently started to converge, but it is not the only one. The following are some of the drivers behind this trend:

Regulation (achieving compliance)

It is not a bold guess that MiFID II will profoundly reshape the markets when it comes into effect in 2018. The regulation will have a direct impact on both agency trading and principal trading. Some of the new regulations will affect principal and agency trading differently (High Frequency Trading will be a separate area, as will market making, affecting principal trading). However, most of the new regulations with have an impact on both agency and principal trading.

One example is the regulation concerning Algorithmic Trading (requirements to monitor the flow in real time); other examples are clock synchronization and pre-trade risk validation. MiFID II will also be an obvious and absolute driver for expansion to other asset classes such as derivatives and bonds. Regulation will also be a driving force to harmonize the market structure, making it possible to achieve economies of scope.

Market structure (staying competitive)

As always, market structure is constantly evolving. Historically, there has been a quantum leap every 7-10 years. It is not a bold guess that MiFID II will cause a quantum leap in market structure, due to the indirect effects of the new regulations. One example is the new Double Volume Caps and their immediate effect on market structure: innovation in terms of new trading models and a proliferation of Systematic Internalisers. These developments will make execution a considerably more complex exercise, both for investment firms engaged in agency trading as well as principal trading.

Proliferation of High Frequency Trading

Remember Flash Boys and the heated HFT debate from a couple of years back? HFT was seen as the root of all evil, and terms like “fake liquidity”, “quote stuffing” and “gaming” were thrown around. there were probably some elements of market abuse involved in some cases. But the vast majority of the problems were caused by inadequate trading systems. Up against the extreme performance systems, many older systems instantly became obsolete, including those used for agency trading such as order management, market data and smart order routing systems. The rough awakening generated massive efforts to boost the performance of these systems by multiples of tens or even hundreds, in order to compete with the HFT-firms. Another way to compete was to build smarter systems, such as smart order routers with timing of orders and tick-data analysis in order to detect signs of gaming.

Expansion to new asset classes

This expansion is both driven by regulations such as MiFID II and new market requirements. The latter became evident when the HFT space within equities became “crowded”, causing many HFT-firms to start trading FX. The change has been drastic; HFT is now estimated to account for roughly 80% of FX futures volume and two-thirds of both interest rate futures and Treasury 10-year futures volumes, according to the U.S. Congressional Research Service, April 2016.

Next generation of trading systems

It is clear that the boundaries between systems or platforms for agency trading and principal trading will be blurred going forward. Both categories must be flexible and functionally rich as well as fast, and here’s why:


To cope with ever-increasing demands on performance due to increasing transaction load, but also being able to make more decisions in a shorter time frame due to a more complex market structure.


In order to adapt the rules to different client demands and an increasingly complex market structure. Flexibility is crucial to achieve economies of scale and scope. Being able to adapt the system to accommodate multiple asset classes will reduce cost of ownership.

Protect IP

With any major shift in market structure, the competitive landscape will change. It is crucial to be able to adapt to new market models and leverage the firm’s comparative advantage. Flexibility is necessary but not sufficient. In order to be truly competitive, it is necessary to be able to adapt the system (components), while protecting the firm’s intellectual property.

For a take on the overall trends currently driving sell-side change, have a look at our recent trend overview “Sell-side evolution” here.

Related Content

Systematic Internalisers: opportunities in a post-MiFID II world

Systematic Internalisers: opportunities in a post-MiFID II world

Execution In the months following the implementation of MiFID II, we have seen and will continue to see a number of Systematic Internalisers (SIs) appear on the market – some of their own volition, some following ESMA’s publication of benchmark data and thresholds. What we have seen is that many of these SIs started off by […] September 18, 2018

Why infrastructure testing is critical to your trading business

Why infrastructure testing is critical to your trading business

FIX Infrastructure End-to-end testing of trading infrastructure is critical in today’s increasingly heavily regulated environment – but compliance comes at a price. So why should financial firms pay it, and what happens if they don’t? In our second blog post on the topic, we explore the most pressing reasons to implement a robust testing mechanism. The most […] September 11, 2018

Trading infrastructure testing and why it’s important

Trading infrastructure testing and why it’s important

FIX Infrastructure As trading processes become ever more sophisticated and regulators race to catch up, the end-to-end testing of trading infrastructure is an increasingly crucial component of compliance. Financial services firms face severe penalties for trading errors – including fines, loss of reputation, potential bankruptcy and even personal repercussions for senior executives. The cost of failure is […] August 21, 2018

MiFID II: The implications for trading systems and infrastructure

MiFID II: The implications for trading systems and infrastructure

Risk & Compliance MiFID II marked a sea change in the approach to the handling of order, trade and transaction data. Rigorous new requirements around data capture, analysis, reporting and record-keeping made the communication of data a central theme in ensuring trading systems were MiFID II compliant, and connectivity – between external and internal systems, databases and processors […] August 14, 2018

Itiviti Talks

Get our view on global capital markets


Subscription successful

Thank you for subscribing!

Close window

Itiviti Talks

Get our view on global capital markets

Weekly email

    Trends in global capital markets from a technology perspective.

By submitting this form, you acknowledge that data collected by us will be handled in accordance with our Privacy Notice.