Auto-Classification Summary
Why do we use classifications?
Not all flow is equal in terms of the ability to effectively monetise the flow. This underpins the traditional A/B book model. It also is key to our approach to risk management.
Where the A/B model uses static mappings of counterparties to risk management strategies we advocate a more granular approach.
Different categories of flow may require different risk management treatment for a variety of reasons. Simple PnL reasons, commission and rebate reasons or legal and regulatory.
We have an automated process that can classify trading behaviour. We work with our clients to refine what kind of classifications they require and automate this process.
We believe that by automating this process
=> it reduces the time for negative trading behaviour to be caught and actioned within your business
=> it also reduces the amount of time and effort required to manually conduct an equivalent review
Automated Counterparty Classifier - Overview
What type of classifications would be useful for your business?
Existing examples include:
Signal Follow - flow that is so consistently getting the market right, there is no scope for internalisation however could be informational in signal formation
Broker - flow that is recommended to be brokered. The only way to monetise is to apply markup and send to other LPs that may be able to monetise as part of a different portfolio
Don't Broker - flow that is currently brokered that could be rehabilitated to Compass management or B-Book strategy.
Fast Hedge - flow that has a limited window of which it may be profitable, but long term risk holding usually results in a negative PnL impact to the portfolio
Don’t B-Book - counterparties that are most negatively impacting a B-Book portfolio over a medium to longer holding period
B-Book - counterparties that look so non-informational in their flow that they may be worth B-Booking.
See Automated Counterparty Classifier - Classifications and Risk Management Strategies for more information on different classifications
What data points would be useful in determining flow management for your business?
Yield Profile
We at Mahi are big users of Yield Profiles / Client Markouts, which look in aggregate at the profitability of holding client’s flow within the first few hours of holding. This is a great indicator of future profitability of the client and how hard it is to monetise the flow.
Depending on the intended risk management and hedging strategy different parts of the yield profile show different characteristics of the flow.
Open/Close PnL
How much the client is making on opening and closing a position on a per trade basis for a given interval of analysis
Lifetime PnL
How much the client has made over the lifetime of trading.
Holding Periods
How long they hold the risk. What window do you have to monetise it, before they supply a closing trade
Proximity to Margin Utilisation
If a client trades close to their margin utilisation is this something that would make you inclined to B-Book the risk
Channel of trading
If a client is trading via Signal/Expert Advisor/Fix API/Clicker/Mobile. If a client is using a specific Expert Advisor. Is this a factor?
Country of Origin
Should flow from certain countries or IBs be treated differently
Large Order Management
Are client’s that trade in large notionals to be handled differently. Should their risk be algorithmically worked?
What intervals of analysis are important?
How much trading history is required to make a decision about flow management. At what point are you satisfied the flow can be judged? Can a client discover a profitable trading strategy through their development as a trader. At what point does a client get re-classified?
How often do you want us to reclassify your flow?
As this classification process is done by machine it can be running as frequently as your business requires
As part of the onboarding process we will work with your business to determine how you would like to classify flow within your business and for what purposes. As part of this process we aim to avail Echo & Compass with as much information as possible to support trading flow management and hedging strategies. If there is something missing that you use to manage your business please indicate what is missing and we will endeavour to integrate this in future versions.
Deliverable
We aim to define in a well described fashion how you wish to categorise and manage your flow. This may be subject to change and as we see the impact of the automated classifications it is fully anticipated that we change this in response to your feedback and insights we can provide.
Once we have your thoughts we’ll run a simulation showing the classifications that result from the definition.