Slide 1

Babis Theodoulidis, Jennifer Wilby and David DiazCentre for Service ResearchThe University of Manchester, England

Knowledge-Intensive Service Systems in the Financial Domain1ContextFinancial Domainfinancial markets monitoring and surveillance

Applying Service System Modelling2Financial Markets - OverviewThe most efficient and effective mechanism to economic prosperity

StructureStakeholders: customer, broker, regulatory body, data and market venues Market Venues: exchanges, electronic, Alternative Trading System, Over-The-Counter, Systematic InternalisersProducts: equities, derivatives and bondsJurisdictions: national, regional or global

PrinciplesMarket integrityMarket efficiencyMarket Integrity: the ability of investors to transact in a fair and informed market where prices reflect information; market integrity depends largely on regulation and the quality of market-monitoring.

Market Efficiency: investors completing low cost trades easily

A market venue can be (Hasbrouck, 2004): a) Stock Exchange: A stock exchange is usually an actual place where people used to trade. Nowadays most of them are almost exclusively conducted electronically. A stock exchange is a term used in US. The equivalent term in Europe is a regulated market (during this project we will use the term stock exchange). Stock Exchanges impose requirements on which companies are allowed to be listed depending on their size, annual income etc. b) Electronic: A market that is purely electronic is called electronic market. The most famous example here would be NASDAQ, the first screen-based dealer market that allowed traders to trade from their computers, transmit orders electronically and no longer required their physical presence in a stock exchanges floor. NASDAQ was allowed to compete with stock exchanges in 1998. c) An Alternative Trading System-ATS (the European equivalent is called Multilateral Trading Facility-MTF): Those are alternative trading platforms that match orders without passing from an exchange and without the intervention of a dealer. d) Over-The-Counter (OTC): This is a broad term covering trades that in general do not happen in an exchange. OTC markets may or may not trade listed stocks. They also have limited if-any requirements of reporting their trades. e) A Systematic Internaliser (SI): It is a company that deals on its own account to execute clients orders outside any of the aforementioned markets.

3Financial Markets Key DriversTechnologiestelecommunicationsautomated trading

Globalisationcross-market, cross-jurisdiction

CompetitionMarket venues, products, jurisdictions

50 percent of the total volume of stocks handled by algorithms in 2010 . As much as 70% in US, and around 40% in the UK.4FM - Monitoring and Surveillance Complexity of Financial Markets has increased dramatically

High profile failures Sub-prime mortgages, derivative contractsHFT and flash crash

Market efficiency and integrity have suffered

SEC and EU public consultations to restructure financial marketsThese configure what I call the integration-fragmentation-competition trio. Markets are now integrated because of better connectivity, but at the same time they are more fragmented because of new connectivity allows some investors to move away from open markets and create or intensify trading in private dark venues. These have been topped with new regulation, and new ways of competition, creating new products, and services (for eg. ETFs, co-location of servers, etc.)

The flash crash was named like this because it all happened within a time frame of minutes, like a flash. On May 6 in 2010, a little after 2.30 p.m. the equities and futures markets experienced some weird conditions which got worsened because of High Frequency Trading allowing a large amount of trades being executed ultra fast (Commodity Futures Trading Commission and Securities Exchange Commission, 2010). During the hours before the flash crash, major equity indices fell over 4% compared to their price the previous day and in no more than half an hour their prices fell an additional 5-6%. Soon, they recovered and the end of the trading day found their prices no more than 3% from their closing price the previous day (Commodity Futures Trading Commission and Securities Exchange Commission, 2010). Over 20,000 trades across more than 300 securities were executed at prices more than 60% away compared to their prices the previous hours. Moreover, many of these trades were executed at prices of a penny or less, or as high as $100,000, before prices of those securities returned to their pre-crash levels. At 1 p.m., LRPs in NYSE had already been triggered more times than in a normal trading day and various markets had a declining liquidity. 5Knowledge-Intensive ServicesService is the application of competence for the benefit of another entity; every exchange process needs to be understood as a service (Vargo & Lusch, 2004)

service is value co-creation, i.e. useful exchange that results from communications, planning, or other purposeful and knowledge-intensive interactions between distinct entities (Maglio et al. 2010)

KIS are services that rely on a continuous process of generation, acquisition and use of new information and knowledge or new combinations of existing information and knowledge (Madhaven and Grover, 1998)

Stock markets offer value propositions (value-in-exchange); traders submit to markets bids and quotes (value-in-exchange); trades (value-in-use)6Service Systemsa configuration of people, technologies, organisations and shared information, able to create and deliver value to providers, users, and other interested entities through service (Maglio et al. 2008)

Modelling financial services as service systems allows us to study their structure, reason about their properties and behaviour, understand their processes and test their validity in practice

Also, I like the systems archetypes concept, because is a direct way to help looking for problems, and then applied pre-defined recipes to solve them.7FSS - ConceptsServiceTrader Venue: display book, company news, etcVenue Regulator: best bid, suspicious transactions, etc

Value-in-exchangeWhen a quote or bid is submitted and accepted by the venue

Value-in-useWhen a trade closes8Trader-Broker also, brokers do internal matching, or decide when to trade, or how to trade (breaking the orders into smaller orders, routing them dynamically to the best venue, etc.)8RightsNo-rightsPhysical1. People

Individual investors, manipulators, traders, surveillance teams, broker dealers, head of SEC or FSA, etc.2. Technology

ECNs, trading platforms, servers, data warehouses, etc. Not-physical3. Organizations

Regulators, broker-dealer companies, investment companies, stock markets, etc.4. Shared Information

Trading information, news, corporate information, etc.FSS - ResourcesBased on Maglio et al, 2010Everything that has a name and is useful can be viewed as a resource.Intuitively, resources, both physical and non-physical, are potentially useful things. All namable-things can be classified as one of four types of resources: physical-with-rights (e.g., a person), not-physical-with-rights (e.g., a business), not-physical-with-no-rights (e.g., shareable information or documents, such as a description of a patent), and physical-with-no-rights (e.g., a technology or part of the natural environment). Rightsderive from laws, and laws are a type of not-physical-with-no-rights resource. An observer can interpret every physical resource as a physical-symbol-system (Simon 1996), with the sequence of symbols associated with the physical resource a description of the internal states of the resource as well as a description of the external relationships (external state). The descriptions (or observer interpretations) of internal and external state of physical resources are further examples of resources of the type not-physicalwith- no-rights. The properties of those descriptions as well as other symbolic operations on those descriptions can create further examples of resources of the type not-physicalwith- no-rights (e.g., information). Formalizing the notion of resources consistently across a broad spectrum of disciplines is a challenge for service science.9FSS - System BehaviourFrom Wilby et al, 2011

10Four-fingerprints of complex systems (Casti, 1992)IrreducibilityInstabilityAdaptabilityEmergence

Provide framework for classifications of relevant principles applicable

Examine in the context of Financial Service System

FSS - System Principles11IrreducibilityStudy the whole as well as the relationships between the parts of the wholeProperties that cannot be discerned from the individual study of the parts

Holistic vs ReductionistDecide what is relevant to the study (scope)

FSS Cross-ProductCross-marketCross-jurisdiction12InstabilityComplex systems are inherently unstable, moving between states of behaviour

Instability is introduced by elements within the boundaries of the service system or the environment

Maintaining the viability of service systems

FSSNew technologies, new venues, new productsRegulations and policies13AdaptabilityActors in service systems are not rational agents

Their decisions and actions cannot be anticipated

Learning and adaptation

FSSmonitoring and surveillanceAuditingAutomated/manual adaptations

14Emergencebehaviour not previously predictable

Creates the so-called emergent properties

Relates to the other principles

FSSNew manipulation scenarios

15FSS System StructureService CustomerInvestors, regulators

Service ProviderSROs, non-SROs, regulators, third party providersCustomerServiceExperienceServiceProviderTaken from (Kwan et al, 2008)16Market Monitoring Value PropositionsCustomersNetworkMonitoring& SurveillanceValue PropositionFocalRelationshipValue PropositionProvider PartnerNetworkValue PropositionRegulatorSROCentral Tape ManagerExternal DataExternal Data ProviderText MiningService ProviderBased on (Kwan et al, 2008)17Market Monitoring WorldviewOutputManagementOfflineEngineReal TimeEngineInformationManagement

RegulatorLive Data FeedProvider

Internal SROData

FactivaCentral TapeManagerVenue AText MiningSS ProviderBased on (Kwan et al, 2008)18Service Network Single Jurisdiction

Based on (Kwan et al, 2008)19SummaryExamine Financial Markets and especially, monitoring and surveillance processes as service systems

Methodology to examine system behaviour as system of systems

Produce a framework for the design of financial market monitoring systems (open closed approach)

Work in progress20Back Up Slidesa collection of parts together with their relationships that forms a whole that serves a purpose that is meaningful to the system alone, that is, not to its parts or their relationships' (Boardman et al. 2008)

Systems ThinkingFrom Schoderbek et al, 1990We adopt a systems thinking view

Elements = entities with attributes

22Archetypesstereotypical systemic configurations of entities and relationships Archetypes are composed of one or more types of relationships among variables, but in general, it is possible to identify two main types of relationships (Senge 1994). These are:Reinforcing relationships, which consider feedback interactions or loopsBalancing relationships, which consider tradeoffs between variables, i.e., inverse relationships between them, for e.g., when one increase the other decrease, when one is activated, the other is deactivated, etc.

Intentionally Holistic KISS

From Wilby et al, 2011