Brad Bailey

About Brad Bailey

Cloud is Down

Cloud is Down

Yes, even the cloud can go down!

For the many firms, including the SEC and CIA, who run their infrastructure in the AWS cloud, Tuesday’s outage was a pain. The economic impact of the outage will easily be in the many tens of millions.

It is particularly poignant as it comes at a time when so many core processes are moving into the public cloud and more and more capital market participants are building in the cloud, or toward a cloud future, as we discussed in The Cloud Comes of Age in the Capital Markets: All Clear for More Cloud.

This outage is a reminder that not only can all technology fail at some point, but it will. The scale of this week’s outage, along with its rarity makes it newsworthy. However, the scale masks the simple truth that the net downtime of this failure is far less than the aggregate downtime, had all impacted firms been running their own infrastructure.

Furthermore, it is a lesson for firms moving into the cloud to consider how to best manage risk profiles across various clouds and models, or ensuring that they are running across regions (a single AWS region went down).

But the news flow now suggests the most common point of failure: the human. And, of course, the proverbial fat finger. As in many cases, in market technology failures, it is at the human/machine interface that is the weakest link.

This is a time to learn, access the risk and move forward.

Straddling the Old and the New – Fintech in the Capital Markets

Straddling the Old and the New – Fintech in the Capital Markets

We are sitting at an extraordinary inflection point in the capital markets. The competitive landscape is in flux as competitors find their way through a maze of constraints. The constraints are well known-increasing regulation, rapidly changing market structure, liquidity challenges, and difficult macroeconomic conditions. There is also a feedback loop with the broader economy; many of the same forces that are constraining the capital markets are creating an unusual political landscape. We have seen this playout with Brexit, and the world awaits the outcome of the US presidential election. These then feedback into the capital market as uncertainty around managing volatility, risk and whether regulation will proceed as expected will be delayed or, radically altered.

For many capital market incumbents: the investment banks, broker-dealers, asset managers, and infrastructure firms are also saddled with extremely complicated legacy systems that are highly siloed, very expensive to run and even more expensive to change. While many are rationalizing systems, in certain areas it is just not possible. In many cases, ancient systems are running broad swaths of the back office, and sit under decades of add-ons, fit-ins, force-ins, and integrate with countless systems internal and external. Capital market firms are often in the habit of creating an abstraction layer above systems to tie more and more data and systems together. This creates a kludgy infrastructure, but it can, and does work.

Given that there are so many challenges, and hence opportunities, we have seen a slew of fintechs increasingly offering capital market solutions. There are those that come from the capital markets and speak the language of the markets. They have grown up in the space and see an opportunity to solve a particular pain point in investment process, trading or operations. There are other fintechs that have entered the vertical from another and are leveraging their data processing, analytical, machine learning, and hardware acceleration prowess in the capital markets.

We have seen fintech disruption in banking, but in the capital markets, so far, it has been much more collaboration than disruption. Fintech firms are bringing unique data, analytic, technology solutions into a highly regulated business. Fintechs that partner with existing firms are offered scale, legitimacy, and clients in a highly risk averse and regulation heavy business. For the brave incumbent firms who are providing capital and nuanced expertise to these innovators, there are rewards: new ways of looking at their business, but more importantly, ready built solutions that they can scale. Overcoming the fear of engaging these firms effectively is a path to finding better and more cost-effective solutions.

In my report, From Financial Technology to Fintech: Trends in Capital Markets, I look at the areas in which the rate of change is greatest, the nature of fintech partnerships in the capital markets and how they are evolving. I look at the pain points in KYC, liquidity, trading, liquidity, collateral and operations. I investigate the growing acceptance of cloud, the importance of leveraging data correctly and analytics and tie these to specific providers with solutions in InvestmentTech, MarketTech, RegTech and AltData. I also look at emerging technologies such as distributed ledger technology, AI, and business models that are looking to remap the capital markets at its core.

Yes, we are at an inflection point and some of the systems out there are kludgy, but in the short term, solving specific business pain points is the key to solving some of the industry’s thorniest problems.

Spot FX Gets Walloped!

Spot FX Gets Walloped!

The BIS triennial survey, the most comprehensive data point, indicated that overall FX volume shrunk 5% from $5.36 Trln in 2013 to $5.09 in 2016. However, FX spot fell by a whopping 23.7%. London maintained overall geographic leadership but saw its share move down to 37% from 41% in 2013. APAC trading centers saw growth from 15% to 21% market share.  Overall, FX swaps and currency swaps grew, and cross currency swaps grew sharply, while FX option volume nosedived.

Spot fell across the major currency pairs Euro 12.5%, Yen 12.5%, Swiss Franc by 13.6% with Sterling rising by 2.6% as the lead up to Brexit caused considerable repositioning in Sterling assets.  No surprise as the Chinese Renminbi rose 41% and became the 8th most traded currency pair.

Capital constraints, digestion of regulatory change in the US and impending global regulation, changes in traditional liquidity provision, scandals and market disruptions since the last survey in 2013 are the main causes of the drop in spot. Additionally, the impact of the SNB’s surprise move in 2015 dislocated active FX trading and had many prime brokers reevaluating  their risk considerations. Creating challenges for smaller and riskier trading shops and hedge funds in maintain FX prime brokerage probably moved some of the FX spot volume onto exchange trade FX futures.


The market structure in FX continues to change quickly with acceleration in the adoption of digital models for trading and analyzing data in the FX market at the same time as major changes in FX market making and liquidity provision which has impacted spot FX trading.

 

 

Human and Machine-Rise of the Cyborg: The Cycle of Voice Trading

Human and Machine-Rise of the Cyborg: The Cycle of Voice Trading

Celent has explored voice trading in Human & Machine-Rise of the Cyborg: The Cycle of Voice Trading, published yesterday. In this piece, we look at the power of voice trading as well as the business drivers, challenges and forces that are driving change in voice communication, collaboration and voice market engagement.

Celent believes that voice is a key channel that will remain relevant and will work more seamlessly with electronic and data channels in the coming years. A move toward unified communication approach and advances in technologies, combined with a challenging business environment, are reshaping the modern trading desk. Cost cutting, front office effectiveness, gleaning better insight into customer behaviour combined with digital automation are pushing this frontier forward. Voice trading remains the major channel for transferring risk, across asset classes, yet remains a challenge due to the difficulties in leveraging this unstructured data set.

Advances in both preparing and leveraging data for advanced analytics are creating a demand for business insights-the demand for better data is ever growing. Firms are beginning to leverage advanced data tools for not only risk mitigation and regulatory requirements, but are creating front office opportunities for better counterparty engagement and communication.

Fintech continues to advance in the capital markets and the implications are profound for incumbent players. Firms that effectively leverage the full spectrum of innovation available are becoming more streamlined and more effective. The overarching need for business model evolution and the importance of technology in the markets continues to ramp up. As one example,last week alternative dealer Citadel Securities hired Microsoft COO to be the new CEO of it electronic market making business.

We are surrounded by advances in voice technology for interacting with machines in our life in general. We are getting comfortable with Apple’s Siri on mobile, and Amazon's Echo in our homes. Similar technologies have advanced in areas outside the capital markets, but leading firms are trying to leverage voice data for better insight, engagement, and automation. While we are nowhere near Robotic Stingray Powered by Heart Cells from Rats published in last week’s WSJ, in merging machine and biological elements we are heading more into an era of the cyborg-where capital market participants will increase their direct engagement with machines via voice interaction.

The next wave of fintech disruption

The next wave of fintech disruption

The bank has traditionally sat in the center of the broader financial world.  The post-crisis challenges have allowed fintech firms to capture market share in traditional banking endeavours such as payments, lending, investments, and financial planning. First wave fintech disruptors with no asset base or legacy banking infrastructure have made significant inroads into challenging banks in their core businesses. Banks have reacted in a variety of ways to these challenges with disparate degrees of success, but only those actively partnering with and supporting fintech innovators have gained a competitive edge.

Similarly, exchanges have stood at the centre of the capital markets for much of human history. The years of connectivity, combined with the earth-shaking changes in the ability of firms to access capital and a global regulatory model that has focused on risk mitigation, have created an ideal world for next wave disruptors to bring solutions to complex trading, liquidity, regulatory, and operational problems that have been difficult for incumbent firms to solve on their own. This investment is going toward blockchain, RegTech, AI and other tools for driving change in the capital markets.

As it has happened with banks, those market infrastructure providers that decide to embrace, leverage and coexist with upcoming fintech firms will be able to further their historical strengths and stay at the core of financial markets.

Since 2008, capital flow into fintech investments has grown sixfold. Last year, about $19 billion in capital was invested in fintech across approximately 1,200 deals, nearly doubling funding flows in 2014. We have seen banks partnering with fintech, filling gaps and bringing critical experience and enterprise scale to these endeavours. Major parts of the financial services ecosystem run the risk of being transformed by pioneering financial technology firms. At the same time, strategic firms have developed innovation centers of excellence, laboratories, and their own CVC funding vehicles to invest and guide in areas of core interest to these firms. CVCs now represent 25% of global fintech capital flows.

This week the Deutsche Bourse announced the creation of its CVC DB1 to fund innovativation in the capital markets. Celent, on behalf of Deutsche Bourse, explores this next wave of fintech in the capital markets and highlights the power of future collaboration between leading financial infrastructure players and fintech firms.

Future of Fintech in the Capital Markets can be downloaded from the DB1 Ventures website. I look forward to your comments.

Markit merger – Fintech disruption and data

Markit merger – Fintech disruption and data
Spring has sprung and Markit, a firm that touches every corner of the capital market, starts this snowy spring morning in NY, with news of a mega-merger. Markit has grown by offering solutions, data and analytics to much of the capital market value chain as well as through multiple acquisitions, so it is interesting to see it now joining with IHS, to become part of a multi-industry vertical firm. According to the press release, IHS (NYSE: IHS) and Markit (NASDAQ: MRKT) will combine in an all-share merger of equals.  The combined company’s reported results for fiscal year 2015 include approximately: $3.3 billion in revenue. It will be interesting to see how Markit’s three divisions will fit into the multi-verticals that IHS serves. Markit’s three divisions: Information, which has been a source of pricing and reference data, with analytics across asset classes; Processing, has been a critical source of efficiencies and automation to the capital markets, particularly in OTC derivatives, FX, and the loan space; and, Solutions, has been a source of managed solutions. Like many people in the financial industry, I was surprised by the announcement of this deal. On a strategic basis, I have thought of Markit combining with a larger market data provider, adding additional data and valuation tools to that firm, or feeling in key data or automation gaps. Or, other market participants across the capital market transactional space which  have been recent, and eager buyers, of data companies. They have been eager to own not only the data, for the creation of IP, for the bigdata analytics, for the potential data tools in the  electronification of trading, but for the recurring and stable revenue model. One recent example, is the ICE acquisition of IDC. Whether any of these other types of deals were considered, I don’t know.  Perhaps, the deal speaks to the challenges that are seen in the capital market as the industry continues to find its way in the post-crisis world. The lack of future clarity, as financial services firms digest the implications of FinTech disruptors,  along with the realities of today’s regulations and capital restrictions, drove the key decision makers to expanding to other industry verticals. However, after two days of mulling the deal over: Markit has sat in a unique place within the financial services, since its inception in credit market data thirteen years ago. The firm has morphed into not only providing critical data, analytics and valuation tools,  across asset classes, for a broad swath of the capital markets, but has been instrumental in bringing much needed automation and  efficiencies to some of the thorniest challenges that the industry has faced within processing OTC rates, credit, FX, and the syndicated loan space, with its processing division, as well as a variety of services and software within the solutions  division. Markit’s growth has always been based on a strategy of hiring key talent, directly from the industry, purposeful partnerships, all combined with aggressive acquisition. This combination has allowed them to create holistic middle and back office solutions, with engaged buy-in from key partners. Both Markit and IHS sit on vast resources, of the true currency of our time, data. Markit in the capital markets and IHS in energy as well as other industries. We can envision creating indices in energy  products, such as Markit has done in credit. We can also imagine creation of products like ETFs and smart equity across the industries where these two companies sit. They can also create research and analytics across the spectrum of industries where the combined company competes. I can see what each firm sees in the other.  

Everyone wants the LSE

Everyone wants the LSE
I cannot imagine that too many people are surprised that there are others who would like to own the London Stock Exchange (LSE); ICE has just confirmed and CME is said to be considering a bid. I do not even want to attempt to count, beyond the three times that Deutsche Boerse has attempted to acquire LSE, the numerous other bids and courtship talks that have arisen over the years. In each case, however, it was a case where the courtship failed to make it to vows. At the same time, any banker worth his/her salt will be making noise around the possibility of other bids, to maximize economic value of the deal. Furthermore, in the case of a freely available exchange (which is mostly not the case given national protection, and the historical pride associated with having a national exchange), they rarely remain single for long. In the regulatory and trading environment in which we live, there is tremendous operational scale in very large exchanges. The technology infrastructure and maintenance cost is high, and global regulation, generally favors a migration to exchange trading and central clearing. And, given the turmoil that blockchain might cause in the exchange and clearing landscape, it will require high levels of R&D budget. Additionally, the continued march toward multi-asset trading, across all asset classes is another factor in this steady drive toward global mega-exchanges. As we have seen the desire for more and more insight, analytics, TCA, and best-execution in equities, we have seen the same call, in FX, and now the clarion is sounding for fixed income. Exchanges with the breadth of product, depth of experience, and vision of a multi-asset future are best positioned to compete with the best product mix, clearing choices, and regulatory insight for their customers. A deal with LSE is not going to be easy as the competitive concerns will have sovereign and European regulators deeply concerned about the implications on equity trading and clearing dominance. Finally, on a European level the deal makes sense; the German and UK exchanges merging under the European flag. However, the UK is not so sure it wants to remain as part of Europe. The Brexit discussion might translate into strong national feelings of pride for the LSE.

Building smart blockchains

Building smart blockchains
In trying to discern the signal from the noise in the blockchain space, the noise level is high, but the signal is strong. My recent report, Blockchain in the Capital Markets: A Smart Distributed Future describes the implications of the blockchain and smart contracts in the capital markets across the value chain. The report explores the Fintech disruptors and the incumbents who are battling for position. Key themes that continue to arise in capital market blockchain use cases are the review of legacy systems (many of which grew up in a time of high margins), low cost of balance sheet, and freely extended credit. These systems need to be optimized for the realities of the regulatory, capital, and profitability metrics that exist today. I have also been reflecting on my participation in The Blockchain Conference last week in San Francisco. This was a great event that brought together some of the leading players in this space. The conference clearly indicated the impact distributed ledgers will have across industry verticals, as well as showing the implications for both evolutionary change and revolutionary change. There was extraordinary commitment to developing enterprise grade, secure, private solutions that will most impact the capital markets. The presentations and panels offered a look into this rapidly moving space, where everyone (from the smallest startups to the largest tech vendors) is approaching a new database model that will have far-reaching implications. The signal is there, and it is strong!

Digital Asset Holdings, R3 emerging as Blockchain leaders in capital markets

Digital Asset Holdings, R3 emerging as Blockchain leaders in capital markets
The news from this morning about R3 testing a trading system with eleven firms (Barclays, BMO Financial Group, Credit Suisse, Commonwealth Bank of Australia, HSBC, Natixis, Royal Bank of Scotland, TD Bank, UBS, UniCredit and Wells Fargo) on  Ethereum blockchain fabric hosted by Microsoft Azure was enough to discuss. Now Digital Asset Holding (DAH) has announced that it has raised US$50 million from thirteen capital market players, which can only be eclipsed by the announcement that ASX will engage DAH to build a distributed ledger solution for the Australian equity market. That was just today! Add in the announcement from Nasdaq with Chain around primary issuance of private equity securities at the start of the year and 2016 is turning into an exciting year for distributed ledger and blockchain applications in the capital markets.   The ASX news is fascinating and speaks to the rapid exploration of the distributed ledger space- according to the announcement:
  “In February 2015, ASX announced that it would replace or upgrade all of its main trading and post-trade platforms. Phase 1 of the program runs to the end of 2016 and will replace ASX’s existing trading and risk management systems. Phase 2 focuses on ASX’s post-trade services, including clearing and settlement of the cash equities market. The system that currently provides the clearing and settlement services to the Australian equity market is known as CHESS (Clearing House Electronic Sub-register System).”
  ASX hopes to achieve the call of leveraging a distributed ledger fabric to: reduce costs, latency, errors and minimize capital requirements.   ASX was one of the thirteen firms mentioned in the DAH capital raise. The other firms are: ABN AMRO, Accenture, BNP Paribas, Broadridge Financial Solutions, Inc., Citi, CME Ventures, Deutsche Börse Group, ICAP, J.P. Morgan, Santander InnoVentures, The Depository Trust & Clearing Corporation (DTCC) and The PNC Financial Services Group, Inc.   The current distributed ledger and blockchain environment is yielding interesting cross-pollination of competitors and vendors, with many firms active in multiple initiatives.   Celent will be among the firms that speaking at The Blockchain Conference on February 10 in San Francisco—there will be a lot to talk about!!!

A profitable future for capital market firms?

A profitable future for capital market firms?
I read a study by Broadridge and Institutional Investor this weekend that contemplates the future of capital markets. The two firms worked together to create a fascinating piece entitled Restructuring for Profitability. The study collected data from 150 equity analysts on their thoughts/opinions/predictions about investment banks. I also attended a panel sponsored by Broadridge that discussed the report’s findings with senior capital market professionals. The piece offers a very interesting perspective, through the lens of the views of an aggregated group of buyside and sellside equity analysts who spend their days assessing capital market firms. What I found especially interesting from the study was that none of the large banks globally will have RoE’s above their cost of equity capital in 2020:
  • The US was nearly there with a gap of 0.09%
  • Europe has an expected gap of 1.31%
  • Asia has an expected gap of 2.77%
The report is full of data, and some key points focused on regulation and where investment bank earnings will come from. Other findings include:
  • 61% of the analysts expect regulatory pressures on global securities firm to intensify between now and 2020. The breakdown on a regional level is even more telling with 75% believing regulation will increase in Asia, 67% expecting Europe regulation to increase and 39% expecting the US to increase. Perhaps getting Dodd-Frank and Volcker out of the way early will pay off!
  • The analysts are largely optimistic about growth rates with a uniformity of view that growth will be better to 2020 vs the 2010-2014 periods. The analysts are most optimistic about M&A/advisory services (growing at a 4.86% CAGR) and least optimistic about FICC trading growing at 0.20% CAGR.
The attempt to close the profitability gaps discussed above, according to the analysts, will come from cost-control and restructuring, rather than revenue growth or balance sheet management. This path will continue to include rationalization and disposing of business units. Moreover, the report indicates a strong belief that banks have underinvested in technology and process improvement, with analysts responding that over the last 5 years banks have not invested aggressively enough in new technology to improve efficiency (61% of the time in US and 66% of the time in Europe). In searching for profitability and investing more aggressively in platform reengineering and technology, a fascinating point was made by a senior banking manager during the panel discussion. He stated that when banks analyze their investment in technology, they need to consider the cost of lack of clarity on necessary capital required, given the general opaqueness around actual regulatory levels, and to add a factor for potential regulatory fines, into project costing analysis to ensure that banks are properly evaluating the project economics of major technology investments. With a realistic view toward the future of their industry, business lines, and impending regulation, senior capital market decision makers need to utilize this type of calculus to ensure they are investing in efficiency in a difficult revenue environment.