The Surging Appetite for Cloud-Based Services

I recently wrote an article for Capital Markets CIO Outlook that incorporates my thinking on the transition from one architecture to another in capital markets. I have the benefit of some of the great thinking of our analyst team on cloud, emerging technologies, and DLT.

While the end-state is unclear, directionally more and more capital markets firms are moving to cloud-based infrastructure, BPO, and IT outsourcing.

CIOs take note: I encourage you to, as much as possible, look outside your own four walls for inspiration.

See here.

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.

A New Architecture for a New Age: Digital Transformation of IT Infrastructure in Investment Banking

Digital Transformation of IT Infrastructure

I recently wrote an article for CIOReview. A full copy of the article can be found here. In the article, I state that investment banks are transitioning their IT infrastructure to a new architecture based on a new vision: digital. The goal of digital transformation is clearly to simplify IT and operations, reduce cost, and thus improve ROE. Digital is driving demand for cloud-based infrastructure, BPO, and IT outsourcing with banks moving many applications to cloud.

But to create  A New Architecture for a New Age, the new architecture is about more than movement from analogue to digital. Emerging technologies like machine intelligence can not only drive efficiency, but also offer advanced analytics and insights leading to investing and trade ideas, superior compliance practices, improved customer engagement, additional revenue opportunities, and more.

Moving from Known to Unknown: Blockchange

To create this aggressive form of digital transformation, a new financial technology stack is coalescing around Internet of Things (IoT) and blockchain, powered by cloud. The blockchain design pattern allows for cryptographically secured environments upon which to conduct wholesale and investment banking functions.

We believe financial institutions will deploy blockchain networks with distributed ledgers in increasing numbers. Smart contracts, which are agreements whose execution is both automatable and enforceable (according to Barclay’s CTO Lee Braine) will be powered by the networks and backed by digital assets, legal templates, and standards. IT and open source organizations will provide the fabric for blockchain networks, including cloud, while a number of technology firms will deploy and manage these networks to support applications atop this fabric.

Smart contracts will be enabled by confidentiality, security, and digital identity. The underlying technology will incorporate cryptography, programmable digital assets, distributed ledger technology (DLT), and interledger protocols. Yes, getting to smart contracts requires a lot of organizational change. Fortunately, blockchain creates some first mover advantages. So it’s not just cost reduction, but actual revenue opportunities that will encourage change.

Moving Ahead

Slow to move incumbents will be uncomfortably exposed to an unforgiving environment. Some will seek partnerships with fintech firms, a kind of hedging against the future (not a bad strategy, but an incomplete one), only to become hamstrung by the next quarter's results.

A better strategy is to decide what the future industry architecture will look like and then work toward becoming a leader by offering a new model for the future. Getting to the new architecture will take a minimum of three years, but most likely closer to 4 or 5. ‘Run the bank’ still overshadows ‘change the bank’ massively. To get from a known architecture to an unknown one requires courage.

French effort to use Blockchain for SMEs could have relevance for emerging markets

The recent news that a French consortium is beginning work on building post-trade infrastructure for trading of SME stocks in Europe will be of great interest to market participants across the world. The consortium comprises of BNP Paribas Securities Services, Euronext, Société Générale, Caisse des Dépôts, Euroclear, S2iEM and Paris Europlace.

There have been several notable developments with regard to experiments and adoption of Blockchain and distributed ledger technology in the leading capital markets globally. However, the signficance of this particular announcement lies in the fact that it tries to address the needs of the a sector that usually struggles to obtain easy access to the capital markets. If successful, such a project could drastically reduce the time taken for post-trade operations, slash costs and generally make it easier for SMEs to raise funds.

In a recent Celent report, we had found that most of the leading global post-trade providers believed that it was still a little early to expect major changes due to Blockchain technology. While this may be true, the current development would be of a lot of interest to the emerging markets around the world. In several such countries, the cost of accessing capital markets is comparatively high and the technology is also often found lagging, as in the case of European SMEs. If the French effort becomes successful, it could pave the way for application of Blockchain technology to specific tasks in emerging markets, not just to enable SMEs to raise capital better, but to help the overall market to leapfrog in terms of modernizing the market infrastructure.

Regulators and market participants in emerging markets should now see Blockchain and distributed ledger technology as a relevant means for streamlining their trading infrastructure. To that end, it is also important that they encourage firms within their jurisdiction to experiment and adopt such technology for specific local applications and requirements, and not just wait to see how it evolves in mature markets in the next few years. 

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.

Canada experiments with putting fiat currency on Blockchain

In keeping with the recent focus on Canada in the wealth management blogs, I would like to make note of a significant piece of news with regard to Blockchain and distributed ledger technology. For some time, the use of fiat currency on the blockchain has been touted as a necessary step for the development of distributed ledger technology. While central banks in the UK and the US have taken the lead in discussions on this matter in the past, the Canadian central bank, Bank of Canada, has recently revealed that it is planning to experiment with the use of fiat currency on blockchain. It will use blockchain technology developed by the well-known R3 consortium for interbank payments, involving some of the leading commercial banks in Canada. While this is more of an evolutionary step than a revolutionary one, it shows the growing willingness of central banks to take Blockchain seriously. If the experiment does prove successful, the possibility of interbank payments using Blockchain in a real-life scenario is quite likely. Even though the use of such technology by retail customers in this context is still someway off, Blockchain proponents would realise the significance of this announcement. It should also encourage further innovation within the sector. 

Capital One Rolls Out a Bank Built Robo

In a blog post yesterday I took automated advisors to task for the black and white way (advisor-assisted “hybrid” model versus “digital only”) they have framed the robo debate. Imagine my surprise when I saw that Capital One’s brokerage arm had launched a platform addressing this very complaint.

The Capital One robo combines a digital interface with telephone access to advisors. It’s an advanced take on the hybrid models offered by Personal Capital and Vanguard, both of which use digital technology (iPads, smartphones and other interfaces) to enhance and scale the contribution of the individual advisor.

What these models do not do is digitize advice delivery. Yes, they deploy algorithms to develop risk based portfolios, but firms have been doing this for ages. The defining characteristic of robo (as opposed to automated) advice is the removal of the real life advisor.

Robot with Benefits

The Capital One robo or robot is a step in that direction in that it automates the entire portfolio manufacturing process, while giving investors the options of getting a wise uncle (or aunt) on the phone to discuss it. This process spans risk profiling and portfolio construction on the front end to compliance and funding at the back.

Needless to say, clients pay for the privilege, to the tune of 90 basis points. This is not much less than the average US advisor charges for his services, and it is a given that other firms will replicate this model, and at half the price. In the meantime, give Capital One kudos for being the first US based bank (Bank of Montreal, whom I discuss in a recent report, was the first in North America) to roll out a homegrown, pure play robo advisory platform.

Cyber Security: Is Blockchain the Answer?

Cyber security has long been a serious matter for financial institutions and corporates alike, but fintech and the digital era make cyber security more of an issue. Delivery of products and services through digital channels means that more systems are available to scrutiny by malefactors. The continuing adoption of fintech APIs (by which institutions provide their clients with third party services) and cloud computing may introduce further vulnerabilities. Meanwhile, the growth of the digital economy is also creating a large population of highly trained technologists — potentially creating greater numbers of cyber attackers and cyber thieves.

Cyber threats affect all industries, but financial institutions are particularly at risk, because of the direct financial gain possible from a cyber intrusion. An important question is whether the existing cyber security guidelines issued by various industry organizations will continue to be adequate in the age of fintech and digital financial services.

Fortunately, the evolution of fintech also entails the development of new technologies aimed at creating the next generation of cyber security. A number of startups are beginning to develop applications using semantic analysis and machine learning to tackle KYC, AML and fraud issues. Significantly, IBM Watson and eight universities recently unveiled an initiative aimed at applying artificial intelligence to thwart cyber attacks.

The traditional cyber security paradigm is one of “defense,” and unfortunately defenses can always be breached. Artificial intelligence, as advanced as it is, still represents the traditional cyber security paradigm of “defense,” putting up physical and virtual walls and fortifications to protect against or react to attacks, breaches, and fraud or other financial crime.

What if there were a technology that broke through this “defense” paradigm and instead made cyber security an integral aspect of financial technology?

This is precisely the approach taken to cyber security by blockchain technology.

Bank consortia and startups alike are engaged in efforts to develop distributed ledgers for transfer of value (payments) and for capital markets trading (where the execution of complex financial transactions is done through blockchain-based smart contracts). Accordingly, distributed ledgers and smart contracts are likely to one day have a place in treasury operations, for both payments and trading.

Blockchain is gaining attention primarily because its consensus-based, distributed structure may create new business models within financial services. In addition, though, blockchain technology has at its core encryption technologies that not only keep it secure, but are actually the mechanism by which transactions are completed and recorded. In the case of Bitcoin, blockchain has demonstrated that its encryption technologies are quite secure. The further development of blockchain will necessarily entail significant enhancements in next-generation encryption technologies such as multi-party computation and homomorphic encryption, which are already under development. In other words, blockchain is likely to not only play a role in altering the way payments and capital markets transactions are undertaken, but also in the way next-generation financial systems are secured.

Future architecture: All roads lead to Cloud

Present vs. Future-State Architecture

Our frenetic activity of client meetings, briefings, conferences, and events heated up in the last few months. We recently spoke to audiences in New York, London, and Tokyo.

The present environment of cost-cutting, evaluation of profitability, capital efficiency, and compliance implementation is consuming much management attention and IT budgets. Operational efficiency and operational risk mitigation are top of mind.

However, across our client base and network of financial institutions and vendors, there is also a continued desire to understand emerging technologies like blockchain/DL and artificial intelligence. Many of you are expressing a strong interest in our opinions on the future state of the technology architecture in parallel with these day-to-day operational considerations.

From this vantage point, we believe the potential of blockchain technology (including smart contracts), IoT, and artificial intelligence will drive incremental IT spending going forward as solutions are implemented, further uses cases are developed and tested, and ecosystems and IT partnerships are expanded.

All Roads Lead to Rome Cloud

With respect to the future IT architecture, one striking conclusion we've reached is that all roads lead to cloud. For instance, major blockchain use cases are being built atop cloud providers. Technology firms such as AWS, IBM, Microsoft, and others appear to be prime beneficiaries of this frenetic activity, some of which is strategic, and some of which may be simply tactical and later disappear. In addition, artificial intelligence may be best leveraged in the future with data that resides in the cloud as opposed to in siloed business operations. Moreover, wealth managers increasingly are considering cloud-deployed solutions. Even compliance (e.g. RegTech) is increasingly being sold "as a service".

Clearly not all capital markets, wealth management, and asset management operations are cloud-friendly, both now and in the future, but many types of operations will move to the cloud.

We see this happening gradually and powered by availability, greater standardization, and creative vendor offerings across a spectrum (from ITO and BPO to managed services, utilities, and yes … cloud possibilities throughout).

A big bank follows the wirehouses upmarket

Money bag icon (flat design with long shadows) JP Morgan Chase’s decision to double the minimum asset level (from $5 to $10 million) required for service by its private banking group underscores the effect that digitization is having on all levels of wealth management. It echoes the approach taken by the wirehouses, who (with the exception of Merrill Lynch, which has served less affluent clients through its Merrill Edge program) have moved steadily upmarket in an attempt to rationalize their high cost service models. As such, the decision does not come out of nowhere but rather reflects the evolving economics of the advice business and the desire to incorporate new service models. It also speaks to the challenges and opportunities facing commercial banks. The Next Shoe to Drop Little noticed in the run up to the announcement of the rejiggered segmentation were a series of layoffs across the private bank. In retrospect, it is clear these were executed to lay the groundwork for the reprised segmentation and the pending launch of what the bank calls Private Client Direct. From the name itself, it is pretty clear that the bank is set to embrace a robo advisory model, perhaps in concert with one of the vendors (such as Trizic, the founder of which, Brad Matthews, is a JP Morgan alum) that have cropped up to serve the bank space. If it moves fast enough, JP Morgan could be the first bank south of the Canadian border (BMO launched its SmartFolio robo advisor platform earlier this year) to roll out such a platform. In truth, the JP Morgan decision is as much a right sizing as a rationalization, since only a small share of current private bank clients are affected by the move. From the bank’s perspective, this tighter segmentation is worth the effort, as small deposits exact a relatively high cost in terms of compliance and offer scant opportunities for profitable lending in the current rate environment. The point has been made, meanwhile, that personal service of the high touch sort is now reserved for the bank’s wealthiest clients. Doubtless management will pull out all the stops to keep these clients happy.