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.

Is this the best time for an event such as Brexit?

It is difficult to read financial news at present without coming across extensive coverage of the Brexit referendum in the UK and its possible impact. As part of the financial sector, capital markets could be at the forefront in terms of bearing the impact of any likely change. There are already widespread claims of how London could lose its position as the premier European financial center. Of special relevance is the advantage that London has due to the 'passporting' principle, which allows leading U.S. or Asian banks and other firms to access the Europan market without any restrictions. Certainly with regard to these firms, if the UK leaves the EU, US and Asian banks that have based their teams in London while serving the European market will have second thoughts about doing so. Different alternatives have been touted, including Paris, Frankfurt and even Dublin. Some believe that all of these cities, and some other European financial centers as well, would benefit from the departure of the leading global banks from London, but this could lead to fragmentation in the European financial industry and reduce the effectiveness and competitiveness of European firms. 
There are various views and opinions that have been expressed during the run-up to the referendum. Many of these hold water. But in my humble view, when it comes to competitiveness, if the departure of the UK from the EU does lead to a fragmentation of the European financial industry, then this is the best time for it to happen. Technology has today advanced to a level that to an outsider, there would be little tangible difference if a thousand people in a bank are based across four difference financial centers in Europe instead of being in one place they were earlier, namely, London. There would certainly be a one-off rise in cost due to such as move, but the industry should be able to take that in its stride. Furthermore, a more fragmented industry in Europe would also have the ability to address national and regional requirements better than a single leading financial center. So financial creativity and innovation might get a boost across Europe. One would expect that London would continue to be a leading financial center globally, but it might be forced to reinvent itself to continue to be relevant for global banks and financial firms from outside the UK. Therefore, as a neutral and a student of capital market technology trends, Brexit does not necessarily hold many fears and might even lead to some interesting outcomes. Whether people in the City of London or the rest of the UK or indeed Europe have the same view, is of course, another matter!

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.

Intra-IDB part II: The ICAP to eCAP deal

Where there is smoke there is fire and the proposed outline for a deal which I discussed in my blog this weekend was announced today.  Long time rivals  in the inter dealer broker (IDB) space Tullett Prebon and ICAP are coming together with Tullett buying ICAP in an all-stock deal. Tullett will now be the 800 lb. gorilla of voice brokering, with about 1500 ICAP brokers  going to Tullett as part of the deal as well as another 1000 employees. The deal will also include certain electronic assets like  ICAP’s 40.2% ownership in iSwap (IRS) , certain JVs and as well as the not clearly defined information services revenue. The details of the deal terms, economics and structuring are discussed in the press release and the analyst presentation. I will focus on certain key points of the deal looking at the ICAP side. ICAP has followed a strategy of acquiring growth and putting together an impressive portfolio of front to back  technology assets. Historically, its main challenge in maintaining the voice business was not only the lower margins, and slowing environment for many of the products traded  but the internal competition between its voice and electronic channels. The electronic businesses have not grown as they should, had this internal friction not been present. This is the case across asset classes. But, as they say, better late than never, and ICAP is on the road to becoming a different company. The new ICAP (let’s call it eCAP) will include: • FX venue EBS and the related EBS businesses • Treasury exchange BrokerTec • Post-trade and processing companies TriOptima and Traiana which serve across asset classes with a focus on FX, rates and credit • FinTech incubator Euclid which has been active in making strategic bets for the firm • Tullett will have the right to the ICAP name What is not entirely clear at this point is what “information services” will remain with eCAP. Given the importance of market data, a detailed understanding of the  value of  eCAP will be a function of whether certain market data assets like data from EBS and BrokerTec will remain with eCAP. Furthermore, it will be interesting to see if the eCAP has the right to compete in interest rate swaps, or what its plans will be to develop an electronic platform for IRS given the loss of iSwap. I would imagine, given the importance of interest rate swaps in the rate world that the new firm will want to have a robust offering in this area. In sum,  eCAP will be a lean technology, execution, venue, tools, pricing, and analytics company. Of course, eCAP will still have a vested interested in the voice business as it will hold about 20% of the newly issued Tullett stock.      

Intra-inter dealer broker deal: facing the future

Speculation reached the point Friday afternoon such that a press release came out regarding the discussions of two major brokers. ICAP and Tullett Prebon, two of the largest inter dealer brokers (IDBs) announced that they were in advanced discussions; it appears ICAP is poised to sell its voice brokering businesses and certain electronic platforms to Tullett. On first blush, it looks as though ICAP will be shedding its voice brokering businesses and certain e-platforms; while maintaining such platforms as EBS and Broker Tec (FX and Treasuries) as well as other platform assets, ancillary businesses around these platforms (such as data and analytics), as well as ICAP’s extensive post-trade infrastructure. Friday’s press release detailed the assets that would be part of the transaction. In summary: • ICAP’s three regionally managed voice broking businesses in EMEA, the Americas and Asia Pacific (1,458 voice brokers); • (“APAC”), including all e-trading products and services developed by ICAP’s e-Commerce team (including Fusion and Scrapbook) (together “Global Broking”); • ICAP’s 40.23% economic interest in iSwap, a global electronic trading platform for EUR, USD, GBP and AUD IRS; • Revenues and operating profits from sales of information services products directly attributable to Global Brokering and iSwap; and, • Certain JVs and investments. IDBs have struggled in the post-crisis world to deal with the changing dynamics of regulation, the nature of their place in the market and lower volumes. Furthermore, MiFID II is on the horizon in Europe and will further change the competitive nature of the IDB space. More importantly, in many cases, IDBs have struggled for years with the right formula to develop electronic distribution and sales channels without cannibalizing their core voice businesses. The pressure on the IDB community has been immense. ICAP now has an opportunity to focus on an electronic future, across assets, from font to back office.  ICAP, with holdings across markets will now be a considerably leaner technology company. It will be able to serve its traditional dealer clients as well as other businesses in the changing capital market world. It is very likely in the next day, with the confirmation of a deal, ICAP will be beginning a path toward being a very different, technology and processing based company. As a final note, it will be interesting to see if there are any other competitors, on the side-lines, who will be positioned to step-in and change the final parameters, or even players in the deal (as was the case with BGC/Cantor in the GFI Group deal).

The future is here

The pressures are well known in banking and the capital markets. Each month there are front page articles of scaling back, overhauling, reorganizing, or closing major bank lines. A continued reworking, a forging of a new business is occurring. Old models are shrinking and being replaced by new business models or being cast aside. Since the 2008 crisis, wave after wave of pressure has made this perfectly clear. Capital constraints, on-going regulatory pressures, and an ultra-low interest rate environment have all struck hard at the existing banking & broker/dealer system. Nearly all players-big and small- are rethinking the very core of their businesses. And this is a multi-threaded problem across all businesses: equities, FX, fixed income, and derivatives. Banks and broker/dealers are trying to balance their existing franchises against the pressures they are facing to create a lean profitable business that supports their clients. There are no easy answers, given the strong interdependence between the wealth, asset management, and capital markets businesses across all products. Many of the solutions are moving from efficiency, or cost-cutting to effectiveness. Costs are being cut-there are improvements in risk, compliance, processing. The cost side is getting better but the challenge remains on the revenue side. This drive for effectiveness is driving business models that support internal and external clients from a compliance, transparency, regulatory, fairness and cost perspective are driving more automation and electronic trading solutions. Celent will be discussing the evolving landscape of innovation in automation and technology at two upcoming roundtables. On September 15th in London we will be looking at changes in the US and European fixed income markets and how new technologies are driving change. Then on September 22nd in Zurich, we will be looking at wealth management and the capital markets and the many changes that are occurring in Swiss banking.

Billions, trillions-actually it’s quadrillions

I am going to start today’s blog post with a short quote from Blythe Masters who was presenting last week at a conference on digital currencies, where she was reported as saying, “It should be fairly obvious that the addressable market for this technology is absolutely gigantic. We’re talking markets that are measured in the trillions, not the billions.” Actually, the dollar value of securities transactions processed each year is measured in the quadrillions. That is the first time I have used the word “quadrillion” in writing but I think I will be using it a lot more in the coming months. The market sizes for possible disruption in capital markets by distributed ledgers/ blockchain technology are absolutely staggering as is the breadth of impact on lowering costs, freeing up capital, reducing counterparty risk, introducing new financial services players, and managing the systemic risk of our financial system. As mentioned in an earlier blog post, we are starting to see different approaches to distributed ledger/ blockchain technology emerge and, frankly, there remain a number of challenges to implementing the right architecture for this technology. However, when you are talking about markets measured in the quadrillions then the financial incentive to innovate and navigate these challenges is arguably larger than any financial incentive in history. Incumbent financial institutions have got to be on the front foot when it comes to understanding the potential impact on themselves and the ecosystem they’re a part of.

What comes first, OTC derivatives trading volumes or the CCP?

In a couple of recent discussions about central counter-party clearing for OTC derivatives in the global capital markets, we have come across the view that the move towards central clearing has not been as comprehensive as expected earlier. What this is referring to is the fact that the number of central counter-parties (CCPs) has not changed significantly when we look at the global markets. In the developed markets in the US and Europe, the presence of existing CCPs and the difficulty for new CCPs to break into the market has been an important reason. In the case of emerging markets, the fact that the volumes of OTC derivatives traded are quite low means that only CCPs in large markets such as Brazil and China are expected to be viable. Hence, not too many CCPs are going to crop up in the smaller emerging markets. This belief is understandable, but we must take into account the fact that the maturity of capital markets in these regions is low. As the emerging markets evolve, the presence of CCPs would encourage more trading in OTC derivatives products and allow for greater innovation and also standardization in the long run. These could be factors that increase volumes for OTC derivatives trading in smaller markets in regions such as Latin America and Asia-Pacific. Also, until recently,  the emphasis for the respective regulators and governments with regard to derivatives trading  has been on exchange-based trading. The presence of a local CCP and the greater transparency that ensues in OTC derivatives trading would encourage both regulators and governments alike to allow for more trading and clearing of these products due to better oversight. Hence, this is a virtuous circle and decision-makers who are looking mainly at current OTC derivatives volumes before they decide whether to have or not have a CCP in their domestic market should also look at the potential for trading of OTC derivatives products in the long run. Similarly, the market participants also should take a positive view towards CCPs in smaller markets, as initial focus should not be whether the CCP would be profitable and competitive regionally and globally, but whether it fosters safer trading and clearing of OTC derivatives and allows for higher trading volumes in the region than before.

A vital utility in the OTC derivatives industry

Leading OTC derivatives industry participants including banks and post-trade services providers are backing the creation of an creating an OTC post-trade infrastructure utility. This hub will help automate the margin management in the industry and is also expected to reduce the disputes around margining. Until recently, moving important functions to utilities was often frowned upon. In several instances, firms showed reluctance to participate in a utility unless there was evidence of widespread acceptance of its services. But now factors such as regulatory requirements and the need to cut down upon costs are creating an environment conducive for the greater acceptance and use of utilities. To that extent, the industry has reached the tipping point with several other instances of utility or near-utility services being offered, most notably for KYC requirements. This is a good sign for the industry overall. The higher cost of operation due to regulatory requirements and the ever-growing need for investment into technology up-gradation means that often it might make more sense to move such services that are either more commoditized or require industry cooperation (or both) onto a utility platform. Hence, such a step in the highly competitive OTC derivatives industry is quite significant. It will help increase automation and efficiency, reduce costs, and encourage other segments in the capital markets industry to consider the use of utilities in a more positive manner.