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.

Symphony messaging: WhatsApp to business’ ears?

It’s official, what many financial institutions have been saying for quite a while is becoming reality: they don’t want Bloomberg (or any third party?) to have access to all of their messaging, trading or not related, anymore and hence have decided to team up as equal partners, in a top-notch technology utility that serves the needs of its members, a key to its potential success, to fund a competitor messaging system called Symphony. The network, the link between the bankers and their clients and between their clients and their competitors is what enables them to be and stay in business: A third party cannot be invited around that table. Not only, Symphony could be offered to other business sectors as a professional WhatsApp. Follow me here: financial institutions don’t trust anymore a third party to manage their messaging data, but think other business sectors will trust financial institutions to manage their messaging data. Although I personally got annoyed when my bank asked me why I was spending some of my savings‎ on our family farm when I asked for a mortgage, I know they probably know my financial situation better than I do, and that I am not a potentially “good” client for them: I trade myself, have little savings, do everything online, so I guess it’s only fair for them to ask. Of course Big Brother is watching me – and so should he. But I am not sure if I would send all my WhatsApp messages on a bank-owned competitor system, would you run the risk that your bank could potentially see all your messages? In the case of corporations and businesses though, things are slightly different: their relationship with their banks are usually extremely deep, their bank helped them get their first line of credit, maybe introduced them to private investors or helped them IPO. And when they wanted to take part in a big project with a new foreign client they bridged the financing of the project, they helped them offset their FX risk, invest their liquidity and manage their treasury… so if they started potentially seeing their employee’s messages to their clients or suppliers, would it really make a difference to them? Probably not. Of course I am extremely simplifying the potentially extreme risk such a system could have; It has been created on the back of a highly secure encrypted internal system Goldman Sachs had developed and has been enhanced with the best of the best (it is said) technology, in an open source environment. We’ll be make sure to test it as soon as it is offered to the public later this year and am waiting for the next Instagram for finance.

Of games played for thrones

As Season 5 of Game of Thrones nears its end, I have come across a number of articles that have been talking about the leadership lessons that we can draw from the TV series (and presumably the books too). The first thing that comes to mind is that our world has enough problems already without having to take pointers from a bunch of people who probably kill each other more often than we have cups of coffee in a day. But then one starts realizing that maybe there is something after all to this fuss about the knowledge to be gained from the GOT. The next thing that comes to mind from there is that if there are leadership lessons to be learned for the world of business in general, surely there must be some for the capital markets too. The leading capital market sellside firms in JP Morgan, Goldman Sachs, Morgan Stanley, Deutsche Bank and so on probably are the parallel of the seven families, along with a couple of the leading buyside firms (the upstarts to the throne?). Daenerys’ dragons can be an example of game-changing technology such as Big Data processing, Cloud services or Machine learning. Similarly, the recent resignations of leading figures at some of these firms can be an example of the blood-letting we are so used to in GOT. If anything, GOT teaches us that merely changing the leadership does not change the direction the kingdom, or the firm in our case, will take. Nor does it change the impact of the environment around us. In the case of the for capital markets, for example, the tough regulatory and economic environment is here to stay. The ‘winter has come’ and we would do well to get used to it. We could presumably go on in this vein, but I am not sure we should draw too many parallels with, or take too many lessons from, a series that makes Greek tragedies look mild by comparison. If the pain on the screen is not enough, we are going to have to live with the very real tragedy of the season ending just when we were getting all warmed up and beginning to benefit from its infinite wisdom.

Market Surveillance issues

As I begin work on the last in the current series of Market Surveillance reports, there are some important points that we can reiterate from the recent research. The first is the all encompassing requirement for surveillance. The recent Deutsche Bank co-CEO resignations have shown the negative impact the benchmark manipulation related sanctions and fines had on not just this bank but the industry as a whole. Similarly, the investigation of a couple of British banks regarding the payments made in the FIFA bribery scandal also shows the need for constant vigilance on part of banking and capital market participants. Firms are embracing the need for holistic surveillance and compliance, which covers not just trading but also related areas such as best execution, cyber-security and AML. Firms that have legacy systems in place might want to continue with several systems, but for the better part, most firms would prefer to have one system that meets most of their requirements. As more advanced technology becomes available, this is becoming more of a reality. Another important aspect is the rising use of machine learning capabilities. Surveillance systems are becoming more advanced, processing both structured and unstructured data, especially through the use of cloud based processing and Big Data technologies. Machine learning takes this to the next level, as it reduces the need for human intervention, and allows for reduction in false positives and negatives. Furthermore, such advanced systems also allow firms to keep tabs with new compliance requirements more efficiently as they can anticipate problem areas based on learning from past experience. Finally, exchanges and sellside have been the main users of market surveillance technology. But increasingly regulators and buyside firms have also started acquiring these systems. For regulators, it makes sense because it allows them to monitor the market independently and reduces their dependence on the exchanges and the sellside for data and analysis. For buyside firms that are playing a more active role in the market, it is important that their trade surveillance is upto scratch, otherwise they are making themselves vulnerable to the same issues that are plaguing sellside firms at the moment.

Hack attack or cyberspionage

As I started writing this blog, yet another major hack has occurred; data for about four million US Federal employees (over 1% of the overall US population) was stolen–in what is certainly a criminal act, and potentially an act of “cyberspionage”, if not an act of 21st century warfare. It is interesting to consider whether we are actually in the beginning of a new cold war, as state actors attack, both commercial and government organizations to harass. Is the purpose criminal, to utilize major data sets for criminal gain, or to learn more about one’s enemy? To bring the focus to the financial services vertical, it is clear that ever increasing vigilance is required to defend the banking perimeter, but what needs to be done on the capital market side? The threats of theft of money, theft of confidential information, and the loss of reputational are shared by every industry, and capital market participants are no different. Moreover, there are additional concerns that are specific to the capital markets, which include:
  • Control loss at an execution venue
  • Spoofing attacks that create false liquidity or deter liquidity
  • Wealth destroying false news
  • Central depositories & clearing houses data attacks
To meet these myriad concerns, the challenge is talent. I do not think we have enough former NSA employees and hackers that want to come to the good side to meet the demand required.  The solution for cyber protection of the capital markets will come from a number of directions: greater cross industry efforts to share insights and knowledge about known intrusion vectors; greater development of big data tools to overlay simple rules based approaches—given the incredible amount of false positives for intrusion, and hence the natural inclination to begin ignoring data; increased focus on holistic risk assessment encompassing internal and external resources; working closely with infrastructure and telecom/data providers to monitor traffic across networks; development of AI tools that help market participants stay a step ahead of the dark side, allowing robust technology defences that can respond. Please see these recent Celent reports for more information: