Innovation: Unlocking value through fintech
By Steve Grob, head of group strategy at Fidessa
Barely a day goes by without a financial technology start-up claiming it is going to do to capital markets what Uber and Airbnb have
done to the transport and accommodation industries. The journey towards true
innovation in capital markets, however, looks much harder because of the
entrenched technologies, processes and regulatory obligations that comprise
global financial markets.
Capital markets today
In the wake of the financial crisis, we're
witnessing the inception of an entirely reshaped industry driven by the twin
pressures to demonstrate relevance whilst ratcheting down cost to reflect the
new economics of market participation.
Combine this with the fact that regulators
everywhere are pushing for even greater transparency, and it is no longer
viable for the sell-side simply to intermediate between its customers and
sources of liquidity. Buy-side firms are also on the hook to demonstrate to
their own investors how they procure research, allocate costs and get the best
possible execution quality from their brokers. Both buy-sides and sell-sides,
then, now have to demonstrate the real value they bring to the party.
The regulatory hurdles of operating in today's
capital markets, and the increasing cost of capital, mean that firms of all
sizes have to scrutinise every aspect of their operations. They need to
develop creative ideas to solve, simultaneously, both the cost and the
relevance problems, defining which of their activities are necessary but
non-differentiating and which can add demonstrable and differentiating
value.
Innovation can add differentiating value to
demonstrate relevance ('Type R' innovation) or help reduce cost
('Type C' innovation). Each has its own very specific set of characteristics
and challenges but the same approach can be used to improve the outcome for
both.
Examples of Type R and Type C innovation
Obvious examples of
Type R innovation in the sell-side include algos or smart routers, but a new
class of more exciting applications is emerging in the battle for relevance and
value-add. Providing context to any particular trading situation, these
intelligently bring together multiple sources of structured and unstructured
data to help the user understand the why rather than just the what. Other examples of Type R
applications are those that help traders interpret the trading landscape more
efficiently. Both can help the sell-side offer demonstrable value to their
clients.
The buy-side can benefit from understanding
context better too. Today the problem isn't about getting data to support a
particular trading thesis, it's about filtering out the noise, effectively
curating what is left and using that information more imaginatively. Tools are
emerging that allow portfolio managers to look intraday into back office
systems to help drive better decision making. Similar tools are helping the
sell-side better understand historical trading shapes that allow them to offer
genuine insight to their clients.
Type C innovation seeks to solve a different
problem set and is all about efficiency and driving down cost. With front
office approaching a point of diminishing marginal returns in terms of further
automation, there is an increasing focus on other areas of the workflow -
post-trade in particular. Firms may boast very low breakage rates in
affirmation processing, for example, but in an area dominated by legacy
technology and often characterised by inefficient work practices, the cost of
getting there is exponentially high. Applications that automate exception
handling through standardised workflow are good examples of Type C innovation
that can really drive down cost. Type C innovation is also being driven by the
growing realisation that firms are unlikely to get to an acceptable cost level
on their own; they're looking at how pieces of workflow can be standardised and
operated on a collective basis. This works well for those areas that are
non-differentiating, such as trade reporting, affirmation processing or data
standards.
Blockchain technology, for example, has the
potential to collapse the cost of clearing and settlement to almost zero, but
it will only work if everyone adopts the same blockchain technology.
Barriers to innovation adoption
Assimilating new innovations is never easy, but
fintech and capital markets throw up some distinct problems for would-be
disruptors. Many innovators (especially the Type Rs) can struggle to convince
large market participants that they meet the mark in terms of resilience,
security and regulatory compliance. Also, many new innovations only really work
if they can be embedded in the trader's existing workflow and operate
dynamically so as to reflect what the trader is actually trying to do. Only by
being tightly coupled with existing workflow can Type R innovation gain
mainstream appeal.
Any new idea only really works in practice once
it is widely deployed, so Type C innovators face an additional hurdle. Where
complete end-to-end trading workflow depends upon the collaboration of multiple
counterparties, achieving uniform momentum across enough parties concurrently can
be a significant barrier to new technology adoption. What is needed is the
means to co-ordinate, lead and execute upon initiatives.
Innovation ecosystems
An ecosystem approach to innovation facilitates
the interaction between old and new technology (Type R) and the bridge between
old and new work practices (Type C). This interconnected network is empowered
by elegant organisation which allows each member to be more successful than
they would otherwise be. Examples from other industries abound, with perhaps
the most famous being Apple’s App Store. The problem with the App Store
approach in capital markets, however, is that the demands from financial
institutions are such that any 'store owner' would either have to abrogate all
responsibility for its apps or spend almost its entire time vetting and
monitoring its app providers.
Whilst the fintech incubators can provide valuable guidance (and money) they can do little to help new firms execute.
What is needed is something far more controlled and based upon a genuine partnership between a proven, established provider that can cover areas such as workflow and resilience, and the newcomers that are now free to innovate in areas such as context and visualisation. The former takes full responsibility for the overall outcome to their mutual customers - commercially, technically and legally - and ensures that the newcomer’s technology is elegantly embedded within its platform to avoid poorly integrated or even conflicting parts. Doing this right takes time and money, but if successfully executed the outcome is likely to be way more certain and impactful.
Ecosystems can also work well for Type C innovation. Competing firms need to be encouraged to work together and share ideas, and this is more easily achieved when organised by a trusted, neutral third party. This needs to extend beyond just the establishment of technical standards, though, to include defining the new workflow and then building and operating any resultant innovation on a utility basis at a fixed margin. By way of example, the specification for using FIX in post-trade affirmations has existed for over ten years and yet it is only relatively recently that a standardised workflow has been defined and is now being rolled out across the industry. This underlines the point that if the same organising party also has distribution across the buy- and sell-side, then the result in terms of driving industry change can be extremely powerful.The road ahead
Capital markets will continue to reshape
themselves and, in so doing, drive the need for the buy-side and the sell-side
to innovate, both to demonstrate relevance and to reduce cost. Fintech
innovation that isn't clearly solving one of these problems or the other
will struggle to gain traction. Even those that do will still face some unique
challenges in crossing the chasm into mainstream success. The elegant
organisation that well-developed ecosystems can provide bridges the journey
from the old to the new. Those firms that can help the buy- and sell-side
assimilate new technology in this way will come to dominate.
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