Tighter budgets, increasing compliance demands and lower profitability have meant that the technology teams at financial institutions have had to drastically cut back investments in innovation. But this, accompanied by continued advances in technology and changing customer preferences, has created an abnormally large gap in the market for smaller independent firms that don’t carry the financial burden of legacy investments. These financial technology – or FinTech – companies are featuring more prominently in the press as vast sums of money are invested at ear-popping valuations.
However, recent venture investments have not reached buy-side technology segments equally. So, which areas have received funding and what do they have in common? How should firms operating in the areas without this investment react? What might come next?
While FinTech is not new, over the past five years there has been a wave of investment concentrated in four areas that has put significant pressure on traditional financial services players:
To a large extent, the remainder of the buy-side industry has seen little action so far. With a total spend across the buy-side at around $60 billion, a large and growing market of relatively stable customers and a fairly fragmented set of suppliers, private equity and venture capital firms have been unwilling to front capital and risk exposure to this segment. This may be due to the low probability that technology spending is going to increase dramatically or the lack of M&A and IPO activity needed to ensure a successful exit. So when offered the alternative of potential unicorn returns from mobile payments, crowdfunding and cryptocurrencies, it is easy to see where the venture investments go. Buy-side firms are focused on maintaining their existing systems and adapting them to make more intelligent order routing based on the new sources of best execution data resulting from the MiFID regulation. This has left little budget for R&D or experimentation. Incumbent vendors appear to have the upper hand in this scenario which is posing a challenge for new entrants except in cases where the more traditional players find it hard to be light or cheap enough to meet tightening budgets.
Fast-forward 10 years and stagnant buy-side firms may well face the threat of disruption – using Clay Christensen’s interpretation of the term. New entrants that have saturated the retail space with a variety of products that span asset classes will have shifted their focus towards growth in the institutional space with blockchain technology enabling those quick enough to adopt it to disintermediate sell-side brokerages and trade directly between one another using an approach similar to Luminex. Even if not all of the operational efficiency and transparency gains suggested by blockchain are realized, it will only take another period of financial distress for the justifications for commissions to be questioned when firms like Robinhood Financial offer zero-commission trades.
Buy-side firms that have avoided the eventual disruption by new entrants will have taken a different approach to the decision-making process around technology investment – one that involves a very clear selection of the capabilities needed to establish and maintain a competitive advantage. Their technology cost base will have transitioned from capital intensive infrastructure to renting managed services resulting in a positive effect on cash flows and an ability to scale up and down as needed.
However, until that day comes, buy-side firms face both budgetary and implementation challenges made more complex by having to support a heavy legacy infrastructure. Meanwhile, technology firms offering those much-needed technology advances face the struggle of overcoming tougher screening mechanisms from increased compliance, vendor consolidation initiatives and battles with defensive incumbents that may copy their product or even be protecting an area they don’t currently serve, all before they run out of cash.
Thomson Reuters is facilitating the transition out of this stalemate by creating an ecosystem for the financial services industry. For FinTech start-ups, the Eikon App Studio is already enabling new entrants to reach the global buy-side customer base of Thomson Reuters. Firms like OTAS Technologies, Genesis Global, FlexTrade, MarketPsych, SavaNet and TruValue are benefiting from infrastructure components, open source APIs, the ability to get to market quickly through a global distribution channel and in-platform connectivity to Thomson Reuters data for integration into their products.
For buy-side firms, this lowers the cost and risks of implementation but it also offers the ability to host applications for distribution onward to clients. Thomson Reuters data centres can be used for cloud deployment of applications and capabilities combined with side-by-side access to Thomson Reuters data. Supplemental managed services range from metadata extraction to open source permanent identifiers that act as a unique and persistent reference for objects that might be companies, instruments and people. The PermID removes the need for mastering data item identifiers while also enabling disparate data sets to be connected to find alpha as well as reducing client onboarding KYC costs.
For the industry, Thomson Reuters is giving participants across the ecosystem the opportunity to benefit from the shorter development cycles of newer technology and rapid access to firms bringing technological advances to market. The future will see buy-side firms improve predictive analysis in their funds using machine learning more extensively for both investment hypothesis development as well as dynamic order routing, while collecting and aggregating data to support those decisions in real time. Their challenge, however, will be to reduce their legacy tax – but perhaps there’s an app for that too.
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