The Profit in Playing the Villain

Several years ago, the capital markets looked ripe for disruption—or so the fintechs wanted you to believe. Almost every day there was talk of a new fixed-income trading platform, a new network, a new piece of technology that would not only solve existing problems, but would go one step further and disrupt the entire process of trading itself.

This was most evident in blockchain, where various early-stage prophets proselytized to a captive audience about how we would no longer need depositories, exchanges, or even clearinghouses. The Godchain would take care of all that.

But it wasn’t just blockchain, and this is important to remember—much of the hype around fintech was actually driven by people looking at various processes like price discovery, information slippage, latency and other areas, and saying they could do better than the banks, because it almost always was the banks that people spoke about. Nobody really wanted to disrupt the buy side, for two primary reasons—first, there isn’t all that much to disrupt in investment management outside of capital-related areas, like fees and performance. Buy-side trading is largely predicated on that, and of course, it’s influenced by technology and the way in which processes are performed, but the primary determinant of performance is often a portfolio manager’s nous, rather than his or her order management system.

Second, the buy side has proved willing, time and time again, to disrupt itself. Years ago, when banks were still debating the merits of moving anything to the cloud, asset managers were moving everything to the cloud. As banks—particularly futures commission merchants—have tentatively begun outsourcing back-office operations to vendors, buy-side firms have been fully on board with this for years now.

Real Value

The real value for the buy side in the fintech craze hasn’t necessarily come from disruption—that already started to happen for them when trading moved to the screen, and the cost of commissions went right down when the sales traders began to be disintermediated. The real value has been generated in the fact that now that there has been a period of maturation and natural selection in fintech, the stronger firms are doing a lot of the work for them when it comes to emerging technologies.

It is, for example, no coincidence that one of the busiest sectors this year has been surveillance, and how artificial intelligence and machine learning have been applied there. Nasdaq acquired Sybenetix in July, while Trading Technologies acquired selected assets of Neurensic in October. Both of these have applications to the buy side, and both of them incorporate advanced technologies that go beyond the traditional cliché of rocket scientists working in finance.

Most importantly, both of them provide the buy side with access to these technologies without them having to spend a red cent on research and development, or expensive PhD salaries. For the sell side, of course, fintech has been a boon in that they can simply circle the survivors and pick off what they want. Fintech, inasmuch as it refers to a startup firm based in a garage, was never going to displace the incumbent tech providers, let alone the banks. 

Indeed, the sell side was more than happy to play the villain for the most part, and allow the bluster and hyperbole to continue for as long as many startups wanted. It might be useful for attracting venture-capital dollars, but in capital markets, it’s hard to attack such niche areas without the ability to scale, or to offer the protections that an incumbent bigtech or vendor can.

As they knew from the start, the funding eventually dries up, and aside from a few success stories, we’re starting to see the disruptors being picked off by the sell side—and indeed, occasionally by some large asset managers with an appetite for technology. Any way you look at it, fintech has been a huge boon for the buy side, but perhaps not in a way that startups initially thought it might be.