Open Platform: Intelligent Approaches for a Changing Sell-Side Landscape

Just staying in the game requires an ever-greater investment in technology. But the growth in infrastructure has to be efficient so that revenue increases at a faster rate than the simultaneous rise in costs. This is challenge enough for any firm, but for scale players, with multiple lines of business to support, it is replicated many times over.

One response has been to consolidate technology provision, so that discrete operational silos are collapsed into horizontal layers that support order management, connectivity or risk management. A single platform that can provide both depth of capabilities─managing workflow throughout the front, middle and back office─as well as breadth across an increasingly diverse array of asset classes, reduces the risk of inefficient technology growth.

But the new climate means that firms must go further still and challenge the traditional idea that in-house technology is always a source of value. In fact, serious questions are now being asked as to the viability of this approach in today's market conditions.

Outsource, Open Source and Secret Sauce
The role of trading technology is primarily to enable brokers to develop, protect and deliver their intellectual property (IP)─the unique features that create true competitive advantage─whether that is highly engineered algorithms, complex basket-trading capabilities, the quality of a firm's people and relationships, or its international reach and capital base.

However, not all technology contributes directly to creating and delivering IP to market. A substantial proportion of technology deployed by sell sides around the world is largely commoditized. It fulfils a necessary function, but delivers no real differentiating value to the business.

Instead, this commoditized infrastructure plays a supporting role to the main attraction─the IP layer that sits above it. But because venue proliferation and regulation continue to up the ante, the amount of infrastructure needed to deliver the same IP has increased greatly─the very opposite of the efficient growth that firms need.

Making the distinction between innovation and commoditization is an iterative process; like blocks falling in a game of Tetris, the arrival and integration of new sources of value can and should push the old differentiating factors into the realms of commoditization.

To achieve really efficient infrastructure growth, the focus has to be on maximizing IP. For everything else, the goal is to ensure that the service is delivered to the right standard and at the right price. This is the underlying argument behind outsourcing, and one that is proving increasingly attractive to the financial services sector.

Ensuring this efficiency is dependent on two factors. The first is provider selection. Global and super-regional brokers will need to ensure they work with third-party suppliers who can deliver on the same scale, with a global reach, multi-asset capabilities and crucially, a workflow-centric approach to technology. However, since the commoditized infrastructure is not a source of competition, it can also be provided in partnership with peers or even competitors.

There are a number of areas where such a collaborative approach could be applied in practice. The legally required storage of trade history files is one─a shared, central storage utility could eradicate the duplication that currently plagues data storage, and minimize costs for the industry as a whole.

Alternatively, post-trade affirmations and confirmations, where demands for shorter settlement cycles, skyrocketing costs of capital, and a proliferation of buy-side approaches has driven up cost and systemic risk for larger sell sides, is also a potential candidate for a community-led approach based on a single open standard.

Intelligent Design
The other critical success factor is making the right decisions about where to innovate and where to commoditize. One firm's IP is another's commoditized service, and the relationship between the two will eventually become a factor in a firm's actual IP. For example, the way in which firms interpret the new Markets in Financial Instruments Directive (Mifid II) rules that require broker-crossing networks to evolve into either multilateral trading facilities or systemic internalizes will have a serious impact on competitive differentiation, and hence, IP. How this flow is matched internally could also be a potential candidate for creating IP, as could global program trading or algorithms, the provision of capital and liquidity, and the security of greater risk-checking and compliance capabilities.

In contrast, exchange connectivity is less likely to deliver competitive advantage as the race to zero has reached a point where the effect of a few extra micro-seconds is negligible for those outside the extreme HFT community.

But the critical point here is that the line between the IP layer and the commoditised infrastructure below it is not set in stone. In today's markets, IP needs to be dynamic and responsive. A unique source of value today may very well be a commodity service tomorrow. Making the distinction between innovation and commoditization is an iterative process; like blocks falling in a game of Tetris, the arrival and integration of new sources of value can and should push the old differentiating factors into the realms of commoditization.

As the cycle of innovation continues to shrink, the more ruthless a firm must be in managing the line between the two.

Steve Grob is the director of group strategy at Fidessa. The opinions expressed by the author do not necessarily reflect those of either Fidessa or Waters.