Innovation in Financial Services Isn’t Dead — It’s Different
Challenge breeds innovation. Challenge drives bright people to come up with disruptive ideas that improve some facet of our life; be it our work life, home life or both. Thomas Edison realized the potential impact of electric lighting and devised a way to make bulbs and lamps available to the masses and also the means to power them in people’s homes. The fact that Alexander Graham Bell’s mother was deaf very likely contributed to his interest in sound, which eventually led to his invention of the telephone. After the personal computer was invented, its potential to revolutionize human interaction and communication was realized, and DARPA eventually connected two computers to form the first network. These great innovators saw challenge and invented ways to overcome it.
Innovation has been a constant in the financial services industry for years, although it can often seem like we’re mired in legacy systems, processes and business silos. There are numerous examples; the paper crisis of the 1970s gave rise to the first electronic trade confirmation system. Order management systems revolutionized trading and communication between counterparties. Risk and analytic systems altered the way that portfolios are constructed and managed. Regulation in the early 2000s gave rise to new trading venues and mandated best execution. Algorithmic and high frequency trading emerged to exploit the resulting market fragmentation, albeit for different purposes. This is just a small sample from the capital markets industry – if you looked more broadly at banking and insurance you’d see numerous other examples of innovation, including ATMs and online banking.
But some might argue that following the Global Financial Crisis, innovation has largely disappeared from the securities industry. Indeed a small sample of data from top-tier brokers suggests that technology spending as a percentage of revenue is down about 10% over the past five years. Is that simply because the industry is spending less or could it be that the industry is spending smarter? Is it possible that the challenge of the market environment has fueled innovation in the securities industry? We’ve embraced new technologies and applications like open-source software, cloud computing, low-latency technologies, virtualization, data analytics and others. These offer both cost savings and also, in some cases, revenue opportunities. That is smart spending, and it is very likely correlated to the overall reduction in technology spend.
[Is Financial Services Innovation Dead?]
Innovation doesn’t necessarily have to be permanent, but rather it must push technology beyond its current boundaries. High-frequency trading may not be here forever; perhaps it will be rooted out by regulation or transaction taxes or simply fade away due to low market volumes, but it’s certainly changed trading and pushed execution capabilities to new limits. And innovation isn’t just about mobile devices, apps and social networking. It can be as simple as having the courage to implement what was once considered esoteric, beta, or “skunkworks” because it reduces cost or speeds time to market for an organization.
Today, we are living in a business environment that’s largely defined by regulation and the changes firms need to make to comply. Brokers are challenged with low trading volumes and the cost of complying with regulatory change to trading and capital requirements. Meanwhile investment managers are largely doing well thanks to rising asset values, but remain keenly focused on keeping the purse strings tight. So how can innovation exist in this kind of an environment? I’d argue that it’s as important, if not more important today, than ever before.
We needn’t look further than the middle office, which in some firms is the quintessential example of a function mired in legacy systems, processes and silos. The industry has long dedicated people and spreadsheets as a short-term solution to middle-office problems. How can this model cope with fewer staff, shortened settlement cycles, traders looking to new markets and asset classes in search of revenue, new compliance and reporting requirements, and the myriad other changes here today and coming in the next few years? The short answer is that it can’t.
That’s why innovation is needed to respond to today’s challenges and drive change in organizations. Firms need to be innovative in their deployment of technology and in the way they leverage that technology to its fullest extent across their organization. Operational efficiencies and cost savings can be achieved by simplifying connectivity to trade counterparties and promoting automation across asset classes and regions via central matching. Staff can be redeployed and risks greatly reduced by eliminating manual trade processing and dependency on email and spreadsheets. Trade failures and unnecessary costs can be reduced by focusing on data quality and utilizing existing solutions for critical reference data like settlement instructions.
This may not be the kind of innovation that makes for cocktail party conversation or earns a speaking slot at TED, but this is the kind of innovation that can bring tangible benefits to securities firms quickly. It’s not “build it and hope they come” innovation; rather it involves connecting to networks and implementing technologies that exist today. Make no mistake, innovation isn’t dead — we just need to think about it differently.
Matthew Nelson is executive director of strategy at Omgeo.