Fintech and the Future of Financial Market Infrastructure
New technologies are disrupting long-established operating models across many business sectors, in some cases transforming entire industries and driving efficiencies and cost saving that would have been unachievable just a few years ago. Even in financial services, which has withstood waves of competition from digital innovators over the past two decades, new mobile payment apps and other technologies are forcing banks to adapt and change.
A recent report by McKinsey underscores the ongoing fintech revolution–venture capital and growth equity deployed by fintechs since 2011 has climbed to $23 billion, more than half of which was invested in 2014 alone. As these firms continue to seek new opportunities to apply their technologies to industry-wide challenges, they are setting their sights on an area of untapped potential–the industry’s back office, where a patchwork of legacy clearance, settlement and processing systems handle financial transactions worth hundreds of billions of dollars each day in the U.S. alone.
This global post-trade ecosystem is a vital but often overlooked part of the capital markets, providing the highest levels of execution, risk mitigation, integrity and resiliency. While there is no dispute that the current infrastructure is efficient, performs well and has dramatically reduced the cost of processing financial transactions through greater automation, the reality is that it has been built piecemeal over the course of decades and new layers are constantly being added in response to changes in market structure and practice.
Cloud computing and distributed ledgers offer the potential to reshape the current environment and lower costs and risks
A confluence of events since the 2008 financial crisis, including new compliance mandates and higher capital requirements, has prompted many firms to explore ways to reduce costs and risks while enhancing efficiencies. This has led the industry to take a fresh look at how technology–in particular, cloud computing and distributed ledgers–can help them achieve these goals.
Looking to the Cloud
Cloud computing may not be new, but financial firms are finally taking notice of the benefits of this technology. According to a recent study by the Cloud Security Alliance, adoption is still in its infancy, but 61 percent of institutions are developing a cloud strategy. The expectation is that usage will increase in the years ahead as companies become comfortable that cloud security is at the same level–or higher–as their own security protocols.
Cloud offers the industry a number of important benefits–most importantly, the ability to innovate, test concepts and fail faster as well as to bring new solutions to market in less time and at a much lower cost. In addition, by shifting what has traditionally been a capital expense to an operating expense, firms have greater financial flexibility and can more easily shift gears in response to evolving priorities. Furthermore, the access to unlimited scale for computing and storage, reduced development costs for infrastructure and middleware and expanded delivery capabilities are other key drivers.
Cloud’s positive impact is visible in many areas of financial services, including at my own firm. For example, we are using the cloud for real-time swaps data reporting for only a few thousand dollars, saving us millions of dollars by eliminating the need to buy, build and maintain internal servers, storage and security structures. In another instance, we have migrated the data servers of our Avox business to the cloud to increase scalability, enhance the security of the data we hold and reduce costs–three of the most widely-recognized benefits of cloud computing.
The benefits of cloud computing are broad, but using the technology requires adherence to certain standards and requires new organizational constructs to own, manage and monitor the cloud environments. For financial firms, moving internally-hosted applications to the cloud requires redirecting financial resources from run-the-bank activities to change-the-bank initiatives.
Another challenge for financial firms is addressing the myriad regulatory issues around hosting data in the cloud. Data is the lifeblood of the industry, but so much of it is subject to comprehensive oversight by a number of regulatory agencies. Moving this type of data to the cloud has added risks compared to data not governed by laws, regulations or industry standards. A core part of a cloud strategy must include a formal process to evaluate these risks and align them with the required levels of protections required for the type of data.
Tapping the Potential of Blockchain
Unlike cloud computing, which has taken time to build momentum among financial firms, distributed ledger technology (DLT) has become an overnight sensation. According to Accenture, investment in blockchain activities related to the capital markets has grown from $30 million in 2014 to roughly $75 million last year, with estimates that the number can reach as high as $400 million before the end of the decade. But for all the hype, it is still unclear whether blockchain is a truly disruptive force capable of replacing legacy infrastructures or a more limited solution that will address targeted pain points.
In all likelihood, the technology will transform certain processes that remain highly manual, but the jury is still out on its long-term impact because there are significant hurdles that need to be overcome to make distributed ledgers functional in today’s securities markets. Among these are scale and performance challenges, integration issues and whether moving processes to the platform is more cost effective than improving existing technology.
While there has been a rush of investment in DLT experiments over the past year, the irony is that many firms are working in private to develop a consensus technology–and the end result could be a new system that looks very much like the system we have today of disconnected silos based on different standards and with significant reconciliation challenges.
The key to realizing the benefits of DLT lies in collaboration and ensuring that the various players are working together to re-architect core processes and practices. In the past, we’ve seen too many instances where conflicting priorities and different perspectives have made aligning workstreams very difficult.
With DLT, the unifying goal should be the same across all stakeholders–to enhance post-trade processing and develop solutions that are consistent with long-standing goals of mitigating risk, enhancing efficiencies and driving cost savings for market participants. By its very nature, blockchain requires open source, neutral protocols and standards to encourage widespread industry acceptance and implementation.
New technologies are changing the way we live and conduct business. Even in the back offices of financial services, cloud computing and distributed ledgers offer the potential to reshape the current environment and lower costs and risks. But as with any new technology, the industry must exercise caution to ensure that future implementations maintain the stability and integrity of the global marketplace and improve upon the current post-trade ecosystem system.