Fintech Trends: The Challenges of Turning Innovation into Application
June 8, 2017By Will Acworth
This year’s FIA Boca put a special emphasis on emerging technologies. Executives from venture capital companies and technology providers shared their perspectives on the growth of fintech startups, the challenges to adopting new technologies, and the potential impact on business models.
The derivatives markets are no strangers to technology. Since the floors first went electronic more than a decade ago, banks, brokers and trading firms have adapted to wave after wave of technology reinvention. But the industry may be entering a new era of change.
A host of entrepreneurs are looking for ways to modernize core operational processes with a set of technologies more commonly associated with Silicon Valley than Wall Street. They are seeking to apply the same revolutionary advances that are powering driverless cars and virtual assistants in everyday life to the more arcane world of derivatives trading and clearing.
Venture capitalists who monitor these trends agree that it will take time to put these new technologies to work, but there are thousands of startups keen to make a difference, plenty of funding to support their ambitions, and a tremendous appetite for new solutions within the capital markets.
Mark Beeston, founding partner of Illuminate Financial, has a birds-eye view of the trend. His London-based firm specializes in making equity investments in fintech startups at the wholesale end of the financial markets. Speaking during a panel discussion at FIA Boca, Beeston said the industry is entering a “golden age of innovation.” Over the last three years, his firm has looked at more than 1,000 companies, all of which were between two and four years old, and all focused on what he called “emerging next-generation technology for capital markets.”
What accounts for this startup explosion? Beeston commented that one reason is the vast amount of talent shed by the banking industry over the last 10 years, including thousands of people with expertise in the inner workings of the capital markets. Many of these people have joined new companies or started their own to leverage their expertise with such crucial but obscure areas as collateral management, order routing, market data and so on.
Another reason is the unprecedented amount of new regulation since the financial crisis and the vast amount of work required to comply with the new rules. Beeston pointed to the overhaul of the Markets in Financial Instruments Directive, known as MiFID II, as a particularly vivid example of the trend. Illuminate Financial tags every candidate for investment on four different vectors: the business unit that it supports, the business function that it supports, the regulatory driver, and other drivers such as cloud or artificial intelligence.
“If I were to put that up on a screen right now, you would see MiFID II written huge. It is, by far, the largest side of the supply side of what we see in the capital markets innovation space,” he said. For example, more than 20 startups are addressing the requirements around the unbundling of research, which is just one part of MiFID II.
Another part of the answer is funding. In addition to independent firms like Illuminate Financial, banks and exchanges are establishing their own venture capital arms to invest in fintech startups. One of the leaders in this space is CME Group. Rumi Morales, the head of CME Ventures, who spoke on the same panel as Mark Beeston, explained that CME’s purpose is not only to make a profitable return on its investments but also to get an early look at emerging technologies that could affect its core businesses.
One company that she mentioned is Nervana Systems, a company founded in 2014 that specializes in deep learning, a cutting-edge branch of artificial intelligence. CME Ventures bought a stake in the company in June 2015 when it participated with eight other investors in a Series A funding round that raised $20.5 million for the company. CME scored twice on this investment. First in dollar terms: when Intel bought Nervana in August 2016, it reportedly paid more than $400 million for the 48-person startup, giving those early backers a profitable exit on their investments.
Second, and perhaps more importantly, CME’s interaction with Nervana helped improve its own understanding of artificial intelligence and how it might be applied in the derivatives markets. Morales explained that the relationship opened the door for CME’s technologists to become more familiar with deep learning and think about ways that it could be applied at CME.
Deep learning is especially well suited for pattern recognition—for example, helping driverless cars tell the difference between a red fire hydrant and a girl in a red coat, and then anticipating which one is going to move, and at what speed. For CME, one potential application could be in recognizing patterns in the order book. A deep learning solution could search through snapshots of market activity over time and identify every instance of the same pattern. That in turn could help CME detect potential instances of market malfunctions or harmful trading behavior.
More generally, deep learning could create a way to “analyze and contextualize our markets through images,” Morales said. She pointed to the growing use of images in everyday life, such as in Facebook postings, and suggested that someday this could affect how capital markets function. “We’re interested in making those far out connections,” she said, “for the benefit of our customers and even for our regulators—anything to make our markets more transparent and easy for people to access and to understand.”
Getting cutting edge technologies into production is no simple task, however. In a mature industry like financial services, with massive investment in legacy systems, it takes time to get buy-in from senior management, time to tailor the technology to specific needs, time to re-engineer existing processes, and time to educate the regulators. The path has been blazed before, however. Cloud computing used to be a buzzword with everyone clamoring for an explanation, explained Scott Mullins, a senior executive with Amazon Web Services, the leading provider of cloud computing services. Now it is well on its way to becoming one of the pillars of enterprise technology in the financial markets.
Speaking on the same panel as Beeston and Morales, Mullins said AWS first began targeting the financial services sector six years ago. Initially it worked with new companies, but as time went on it started working with larger, more established enterprises. To get buy-in at that level required many conversations with senior executives to explain how cloud technology worked and what benefits it could deliver. The first question used to be about security, but that’s now changed, Mullins said. The focus is now on thinking through the implications and exploring the potential opportunities for transforming business functions.
“The conversations that we are focused on the most these days is helping those people in the middle,” he said. “Not the C suite or the developers, because they both get it, they understand the value proposition of what we offer. It’s helping the people that are in the middle of the value chain—the compliance officers, the risk officers, the people who are responsible for operations—understand how to evolve all those processes that we have today in the industry.”
As an example of how far the industry has come in adopting cloud computing, Mullins said AWS is now working with exchanges to move their matching engines to the cloud. In 2015, the International Securities Exchange moved disaster recovery for its three options exchanges to AWS. That gave ISE the ability, if something happened to the physical facility in New Jersey where its matching engines are based, to restart operations on the AWS cloud rather than failing over to a dedicated physical location somewhere else in the U.S.
“That gave them the opportunity to be able to bring that exchange back up in minutes instead of hours,” Mullins said. “In fact, we ran a simulation at our Reinvent conference last December. We built a mock exchange matching engine on AWS and then tore it down on the East Coast and built it back on the West Coast to simulate disaster recovery.” Mullins added this step-change in performance means that companies can think about the problem as “disaster resiliency” rather than disaster recovery.
Another feature of cloud computing is that it has changed the way firms think about innovation. London and New York are still the main hubs for capital markets fintech, but Beeston, Morales and Mullins agreed that entrepreneurs can tap into computing resources from anywhere. In fact, some of the emerging capital markets fintech companies are based in cities like Austin, Denver, Berlin and even Washington, D.C., Morales said. Mullins added that cloud computing is promoting a change in culture, with developers sitting side by side with operations staffers and working together to iterate changes in the software architecture much more quickly than in the past.
So what’s next? If cloud computing is becoming the new normal for core operations, how long will it take for newer technologies such as distributed ledgers and artificial intelligence to penetrate the derivatives markets? At the moment, the hype is far ahead of the reality, but there are clear signs at the top of the industry that dramatic changes are expected in the coming years.
During this year’s exchange leaders discussion at FIA Boca, Jeff Sprecher, the chief executive officer of Intercontinental Exchange, said his company is placing its bets on data. In late 2015, ICE paid more than $5 billion to buy Interactive Data, making it the third largest provider of financial data behind Bloomberg and Thomson Reuters. ICE is now integrating IDC’s data assets and coming up with new ways to realize the value of data across all of its businesses.
“All of the emerging technologies that make our business run better, faster, and cheaper are powered by data and information. Trading decisions and algorithms, risk management decisions, the blockchain, the cloud—the underpinning for all of those things is the ability to handle a lot more information and make a much more informed choice in managing affairs. So I have my firm investing in that backbone of information,” said Sprecher.
Adena Friedman, the chief executive of Nasdaq, went a step further. Will data be important? Certainly, but in her view the real value will come when all of that information is stored on the cloud so that it is available on demand, and then consumed by artificial intelligence backed by massive computing power.
“You’re making very smart decisions using machine intelligence behind the data. And then you’re serving it up into an exchange environment that’s also likely to be more cloud-based over time. That creates a much more integrated work flow for the entire industry,” said Friedman. Project that forward over the next 10 years, and “you’ve got yourself an entirely new environment in which investors and traders are interacting with the capital markets.”
This article is based on discussions that took place during FIA Boca 2017. To listen to those discussions in full, click these links: