THE INDUSTRIALIZATION OF CAPITAL MARKETS:
where are we now?
The notion of centralized infrastructure and services is not new. It has been used successfully in
other industries for years. There is, however, a renewed interest in industrialization within the capital
and commodity markets. Many firms are once again considering how utilities could help increase
efficiencies, reduce costs and, ultimately, improve their return on equity (RoE). In this article, Ryan
Baccus discusses the ways in which today’s industrialization efforts are putting market utilities back
in the spotlight, when they make the most sense and what firms can expect in terms of benefits.
Introduction
Definition of Industrialization
The process in which a society or country (or world)
transforms itself from a primarily agricultural society into
one based on the manufacturing of goods and services.
Individual manual labor is often replaced by mechanized
mass production and craftsmen are replaced by assembly
lines. Characteristics of industrialization include the use
of technological innovation to solve problems as opposed
to superstition or dependency upon conditions outside
human control such as the weather, as well as more
efficient division of labor and economic growth.
Source: Investopedia (filed under labor unions)
Figure 1: The Evolution of SABRE—An Example
of a Successful Market Utility
The concept of industrialization and the potential of leveraging
economies of scale to reduce costs and increase profits is not
a new one. Outside of financial markets, there are numerous
examples within manufacturing, telecom and even the
airline industry (See the Sabre example in Figure 1) where
organizations have been able to work together to standardize
elements of the supply chain. There is also a rich history
of events where firms have also co-invested in technical
solutions that provided an enhanced service at a fraction of
the cost compared to a scenario where each organization
would have individually built solutions.
There have been a number of successful initiatives within
the financial markets community to develop new concepts
collaboratively that have resulted in the creation of market
utilities and other central market infrastructure. These have
typically occurred with a limited process scope where a
business function was not already being performed and there
was an appropriate regulatory incentive acting as a catalyst.
The industrialization proposition, by its very nature, has a
more commercial focus, which means that the conditions for
success are more complicated. As such, it has traditionally
been more challenging to mobilize market participants to
collaborate and co-invest.
Paper-based ticket
system for air tickets
American Airlines (AA) and IBM
jointly announce plans
for semi-automatic business
research environment (SABRE)
EasySabre introduced to allow customers
to make reservations directly
Saved 30% on its investments
(1988) 36 million fares
1960s
Expand service to hotels and cars
1970s
1980s
Acquisitions and partnerships to
expand services and integration
1990s
System is expanded to broad travel
agent user base, not just AA agents
Addition of integrated
frequent flyer program
Online terminals are added
Joint venture with ABACUS
to access Asian market
2000s
(1978) 1 million fares
CROSSINGS: The Sapient Journal of Trading & Risk Management
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One of the more high-profile examples of the industrialization
proposition within the capital markets is the JP Morgan
Arcordia service. Created to drive greater industry
standardization, Arcordia, which was spun out of the
JPMorgan back office in March 2000, was a provider of ASPbased post-trade processing services for over-the-counter
(OTC) derivative trading for use by other organizations. Widely
recognized as a leading platform with rich functionality, the
commercial operations of Arcordia were, however, wound
down in November 2001 with a JPMorgan spokesperson
confirming at the time, “Recent events and the continued
economic slow-down have caused the firm to re-evaluate
its external Arcordia business plan.”1 The Arcordia offering
preceded years of rapid growth in the OTC derivative market
and the general sentiment was that the market practices and
dynamics were not mature enough at the time for the offering
to succeed.
Market Conditions and the Case for
Industrialization
The current market environment is characterized by shrinking
margins, increasing cost pressures and more exacting
regulatory standards. This has created an environment
where there is a significant focus upon opportunities for cost
reduction and return on investment and where substantial
funding has been channeled towards meeting global
regulatory requirements.
In parallel and through a number of successful internal and
external initiatives, there is also a greater awareness and
willingness to collaborate on common challenges faced by
the marketplace. Together, these two factors have created an
environment that has the potential to drive efforts for marketwide industrialization to a successful conclusion.
As one would expect, the financial markets have undergone a
major transformation in the years since the Arcordia offering.
But are market conditions any more stable now and, if so, what
does the capital markets’ industrialization roadmap look like?
Figure 2: Industrialization Drivers and Enablers
Industrialization Drivers
Volumes: While the Bank for International Settlements
(BIS) statistics show a steady increase in OTC volumes
(notional outstanding) since the financial crisis, the
revenue at many major investment banks has declined.
2014 represented a particular challenging time with FICC
markets, in particular, providing disappointing returns
(Tricumen estimates that the top 13 banks’ FY 2013 capital
markets revenue for FICC was down approximately 9.5%
from FY 2012 levels).2
Profits: At the same time, organizations’ efforts to reduce
headcount and take operational costs out of the business
continued to slow down in 4Q13. Cost reduction programs
are expected to accelerate in the first half of 2014 with
a number of organizations looking at ways in which to
transform the business including reviewing the scope and/
or the business mix of their FICC divisions, extending well
beyond the disposals of physical commodities units.
Industrialization Enablers
Standardization: OTC derivatives regulations have enforced
greater standardization in trade execution, clearing and posttrade services across the industry. The adoption of these
standards across areas like reporting, confirmations and
portfolio reconciliations has also increased the number of active
participants on these platforms from what was once a largely
major investment bank user base.
Data Quality Demand: There has been wide support for new
industry initiatives, such as Know Your Customer (KYC) and client
data, underlining a shift in ambitions as organizations consider
moving critical business functions to an external provider.
Rationalization: Internally, application rationalization efforts
as part of cost-cutting initiatives have reduced the diversity and
levels of customization within major investment banks toward
global standards. This is paving the way for true service-oriented
architecture and business “functionalization” benefits.
Costs: A number of institutions also recorded significant
costs in 2013 due to litigation or as a result of the
investment required to keep pace with global regulations.
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Given these conditions, there is a greater willingness
throughout the market to consider industrialization initiatives.
However, the scale of ambition across organizations varies
depending on experiences and circumstance, with the
challenge of balancing initiatives focusing on optimizing
sourcing and location strategy, internal group-level
functionalization and market-wide industrialization. Based on
perceived delivery risk, there is often a portfolio of initiatives
working toward different levels of standardization at the same
time. As such, there seems to be greater demand for functionspecific industrialization efforts rather than attempts at
replacing entire post-trade services.
The Focus for Capital Markets Industrialization
What makes a function more suitable for standardization? The
following characteristics of a function should be evaluated
before determining whether to standardize it or not:
•Competitive advantage—The level of competitive
advantage associated to the function by clients
•Market breadth—The number and profile of market
participants that perform the function
•Efficiency—The level of effort (cost) and inefficiencies
associated to the function
•Stability—The likelihood of major change affecting the
function in the short to medium term
Figure 3: Industrialization Value Chain—Standardization can act as a key enabler or a primary limiting factor for
industrialization efforts. The value chain below highlights gradients of standardization that can be used to evaluate
industrialization opportunities and understand the prospective impact and, ultimately, adoption.
Regional
Standards
(i.e., FICC EU)
Global Product
Standards
(i.e., FICC Global)
Global Division
Standards
(i.e., OTC Global)
Business Global
Group
Standards
Standards
(i.e., IB Global) (i.e., Parent level)
Industry
Standards
Figure 4: Trade Documentation Industrialization Stability Assessment Matrix
Industrialization Suitability Assessment
Competitive Advantage
Market Breadth
There is no perceived advantage in the trade documentation
process. Regulation has narrowed the performance range
significantly given T+1 documentation standards.
The application of T+1 trade documentation regulations impacts
a significant portion of the market. Without a more collaborative
process, the industry as a whole will not be able to meet
regulatory requirements.
Benchmarks will collectively drive improvements in
performance across the industry.
Efficiency­—The documentation exchange processes that
exist today are seen as archaic and are typically managed
on duplicative infrastructure for confirmations, legal
documentation and term sheets.
Stability—Regulators are expected to remain in an observing
status for some time but have communicated standards and are
currently receiving metrics and reports so are able to identify
outliers.
Market participants maintain their own populations of
templates and terms that are exchanged with a common
client base.
Electronic volumes processed over electronic trading venues and
electronic affirmation platforms are expected to grow.
CROSSINGS: The Sapient Journal of Trading & Risk Management
ISDA is increasing levels of standardization through updated
equity and credit derivative definitions.
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Client reference data is an area that meets the criteria
previously outlined due to its non-proprietary nature and
the significant cost for market participants. This has been
reflected in recent market offerings from the DTCC, Markit,
Thomson Reuters and SWIFT. Another area that fits the
suitability criteria is the potential for a central utility that could
provide for netting efficiencies across margin and settlement
movements, given the upcoming enforcement of margin for
uncleared trades for OTC derivatives and the market-wide
demand.
An area that was less straightforward was trade
documentation. While it is largely considered to be a nonproprietary function, the changing landscape and uncertainty
around trade volumes make this an interesting function to
explore. Can the trade documentation function be moved
into a shared service that can ultimately drive reduced costs,
increased controls and more effective compliance by creating
greater levels of standardization and enhanced transparency?
While largely perceived as a non-proprietary function, trade
documentation is still managed bilaterally in most instances.
The analysis in Figure 4 suggests that trade documentation
is, in fact, a good candidate for standardization. However, the
uncertainty around volumes and processes could see the
industrialization take place gradually (potentially focusing on
the issues of document exchange initially) to ensure that the
perceived long-term benefits can be realized.
Outside of core business functions there are other
opportunities for “utilitization” and where innovative solutions
could help in terms of economies of scale. As an example,
Goldman Sachs and Fidelity Investments have recently given
their backing to the Open Compute Project, an initiative to
open source hardware and datacenter designs. It is expected
to transform the way in which infrastructure is designed and
manufactured in the IT industry. Jay Parikh, vice president of
infrastructure at Facebook, which founded the Open Compute
Project three and a half years ago, said that in the past three
years Facebook has saved an estimated $1.2 billion on IT
infrastructure costs by doing its own designs and managing
its own supply chain. CEO Mark Zuckerberg later added that
on top of this savings, Facebook has saved enough energy to
power 40,000 homes for a year and reduced carbon dioxide
emissions at a level that is equivalent to removing 50,000 cars
from the road for a year.3
Grant Richard, managing director of technology infrastructure
at Goldman Sachs, gave a presentation at the Open Compute
Summit where he outlined the potential impact of the Open
Compute Project for his organization, summarized in Figure 5.
Figure 5: Goldman Sachs Technology at a Glance
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Firm and public
designed data centers
8,000+
Engineers and
technologists
1.2 BN
Lines of code
34
Megawatts
available
10,000
Network devices
118,000+
500,000
Computer cores
4,000
Servers in
the “GS Cloud”
Applications
16 MM+
45,000
Software charges
per month
Servers
28 PB
Storage
59,000
Databases
50,000
Remote desktop
sessions
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Ryan Baccus
“The majority of IT, processing and support behind
banking services is delivered in-house with platforms
that are highly duplicative across players and offer very
little by way of competitive advantage.
is a Vice President based in London
driving Sapient Global Markets’
Regulatory Response offering.
With more than eleven years of
experience in the OTC derivative
market, Ryan has led a number of
high-profile engagements for major
global investment banks, industry
associations and central market
infrastructure providers with a
specific focus on execution and posttrade services.
rbaccus@sapient.com
“We estimate up to $7-9 billion of industry costs could be
pushed out into an external supply chain (net savings of
$3-5 billion) that can deliver scale economies as well as
enhanced flexibility and potentially more innovation. We
expect only a part of this to be achievable within a 2-3
year time-frame and estimate $1-3 billion of annual cost
savings at stake by 2016.”
Source: Morgan Stanley - Wholesale & Investment Banking (March 20, 2014)
Mobilizing for Capital Markets Industrialization
References:
The business case for any industrialization effort can be
complex. At the heart of these types of initiatives is an intuitive
benefit model. However, due to the long-term payback and
a range of commercial models, there are a number of
subjective scenarios, such as trade volumes, levels of
STP and delivery confidence, etc., that must get factored
into the numbers. But for those organizations that make
the commitment to industrialization, the benefits can be
significant. While the initial design will likely be complex given
the inherent challenges around security and commercial
models, the key to success is establishing the right governance
model—one that is empowered and able to commit to
long-term initiatives where there is the potential of materially
impacting the organization’s ROE. For organizations looking
to meet ambitious cost-reduction targets, industrialization
stands out as a viable option that can enable genuine business
transformation.
1.Finextra, “JPMorgan Chase winds down Arcordia,” http://
www.finextra.com/news/fullstory.aspx?newsreview=com
ment&newsitemid=3714 (November 7, 2001).
CROSSINGS: The Sapient Journal of Trading & Risk Management
2.Tricumen, “Capital Markets Results Review 4Q13/FY13,”
http://www.slideshare.net/DarkoKapor/tricumen-4-q13capmkts-resultsopen.
3.Enterprise Tech Systems Edition, “Goldman Sachs
and Fidelity Bank on Open Compute,” http://www.
enterprisetech.com/2014/01/29/goldman-sachs-fidelitybank-open-compute/ (January 29, 2004).
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