Monday, December 3

A visionary talks about the future of Finance

I indirectly worked for Till Guldimann before and the man has the brain the size of a planet. But read his interview, this is very thought-provoking.

Title: Taking Stock of the Future
Date: 1 November 2007

Industry veteran and visionary Till Guldimann's job is to figure out how the rapidly evolving global market structure and technology advances will converge to change our world.
By Donna Miskin

You could say that Till Guldimann became SunGard's guru for long-term strategy the old-fashioned way-through acquisition. But he has certainly earned his standing as thought leader and visionary-as evidenced by his roles at major industry events-through his long experience in banking and technology.

A native of Zurich, Guldimann trained as an engineer. While studying, he turned his hand to brain research-"using early computers to analyze brainwaves," he says-and did a stint at the National Institutes of Health in Washington, DC. After earning his MSEE, he worked a year in Japan as a software analyst for NEC before deciding that engineering was not his bliss and heading for an MBA from Harvard Business School. He then joined JPMorgan and became an investment banker for 21 years. At JPMorgan, he was a lending officer in Zurich and New York, then headed the consulting group in London, moved to head of trading in Hong Kong during the Thatcher years and then returned to New York to become chairman of the Market Risk Committee and head of the Global Research Group. There he developed the bank's risk management systems and the RiskMetrics initiative.

In 1995, Guldimann left the bank to join Infinity Financial Technology, a derivatives trading and risk management software startup in the San Francisco Bay Area. The company went public in 1996 and was bought by SunGard in 1998. The rest is recent history.

At Sibos in October, Guldimann led the futuristically focused panel, "The 2013 landscape: will you still be a part of it?" The group included Anders Reveman, an independent consultant with the European Central Bank; Chris Foskett, managing director and group head, financial institutions group at Citi; Adrian Farnham, COO of Turquoise; and Don Donahue, president and CEO of the Depository Trust & Clearing Corporation (DTCC).

Some panel predictions included that on the exchange and depository front by 2013 Europe will have two to three clearinghouses but only one settlement provider. However, expect local depositories to be maintained to accommodate different laws, cultures and languages. Exchanges will continue to consolidate with NYSE-Euronext, Nasdaq, Deutsche Börse and the London Stock Exchange and likely Shanghai forming hubs or groups of markets. At least some of the alternative trading systems spawned by the Markets in Financial Instruments Directive (MiFID) will make an impact. Brokers will continue to have a role as intermediaries between issuers and investors. Technology will continue to provide a competitive edge as reliance on it grows. And despite the recent turmoil in the credit markets, further securitization is accelerating.

Since Guldimann's forte and job is keeping an eye on the future-trying to anticipate change and the moves industry segments will make to embrace it-Waters has had a chat with him on more than one occasion in recent months, including in Boston at Sibos. Here are some takeaways from those conversations in his own words.

More on the markets

Comparing all the sizes of the markets to the size of the economy, we can see where they will grow in the next five years. An interesting aspect is the size of the derivatives market. The trading revenues of the new CME Group are larger than those of the Nasdaq and the New York Stock Exchange (NYSE) combined, not including Euronext. And don't forget over-the-counter (OTC) derivatives. The derivatives market is huge and will grow faster than the cash markets. Overall, most of the trading volumes are now in the G7 countries, but a large part of the gross national product (GNP) growth will come from the emerging markets.

Seventy-five percent of the $6 billion in trading revenues globally is now consolidated with five exchange groups: CME-CBOT (derivatives), NYSE-Euronext (cash and derivatives), Nasdaq-OMX (cash and derivatives), LSE-Borsa Italiana (cash), and Deutsche Börse (cash and derivatives), with the rest scattered around a plethora of smaller exchanges. Given the growth of the Shanghai stock market with an estimated $1 billion in revenue in 2007, there is no question that Shanghai will evolve into one of the big financial centers of the world.

Exchange consolidation

We have seen massive consolidation of the exchanges but we still have another 200 exchanges out there and most are really small. It's the depository and the clearing side that needs to consolidate. There are over 100 depositories in the world, but the ones that matter today are well-aligned with the big five exchange groups. Somehow the smaller players will have to be linked up. Since the growth will be in the emerging markets, it means everybody will have to deal with the small depositories there.

Arbitrage in US equities is almost over. It will be incremental in G7 countries. In the newer emerging markets where mechanisms are not as efficient, there will be a huge pile on-in Latin America, Asia and ultimately, Africa. Hedge funds will change the game and investors will turn increasingly to the emerging markets.

Packaging Securities

Historically, securities were defined by the issuers assisted by their investment banks. If they needed debt, they issued bonds. If they needed equity, they issued shares. In the last 15 years we've seen securitization of bank debt or credit cards. Banks had assets and they were repackaged to sell to investors so those securities were defined by the needs of investors, who wanted to buy a credit card portfolio. Now the same concept is being applied to other securities. With exchange-traded funds, investors can say, "I want to buy Japan," or, "I want to buy the telecommunications industry worldwide," and somebody creates a security that reflects that. The situation now is that some securities are defined by what the issuer wants and some securities are defined by what the investor wants and in the middle are the packagers, which take instruments from one, repackage it and shoot it out to the other side. And the arbitrage people are sitting in the middle and using futures, forwards, derivatives to combine and hedge it all. When we project the number of securities that will be outstanding in the future, we usually do it by GNP forecasts, how big is the economy, how many securities does that take. That's standard. But looking at this repackaging dynamic, there will be far more securities than the GNP growth would suggest. So the conclusion is there will be a proliferation of securities and the growth in outstandings will be faster than anything we have seen in the past.

What happens to brokers?

The brokerage business is changing from providing access to markets to creating new securities from existing, other securities. Only a few global houses will be able to provide direct market access through one channel because connectivity is a scale business. Smaller local shops know exactly what the guy in southwest Milwaukee wants, so they can take all these instruments and package special new investment tools for him. The creation of financial instruments is no longer dependent on the issuer; it is dependent on the creativity of the intermediary. It's a big growth industry, despite the credit crisis, which went a little too far, too fast, not unlike the Internet bubble. In this business, collateral management is very important and that's the second big growth area. When everybody has to deal and settle in all these multiple instruments, to do it efficiently you have to manage collateral and margins very efficiently. So collateral and margin management among the plethora of markets is going to be a huge business. For that, it is not necessary to be big.

A co-location conundrum

Today the only data driving black-box trading is market price data. What is yet to come is digital company data and news. The more digital data you get and the faster your computer is, the more decisions can be made by black boxes. Annual reports are now being posted in digital form (XML) on the Securities and Exchange Commission's (SEC's) Edgar Web site. Company data is turning digital, which means that there will be much more information available to the black boxes.

In the information age when an unlimited amount of information can be distributed to anybody in the world, everything is available to everybody. You can sit in Connecticut. You don't have to be on Wall Street. The pipes have become so big and efficient that the cost of shipping information is zero. However, the time it takes to go from Chicago to New York cannot be faster than 8 milliseconds, the speed of light. Analyzing information very fast means it matters where you sit. If you want to trade in Chicago, you better sit in Chicago or you better have your black box in Chicago because you can't have your black box in New York and be 8 milliseconds slower. Co-location: What does that mean? In the US, the derivatives market is in Chicago and the cash market is in New York, and a juicy part is to arbitrage the two of them against each other and they are 8 milliseconds apart. Compare that to Germany where they sit in the same location. It could be that Germany is the more efficient market. It could be that some of the derivatives market is moving to New York or the cash market is moving to Chicago.

So what if the SEC decides Edgar will release company news first? Then you should have your black box in Washington, because you can analyze a new 10K report faster than 8 milliseconds with the right machinery and make your trades. Where does this go, because you can't put everything in one place? Nobody understands that yet, but the speed of light is suddenly having an impact on the structure of the market. Nobody has thought that way before. A second was good enough five years ago. Today in some markets, 8 milliseconds really matters. That's why people are co-locating. It's a whole different ball game.

In a nutshell

When you have more derivatives and more arbitrage between and across markets, the markets become far more interdependent, and therefore regulation is forced to become far more global. Black boxes are going to be important for arbitrage. Distance is going to be important. Clearing, margining and netting are very important. Repackaging of securities and how you manage them will be very important. Regulatory alignment like international accounting will also be very important.

The IT business environment

Now, instead of cost containment, there is speed. Instead of careful deliberation, there is agility, which is more important than anything else. That's counter to the trend in the last five years when firms had to become more efficient and centralized and put extra controls on spending-not that these controls are no longer necessary. You need size in order to get the economies of scale and to cut costs. You need the agility to exploit newer faster markets. Here is the dilemma.

Scale and growth

Financial services firms have to cut costs for the same transaction and service by 10 percent per year for the foreseeable future just to stay in the game. That's a huge driver for consolidation and economies of scale. The purpose of acquisition was to put more volume through the same machinery. You need cost control plus innovation to go after new opportunities, new markets, new instruments, new clients and new geographies. However, most important innovations over the last 20 years have come from small shops.

The rise of collaboration

In technology, Unix is getting replaced with the open source Linux; Yahoo! by Google; Encyclopedia Britannica by Wikipedia and Who's Who by Facebook and FaceBook by OpenSocial. The old is about centrally managed production and distribution of content. The new is about collaboration and sharing content and services. In looking for the next innovation in IT as it applies to finance, pay attention when you see these collaboration and sharing content ideas. The psyche of the changing mindset is that you don't have to have an idea of where you can make money. You can have an idea of how other people are making money so you can make money on their making money. That's a fundamental change.

Innovation flips to the consumer side

In the past, most of the chips/integrated circuits went to commercial applications-mainframes at GM or at Citi. In the future, more chips will go to consumer items. The Xbox today is significantly more powerful than the average laptop. That means most of the software innovation for the next five or 10 years will be consumer driven. But in large financial institutions, the IT department lets nothing past security. If you walk in with your personal computer, let alone your Xbox, you either have to give it up or they castrate it. Of course, their concerns are valid. The key issue, though, for large organizations is where to set the boundary between what they want to protect for security and confidentiality in house and what machinery and what gadgets employees can use. And where are the boundaries for how customers, particularly if they are individuals, can link to you? The bulk of innovation will be on the consumer side now. So the message here is rethink the boundaries. Be aware of the consequences. The senior IT managers in large financial institutions will be out of touch for the sake of security because they are no longer exposed to what's new out there.

Open source rules

Open source is one of these big collaboration things. At the beginning everyone said open source-you must be kidding. Today, Linux is replacing Unix. In Silicon Valley, the main qualification for a startup CIO is that he or she knows open source, where to get what and how to use it. In an IT shop in a large organization, the qualifications are can you manage large projects and do you know how to code a solution. This means the use of open source in startups is much higher than in larger organizations. As a consequence, startups are much faster and they can make many more mistakes, because it's much cheaper. This is another driver for innovation coming from the smaller shops.

Building sensitive systems

The third trend is business process management (BPM). Workflow systems streamline repetitive human actions around a given departmental IT solution. BPM goes one step further. It describes the logic of what people across business segments do and then the system is built around that. Take for example, how a large bank manages changing customers' addresses. The call comes into a call center, an agent verifies the caller is a customer and hands off to another agent in a different department who pulls up the existing documents. The request is then passed on to another agent in another department for the actual updating, and then a fourth agent reports back to the customer that the address is changed. Workflow goes through multiple operation centers and multiple systems and that is very hard to measure. So you build feeling nodes or sensors into different systems, like the FedEx Web site that can tell you where your envelope is now. These sensors provide information on what happens to each transaction, where and when. Statistics can be gathered to show where the bottlenecks are, where the delays are, so the process can be improved across business segments. Beyond that, instead of just sensing information, commands can be given to control and optimize the process. The new BPM systems comprise software to describe, software to measure and software to control process. SunGard acquired a German software jewel, a company called Carnot, which simulates and monitors processes and can also manage them by initiating software steps and integrating applications.

What is happening at SunGard?

Our greatest challenge is how to integrate a vast set of independently developed solutions. The answer is service oriented architecture (SOA) with an open source twist that we call "federated development." This means that any of our development organizations can ship in codes into a central repository and put a price on it or say it's free, and anybody else can reuse it. It's like open source inside SunGard. In the development of a new application it's not unusual that 70 percent of it exists somewhere else. So all these independent business units that never talked to each other before can now through this mechanism talk to each other and they can reuse code in the service of their client.

This approach started in 2002 as an experiment by an exasperated head of development to deal with a salesman's selling a solution that combined eight applications of the wealth management workstation packaged into a single application. Other units were starting to adopt this approach by 2005, when we went private. Going private allowed us to think long-term to transform the enterprise with new ideas. We then put the entire SunGard-all 190 development units in the Financial Systems Group-on this Common Services Architecture (CSA), combining an SOA platform with an open-source governance structure. We announced it in 2006.

What goes around ...

This year we announced Software as a Service (SaaS) on a shared platform we call Infinity. Instead of providing and hosting a solution, like an ASP to one user, we are providing and hosting a service of a bunch of services to multiple users. If we build our software so that everything is CSA-compliant, you can throw different services into a basket and reuse each. If you want a special solution, you can select specific services from the basket and orchestrate the services yourself into solutions tailored to specific needs. This is SOA deployed to users-as in, "I like Invest One but I would like to have a little piece of Front in it." In order to actually manage a solution as a combination of services you need business process management software. That is why the addition of BPM is important in this strategy.

This is the whole logic. We have a revolution from control to networks. We have the challenge in the industry to handle scale and innovation at the same time. We have consumerization, open source, BPM. We have Infinity to provide SaaS. We have the business model and the hosted services to roll it out. We believe that the future of SunGard is growing the federation by buying small innovative shops. That's why we continue to do acquisitions. We believe there will always be smarter, smaller shops out there and now we have a mechanism and an architecture to integrate them and deploy their innovation without killing the inventors.

The speed of change is accelerating. There has never been this much opportunity for agile organizations. We are morphing SunGard into a collaborative network of innovators as we believe the industry is moving toward a network of specialists. Welcome to the 21st century.


© Incisive Media Investments Ltd 2007

All this to be taken with a grain of piquant salt!!!

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