:: The Park Paradigm ::

Markets for the Digital Generation

Yesterday I spent the day at the first (of what will probably become annual) Fintech M&A conference, sponsored by Finextra and Deutsche Bank. There were some very interesting speakers and the quality of the discussion on the panels I saw was good, however the most valuable aspect of the day - like for most good conferences - was the fact that the organizers managed to assemble a fantastic group of 200 or so of the key players and decision makers in this market in one place at the same time. It was great to catch up with many people I haven’t seen since leaving investment banking last year and also to meet a number of people I’ve often crossed paths with but never before had the opportunity to meet in person.

Hermann-Josef Lamberti, the Deutsche Bank COO and Board Member, kicked off the day with a very good keynote, which more than anything set the stage for many of the discussions and conversations that followed throughout the day. (It would be great if he made his presentation available on the web to link to, I wonder if he has a blog?…) In particular, he highlighted how technology was “binding innovation and globalisation together in a single process” with complete virtualization of compute power driving a fundamental transformation of how one needs to think about the business, and highlighting that technology has been the key driver in reducing cost-income ratios in banking by 15-30% over the past 5-10 years. He forecasted a doubling in trading volumes over the next 24 months (continuing the strong growth in volumes over the past decades) and pointed out that they use peak levels of trading (ie during exceptionally high volume periods) as a good tool to forecast average trading volumes expected 1-2 years forward. He also made the point that mastering complexity (in IT) is key to sustained successful growth in banking.

Just before lunch, Tim Frost moderated a panel discussing the future of exchange consolidation with participants from the CME Group, Nasdaq, the Bombay SE, the Dubai Financial Center and TradeWeb. There was an interesting mix of agreement and dissent as to how the panelists viewed the likely future landscape for financial exchanges but what I found particularly interesting - and encouraging - was the relatively pragmatic view that change would likely continue apace and that innovation (possibly driven by new entrants) was likely to play a key role in sorting out the winners from the losers over the next decade. (Perhaps AmazonBay is having its intended effect, it just took time to sink in… ) There was a general consensus that volumes traded on exchanges will continue to grow strongly (secular growth, new products, new geographies all contributing) which is a thesis I certainly subscribe to, however I can’t help but wonder if at some point in the next couple years we won’t see exchange valuations disconnect (perhaps violently) from the heretofore correlated rise with volumes. I keep coming back to the many parallels I see between the large financial exchanges (today) and the giant telecom network operators (c. 1997)… The analogy is not perfect of course but probably closer than most senior executives of exchanges would want to admit. While the volume of voice and data (now the same thing basically) has continued to grow exponentially pretty much without a hitch, the valuations of the operators - after rising spectacularly in the first phase of this growth when they were able to perpetuate ‘old paradigm’ (high) transaction-based pricing on an essentially fixed-cost infrastructure that had massive operating leverage as volumes exploded - then crashed as the business model collapsed with the shift to a ‘new paradigm’ (low) network-access-based pricing model more in line with the new operating economics of the business. In other words, while exchanges are currently in a ‘golden age’, ultimately don’t the forces of competition re-align pricing to reflect the ‘cost-of-goods-sold’? In other words, what is to stop someone from building a state-of-the-art exchange and completely rewriting the revenue model of the industry by going to a flat rate capacity based model (or even free for some customers.) What happens when the trading equivalent of VoIP (call it SToIP - securities trading over internet protocol) hits the market? I don’t think the big exchanges go away, but neither then did the big telecoms…however their valuations were - how do you say… re-rated. (And I think if you asked them, they would say the business transformation they went through from 2002-2005 wasn’t a barrel of laughs…)

Just after lunch, I had the pleasure of moderating a panel on the future of the inter-dealer (ie wholesale) broking business, and was blessed with a fantastic group of CEO/COO panelists: Lee Amaitis (BCG Partners), Grant Biggar (Creditex), Patrick Combes (Tradition), Chip Carver (Swapswire) and Mark Yallop (ICAP). As in the morning there was a strong consensus that the strong growth in trading volumes of the last decade was set to continue for some years to come and competition would continue to be fierce. There was a feeling that you might see some further consolidation, however much of this had already happened. The development of new markets - both geographic and new asset classes - was seen as a key driver of future growth. We also had a thoughtful discussion of the potential for mergers between exchanges and OTC brokers, with some seeing this more likely to happen than others. Both Mark and Lee pointed out that the “all-to-all” trading service provided by an exchange was significantly different than the bilateral trading model of the IDB business and would pose significant challenges (in terms of integration, customer expectations, etc.) to anyone looking to marry these two types of trading platforms. (Relative) valuation issues were also highlighted as likely to preclude an of the IDBs from looking at these types of deals in the near term. Finally, there was an interesting discussion around the pros & cons of vertical integration through the entire trade cycle (execution, clearing, settlement, etc.) and my take was a cautious consensus emerged that this was unlikely to emerge as the winning model for a variety of reasons but most notably because customers (the traders) valued choice in execution venues very highly and were unlikely to be happy if they felt constrained.

Finally Lloyd Dorfman, the founder and Chairman of Travelex, finished the day by telling the wonderful story of how he built Travelex (in particular with respect to how it was financed and his experience of private capital) over the last 30+ years. Looking forward to next year, maybe they’ll have wi-fi next time so I’ll be able to write this in real time…

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