The Real Technological Revolution Is Yet To Occur In Financial Services

(adapted from my article in SWIFT’s Market Infrastructures Forum Magazine, published in September 2013)

Innovation is virtually synonymous with technology. In financial services, where digital technology pervades every aspect of the industry, this claim has achieved the status of a truism. But the real technological revolution has yet to occur in financial services. Technology has so far made it possible to accelerate the pace and volume of transactions, but it has not transformed the relationship between the industry and its customers in the same way as it has in, say, retailing, publishing, television and film, or popular music.

In other industries, the exponential increase in bandwidth, computing power and storage sizes is now combining with hyper-connectivity – namely, permanent connection to the Internet via smartphones and tablets – to transform the relationship between the providers of services and consumers of services. Erik Kruse, Networked Society Evangelist at Ericsson, borrows the phrase of MIT technologist Kevin Ashton to capture how the Internet is now linked to all aspects of the physical world: the “Internet of Things.”

The bar coding of items in shops is an obvious instance of this, but paying for those things by debit or credit card is another. Similarly, consumers now use Internet technology to obtain information, order goods, move money between accounts, purchase foreign currency, buy insurance, compare prices, and so on. Inevitably, this is having a profound effect on the behaviour of consumers. Industries which were primarily supply led (whatever they claimed to be) are becoming demand-led.

This is especially true of the next generation of consumers. The Internet is now more than 20 years old, which means that anyone under 40 has never known a social or working life without it. As a result, younger consumers come to the market with different expectations of service providers. Instead of technology being used to hold them captive, they expect service providers to use technology to empower them to determine not only how services will be provided, but what services  will provided.

That trend has implications for the financial market infrastructures that service the payments and securities industries. “Infrastructure-based models are at a big fork in the road,” says Andrew Davis, global head of e-commerce strategy and innovation at HSBC in Sydney. “Not only is the wave of change – shorter processing times, always-on connectivity, accumulation of data – requiring the providers of market infrastructure services to revamp platforms and open up their service offering, but the overall role and purpose of any ‘infrastructure layer’ needs to be re-defined and turned on its head.”

There are some obvious ways to redefine (and invert) market infrastructures, and some less than obvious ones too. An obvious opportunity is that the growing use of debit and credit cards creates scope for automated clearing houses (ACHs) to settle transactions between buyers and sellers in ways that are cheap for consumers but still profitable for banks, after taking account of capital as well as investment and processing costs.

In fact, in order to service the burgeoning opportunities in the global payments industry, a complex ecology has already emerged between ACHs, the real-time gross settlement systems (RTGS) run by central banks, a variety of batch payments processing systems, the multi-currency settlement system that manages inter-bank credit risk (CLS), messaging standards such as ISO 15022 and ISO 20022, and communications networks such as SWIFT. A high proportion of the payments processed through that complex ecology are generated by the securities industry, which has a networked eco-system of its own. It consists of stock exchanges and other trading facilities (where securities are traded between buyers and sellers), central counterparty clearing houses (or CCPs, which mitigate the credit risk between the parties to a securities trade), and central securities depositories (or CSDs, which manage the exchange of securities for cash).

The role which all of these market infrastructures have in common is that of intermediary: they are almost never the principal to a transaction, but instead stand between the buyer and the seller. It is in their nature to be in “the centre” of a transaction. Their intermediation aims always to reduce risk, accelerate processing, increase efficiency and enable transactions between financial institutions and their clients to be monitored.

An intermediary role also means market infrastructures link up a wide range of other intermediaries, and form links with each other. As “hubs” and “nodes” linking the different parts of a financial services industry heavily reliant on digital technology, market infrastructures are inevitably among the first institutions to be impacted by technological change. Their growing popularity with regulators is accentuating this effect, by forcing them to invest in technology that enables them to expand their range of duties.

Viewed from a strictly technological perspective, market infrastructures are applications that process transactions between participants in financial markets. From the point of view of those participants, market infrastructures appear as a number of applications available in the so-called “cloud.” These applications can be invoked either explicitly (for example, submitting a settlement order to a CSD) or implicitly (for example, a payment instruction is copied by the network provider to an RTGS for settlement and netting). The participants in market infrastructures play the role of the consumer in other industries. In fact, although they are intermediaries themselves, they are the consumers of market infrastructure services on behalf of their customers. And they are having effects on market infrastructures that are analogous to the effect that readers are having on the publishing industry, or viewers and listeners on the audio-visual industry.

First, financial market participants expect market infrastructures to use open, standardized application programming interfaces (APIs). These are the components that determine how digital components interact with each other, and consumers increasingly expect them to encounter no barriers to the combination of different applications at all. An obvious example of open APIs on the Internet is the way in which Google allows its maps application to be combined with and embedded in other applications.

Second, users expect market infrastructures to be able to establish their identity instantaneously, and so permit transactions to be processed without obstruction in real-time. With even one financial institution having multiple identities, which correspond to the various parts of its business, this challenge is far from straightforward. The authentication of a counterparty through standard digital identifiers (such as legal entity identifiers, or LEIs) without breach of confidentiality requires up-to-theminute data, processing power and impeccable authorization procedures.

Third, financial market participants expect market infrastructures to exchange information using international standards such as ISO 15022 and ISO 20022. These messaging standards now cover payments clearing and settlement, and pre- and post-trade clearing and settlement of securities transactions. Yet their adoption is still far from universal. If seamless and instantaneous exchanges of cash and securities are to be achieved, both consumers and market infrastructures need to adopt a common language.

Fourth, users expect market infrastructures to complete transactions in real-time, and on a gross basis. In other words, they are no longer satisfied by batch processing cycles, in which unsettled transactions accumulate for hours or days before being settled on a net basis. The modern user of a cash payments or securities settlement system expects transactions to be settled as they arise, and on an irrevocable basis, to eliminate counter-party exposure risk as soon as technologically possible.

Fifth, market infrastructures are increasingly expected to deliver data and reports to mobile devices, without any loss of security. Indeed, consumers no longer see mobile telephones and tablets as tools for the passive receipt of data. They expect to use them to initiate transactions, correct errors, and grant approvals. Consumers use their mobile devices in this way in their day-to-day lives, and expect the same degree of flexibility and convenience to be available at work, without confidentiality being compromised.

Sixth, client service can no longer be restricted to a help line or even a call centre whose operatives are online to answer the telephone within three rings. Users of market infrastructures are not interested in internal organizational matters of that kind. They are familiar with the use of social media in other aspects of their lives and business, and expect market infrastructures to equip them with online tools that enable them to find the cheapest or safest way of settling a transaction, monitor the status of a transaction, and to talk to them regularly via video and newsletters.

Seventh, market infrastructures are coming under increasing pressure from their users to add value to the data generated by their core operational processes. Knowing that a sum of cash has moved from one account to another, or that securities were safely delivered, will in future become the raw material of sophisticated business analytics services. In combination with data from other sources, it will enable users of market infrastructures to benchmark their operational performance against a peer group, identify bottlenecks and inefficient customers, and adapt their prices.

Market infrastructures need to embrace some or all of these trends. The question is how to do this. Importantly, investment in technology or revised processes is the least important response. All seven of the trends represent opportunities to innovate not within the market infrastructure as an application in itself, but at its edge. In other words, successful adaptation to the seven trends depends on changing how the application is accessed and used, not on changing what it actually does.

Altering access and use is obviously far riskier and more complex than investing iin a new technology platform. Collaborating with other organizations from inside and outside the market infrastructure industry enables experiments to take place without putting the core operations at risk of disruption. My own term for this is the “sandbox”, where innovations can be tested in a non-competitive and safe way.

One good candidate idea for the sandbox is a “cloud of applications” for market infrastructures, helping them adopt collectively the seven trends described earlier. In this view, market infrastructures would be able to subscribe to share applications to help them adopt and cope with the seven trends described above, but without the cost to understand and implement them themselves.

“Just the word itself, infrastructure, conjures up images of steel and concrete, heavy, immovable building blocks, which once put in place will last the test of time,” concludes Andrew Davis of HSBC. “But these characteristics are now the very reasons why they are at risk of becoming redundant. Infrastructure needs to claim a new space, to be a conduit for the design and delivery of new models and new services across an eco-system.

One could think of it like laying down a spider’s web, which can mould and shape itself to the environment: invisible to the untrained eye, flexible to accommodate change, whilst bringing strength and certainty to those that use it. That is both the challenge and the opportunity that lies ahead.


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