When IP becomes commoditised
Let’s step into a time travel capsule and go back to the 1980s, when the computers did the heavy lifting with mainframes and batch driven programmes to maintain the ledgers and run all the reports needed to run a financial institution. Much of the trading business was done either as open cry trading, or over-the-counter, deals were written on tickets, and were keyed in by the trade support staff. Trade volumes were a trickle compared to the current day.
The 1980s saw computers developing beyond the dumb terminals with green fonts. We saw the arrival of powerful desktop computers running UNIX, and the emergence of what would become PCs. The impact was huge. Trading began a rapid shift to electronic trading.
With the emergence of the new hardware, the race was on to build the software that gave each financial institution a trading edge.
It began by simple steps. Traders traditionally wrote tickets that the trade support team keyed in, position keeping was manual. Persuading traders to key in their own trades met with some resistance, until they realised they had realtime positions, and importantly risk metrics were being calculated as their positions changed or when there price changes. The traders had a big advantage that they were no longer trading blind. Aggregated positions were a godsend to management who now had a realtime overview of the whole desk and could intervene in a timely manner if things got too risky.
This software was big IP capital that financial houses could use to gain an edge in their trading operations. In the 1980 and early 1990s it was the investment banks with proprietary trading desks who had the firepower and talent to develop the sophisticated software that gave them the edge.
The emergence of Open Source software began to challenge the proprietary software. In 1991 saw the launch of Linux [1] an open source operating system modelled on UNIX. The mid to late 1990s the internet emerged as a force. The impact on financial software was huge. The advantage of custom, infrastructure software began to diminish.
The secret sauce in proprietary decision support, trading and risk systems was now running on the open source frameworks of Linux and embracing the internet protocols.
The open source world was not restricted to operating system software, it had begun to proliferate, projects such as MySQL, an open source database were launched and the vast libraries of utility code.
The impact of open source was to rapidly increase the software development lifecycle and facilitated the formation of companies to serve the finance industry. Combined with the changes to trading that was becoming mostly electronic, there was a need to respond to both the markets and embrace the open frameworks. It is no coincidence that the 1990s spawned the established trading platforms we see today.
The big thing was the cloud. It changed everything. At first the finance industry was hesitant, concerned about privacy, security and to some extent compliance (such as where is the data held and who has access to it). Any hardware advantage a financial institution was greatly reduced. Hardware advantages are the preserve of the High Frequency Trading houses through their investments in microwave transmissions between exchanges and in FPGAs to process their orders at the lowest latency possible.
The cloud opened up elastic computing on an industrial scale, and the ability to process petabytes of data. Cloud was further enhanced by the open source tooling such as docker and kubernetes allowing software engineers to write code spanning hundreds of machines.
For financial institutions much of the competitive advantage of software had disappeared by the 2020s. What was left is the know-how, the IP in building sophisticated models for trading, risk management, portfolio construction, analysis and research. The hardware, much of the underlying software used in finance now commoditised.
What next for financial companies? Does it make sense to have a traditional technology department? The question is no longer where the teams are located, global teams have long been established in finance. The bigger question is what technological advantage or IP is important to the business? What gives a financial institution the edge over their competitors?
Does the technology team need to custom build, and maintain, software that is widely available? Are there vendors with best-in-breed solutions that would offer the frameworks to allow the financial business to focus on the value creation?
From a business perspective removing the overheads, capital on the balance sheet, and reducing the management overheads spent on managing technology allows a sharp focus on what matters.
The vendor solutions work in a competitive marketplace and they have the incentives to ensure that their products remain competitive, they strive to innovate. In short the vendor’s focus is on adding value for their customers.
By shifting the technology to a vendor solution for the utility and infrastructure frees the business to focus purely on value creation and remove the overhead and distraction from running utility or commoditised technology.
The focus on the value generation can change the dynamics of the business, the mission becomes sharper when the whole company is working towards the same goal.
