Infrastructure

07:30 AM
Allan Grody
Allan Grody
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Financial Industry Infrastructure in Need of Rebuild

The C suites are responsible for tearing down silo thinking and reengineering the financial system. So far, they've left much to be desired.

One of the myths of the financial industry is that its members are innovators of sophisticated technology. True, some are, occasionally, but most aren't. They are great at spending huge sums of money on sophisticated technology developed by software and computer companies, data vendors, and platform developers. That's why vendors and technology companies love to do business in this industry. That is where the money is. And that is where and why all new things are first vetted.

That's all the more reason why the financial industry should be at the tipping point of major leaps in technological deployment for cost efficiencies and infrastructure re-engineering, but it isn't -- nowhere close. The financial crisis should have been the root of that change. Aggressive regulators have been the change agents, but the legacy mind set and competitive nature of the industry's business models are holding back progress. Money is being spent on front-end, revenue-driven applications, not infrastructure rebuilds. That's what you get when budgets are driven by revenue-driven silo owners.

The technology innovators of today, the Silicon Valley and Silicon Alley entrepreneurs, have given us new infrastructure platforms: all-on-all-the-time plug-in cloud computing; globally pervasive big data networks; massively parallel computer power; multiple data stream computational processing power; and speed-of-light communications. Unfortunately, this technology is being used incrementally at the front ends in silos, not strategically for wholesale re-engineering, as is needed. Why not? Infrastructure rebuilds are the sole province of the CEO and the C-suite executives. That's where the silos come together. The rebuild is long overdue. Regulators have taken the first step, but they need direction. The CEOs need to step up.

Regulators themselves are taking direction from the pan-ultimate power brokers, the G20 global leaders. They have empowered a new standards entity, the Financial Stability Board (FSB) to organize regulators toward adapting standard practices for "stabilizing the global economy." It is heartening to see that the board's first focus is on standardizing data for regulatory reporting, so that regulators can see what they are mandated to oversee, and they can see it globally, so that they can mitigate the contagion of system risk, which almost did us in in the 2007-2008 credit crisis. Unfortunately, these leaders too are failing to grasp the revolutionary power that is theirs to exercise if they can only cooperate before they return to nationalistic instincts and self-interests. They too suffer in silos, though theirs are sovereign states, not strategic business units.

The FSB's most important initial paradigm-shifting initiative is establishing common global codes for financial market participants (the LEI), financial products (the UPI), and financial transactions (the UTI). The board also plans to standardize how transaction data is to be aggregated across the globe once these codes are implemented.

It is quite prescient of the FSB to start out resetting the pillars of the financial systems through creating a bar code-equivalent identification system for the financial supply chain. A global identification system for managing transactions across the global financial supply chain is long overdue. With such a universal coding setup, re-engineered enterprise-wide systems and cooperatively re-engineered infrastructure systems can be built using software tools in common use.

This is the first time regulators are embracing such a fundamental global infrastructure practice in an attempt at a global solution to a global problem -- the first attempt to define a universal coding system and design a new global market infrastructure for swaps. However, the industry is mired in legacy thinking, best practices of another era, and a Rube Goldberg infrastructure that evolved from supporting revenue-producing front ends when the plumbing needed to be fixed first.

We need the CEOs of the global financial institutions, now called global systemically important financial institutions (SIFIs), to clear the path and organize their own equivalent of the Financial Stability Board, as the G20 heads of state have done for regulators. (SIFIs have already come together as a group as the Financial Services Forum.) Then the ultimate decisions makers in both camps can be held responsible for re-engineering the financial system. They will at least pay attention to what is too easily dismissed as just "plumbing." To industry professionals, proper plumbing is well understood as essential for smoothly functioning automated business applications globally connected through a vast array of networks and computers collectively referred to as the "global financial system."

To quote Albert Einstein, "We cannot solve our problems with the same thinking we used when we created them."

Allan is President and founder of financial industry joint venture development company Financial InterGroup Holdings Ltd; and strategy & acquisition consultancy Financial InterGroup Advisors. The companies are engaged in the capital, contract, currency, cash and investment ... View Full Bio
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Greg MacSweeney
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Greg MacSweeney,
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7/11/2014 | 8:50:10 AM
Re: Wake-Up Call?
That's a pretty scary scenario that you outline. I certainly hope it doesn't come to that. But you are right. The longer the industry continues to rely on an aging infrastructure (and make patches and fixes to keep it going), the higher the probability that a major outage will take place. Fingers crossed it doesn't happen (but crossing fingers, much like hope, isn't a strategy).
allang119
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allang119,
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7/9/2014 | 10:01:47 AM
Re: Wake-Up Call?
Infrastructure rebuilds or 'fixing the plumbing' is more about new designs than patches on top of crumbling legacy infrastructure.  I think of Y2K more as a massive undertaking to fetter out the known instances of legacy system time bombs.  It is the unknown ones I worry about - the ones that appear almost weekly and that stop markets, allow passwords and accounts to be stolen, cause flash crashes and flash freezes, and is susceptible to denial of service attacks. This is taking place while a million quotes are transmitted every second, trades get done in milliseconds  and it still takes three (3) days for payment to occur and assets to be exchanged. This later point is directed at the legacy back office Rube Goldberg infrastructure upon which all the other failing components are built upon.                                   

It is just a matter of time for the multiple back office systems and interconnected financial market utilities to have a  free fall outage, a  day and  then a second day (that's already happened), and  then again a third day, when the payment and settlement flows  for cash equity markets are due, that the whole financial system stops.  A credit crunch of major proportions. A tail event for sure, but as we all know now, the probability of that tail event occurring keeps getting more probable.  The CEOs will then take notice for sure. A shame they can't step up before this scenario happens.                                                                                                              
Greg MacSweeney
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Greg MacSweeney,
User Rank: Author
7/9/2014 | 9:06:15 AM
Nobody thinks about the plumbing
As you noted, the big banks need to focus on improving their infrastructure and modernizing it using technology from this century. However, the plumbing that the financial industry relies on is taken for granted. It is the farthest thing from the C-suite's minds. Meanwhile, business unit owners are busy tracking down every last dollar of revenue and they don't seem to be bothered by the fact that most of the plumbing is decades old.

To start focusing on infrastructure now as you describe, is a massive shift in thinking. Hopefully, one or two bank CEOs will take a leadership position on this important topic and will shine the light on the industry's aging infrastructure.
KBurger
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KBurger,
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7/8/2014 | 9:12:11 PM
Re: Wake-Up Call?
Thanks for the additional thought-provoking analysis. I guess this also is why we see financial services firms essentiall acquiring innovation (eg, BBVA buys Simple, Allstate buys Esurance, etc.). Also -- funny you referenced Y2K, I was thinking about Y2K when I read your article. I was thinking about it more as the last instance (at least that I could think of) of a massive, industry-wide, somewhat unified focus on infrastructure.
allang119
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allang119,
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7/8/2014 | 6:19:36 PM
Re: Wake-Up Call?
Appreciate your kind remaks. My reply:

 1. Financial institutions are not internalizing the fact that technology companies are transporting domain knowledge gained from their work with financial institutions to others – retailers, distribution companies, and network suppliers like Walmart, Tesco, Bloomberg and Markit.  India based companies proliferated in the Y2000 era, crawled through every legacy application to seek out paralyzing year end miscoding's and wound up with the domain knowledge that was embedded in the business applications they alone now knew.

 

 2. Financial institutions have not yet realized that the financial system they operate within is truly a 'system'- an interconnected set of communication lines, computers, operating systems software and business applications. Others are better at creating, managing and innovating around such infrastructure. That is where competition is to come from – Amazon and E-bay, Microsoft and PayPal, and yet unknown scores of entrepreneurs who have facility with technology.

 

3. There will always be a need for financial innovations - the next money market concept, the ETF, the S&P e-mini contract, securitized assets, et al. However, the ideas have always been developed into actual products or services by lawyers, accountants, tax experts and, of course, increasingly enabled by technology companies. What is left for the 'traditional' financial institutions is the old boy network of contacts, knowing who needs what and how to raise the money and from whom – still very valuable, but as generations change and society gets more financially literate, this value proposition is also vulnerable                                                   
KBurger
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KBurger,
User Rank: Author
7/8/2014 | 4:17:45 PM
Wake-Up Call?
Great analysis, Alan. I love this statement: "[Financial services firms] are great at spending huge sums of money on sophisticated technology developed by software and computer companies, data vendors, and platform developers." That's a great point, I never really thought about the industry's approach to technology that way. Do FIs realize they are being used as testing grounds and cash cows from businesses that may one day actually compete with them?
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