Cloud computing has been discussed on Wall Street since the early days of Salesforce.com circa 1990. Depending on how it is defined, the “original cloud” could date back even further, to the founding of Bloomberg and the widespread use of mainframe computers in the 1980s. But despite those early beginnings, Wall Street today is underutilizing this resource and its potential competitive advantage.
Greenwich Associates research shows that 80% of buy-side firms utilize vendor hosted execution management systems (EMS). Web-delivered applications, often referred to as software-as-a-service (SaaS), are also common, ranging from customer relationship management (CRM) to email to market data terminals. For the largest firms, internally built applications delivered in this way often consist of a pretty front end hooked up to a legacy back end. The cost and ease-of-use benefits of these approaches cannot be understated; however the capabilities of these approaches only scratch the cloud's surface.
The information and processing behind these products run in a cloud environment, but the cloud itself is mostly if not completely obscured to simplify the user experience. For that community to move en masse to the next stage of adoption, a number of perception issues must be addressed.
Security concerns remain a significant impediment, as evidenced by conversations conducted with market participants for this research. For example, investment firms are perpetually concerned with ensuring that their financial models remain proprietary. Hedge funds generate alpha, and hence profits, from their investment models and so prefer to keep those ideas close to the vest. The last 10 years brought a realization that operating servers out of a third-party data center provides more security than an on-site data room. Better physical security and disaster recovery were major drivers of the shift.
[For more on how compliance concerns are slowing cloud adoption, read: Is Compliance Preventing the Cloud From Reaching Its True Potential?]
The next 10 years will bring a similar shift towards the cloud. Physical security is improved with data centers used by major cloud providers operating in unknown locations. Disaster recovery gets a boost as compute power and storage is virtual and can move from one physical location to another with little if any downtime.
These differences are not intended to show that security at third-party data centers is inferior to security provided by cloud-computing providers, but instead to drive home the point that specific concerns over cloud security are unfounded in 2014.
Compliance concerns have also acted as a powerful headwind. Investment firms are justifiably preoccupied with staying on the right side of their relevant regulators, opting to avoid anything with even the perception of compliance risk. A tarnished reputation can kill a hedge fund as fast as a cloud provider, especially in these years after the credit crisis. With this in mind, many firms choose to take the safest approach, which in IT terms means sticking to the status quo.
To be fair, cloud computing inherently raises thorny regulatory issues. The storage of customer information can be tricky, especially when jurisdictional concerns enter the picture. The European Union's Data Protection Directive makes it difficult for a company to transmit personal data outside of the EU, even to the United States in many cases.
Regulators have also spoken. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) are both utilizing cloud computing themselves. The European Union has also worked to help cloud adoption, recently releasing proposed changes to the existing Data Protection Directive that would considerably simplify the process of moving data across borders.
Along the same lines, the Commodity Futures Trading Commission (CFTC) recently issued cybersecurity guidelines that, while not addressing cloud computing directly, set forth standards and put cloud computing squarely within the acceptable category.
Although risk-taking is rewarded on the trading desk, it can be grounds for dismissal in IT. While a select few trading firms use leading-edge technology to find alpha, such as tapping the cloud for extra compute power, as a whole financial service firms are not technology early adopters.
This means the conversation must include not just the CTO, but also the CFO whose goal is to grow the top line while shrinking the bottom line.
Why this matters now
Increasing regulatory certainty, acceptance that many tried-and-true investment strategies have changed for good and a resurgence of structured products are driving up the demand for compute power, but IT budgets aren't keeping up.
Although parts of the industry have bounced back from the depths of the credit crisis, the problem for financial service firms: IT budgets have not bounced back in step with the resurgence in structured products. Annual technology budgets among the institutional investors taking part in a 2013 Greenwich Associates study averaged $5.5 million. Hedge funds were the biggest spenders, with annual budgets averaging $7.9 million. Although the analysis and valuation of structured products is no less complicated than it was back in the boom, it is unlikely that the renewed growth in this market will cause these budget numbers to expand significantly.
So how much can a move to the cloud save a hedge fund? There is of course not one single answer, as infrastructures and needs vary greatly from firm to firm. For a hedge fund that requires just over 3,600 cores to perform calculations for its products, the cost would be approximately $1.9 million per year if utilizing an enterprise cloud offering. The cost for an on-premise grid would be $4.1 million. A cost savings such as this -- over 50% -- is hard to ignore.
Cloud computing is a buzzword, but it's much more than that. Its adoption in the investment community has begun, but its true benefits are still being left on the table. Improved cloud offerings, reduced IT budgets and a market that requires more complex calculations to be completed in ever-shortening timeframes with ever-greater accuracy will finally drive investors to move beyond hosted email servers and execution management systems to unlock the true scale cloud can provide.
Editor's note: Greenwich Associates is a provider of global market intelligence and advisory services to the financial services industry, specializing in providing fact-based insights and practical recommendations to improve business results. Greenwich Associates' data focuses on the key metrics required for effective business management: operations performance, service quality, sales effectiveness, share of wallet, market share, brand, and behavioral trends. Greenwich Associates is based in Stamford, CT with additional offices in Pleasanton, CA, London, Singapore, Tokyo, and Toronto. Visit www.greenwich.com for more information.