The biblical tale of a young, scrawny David bringing down the giant Goliath with a mere slingshot is one that remains a source of inspiration for underdogs. In the securities industry the largest players almost always triumph. The arrival of the internet briefly raised the prospect that newcomers might overturn the established order, with online marketplaces replacing old-fashioned salesforces and capital markets teams.
In response, though, the leading firms have hit back with a huge investment binge covering in-house development of new technologies, establishment of collaborative trading platforms and exchanges and a continuing search by in-house specialist investors for new e-finance companies and technologies that might be tomorrow’s winners.
The collapse of internet stocks and the imminent failure of so many internet companies has barely dampened the big banks’ eagerness to invest in e-finance. Funds are flowing through a bewildering number of channels, with many banks now having individual business groups buying into e-finance plays, as well as specialist in-house venture capital groups seeking strategic e-finance investments and conventional private equity investing arms also covering the internet.
Banks are so concerned that they may miss out on a breakthrough technology that they are willing to accept the obvious danger that they will end up wasting an awful lot of money.
There is significant overlap in the investment approaches the leading firm are taking, though all seem to agree that the no-brainer days of simply funding the latest hot areas are long gone.
“Our investment and incubation philosophy is based on an e-finance landscape that at any one time represents our assessment of the opportunities going forward. I like to think we’re not subject to what’s hot,” says Peter Maillet, managing director for LabMorgan, JP Morgan’s e-finance investment arm. “Yes, there are certain things that are in vogue right now, but we try not to let ourselves be overly swayed by that and, instead, try to link investment opportunities to what we think is going to be strategically relevant for JP Morgan in the future.”
Although many conventional financial investors now see the technology sector as taboo, it remains the primary area of interest for firms seeking strategic investments. But the stock market’s disillusionment with the tech sector has at least provided a wake-up call for venture capitalists that were previously jumping into half-baked business plans simply because they were in areas considered hot. Now, investors in the banking community are looking beyond trendy technologies, and are holding out for companies that have solid business plans, existing products, strong management and the near-term prospect of profitability. Bankers are now focusing on companies that can flush out their firms’ offerings and enhance the businesses where they are already strong.
“We’re looking for people who’ve got ideas, who’ve done the seed development, thought about the business context, have gone out and started beta testing with potential customers and are just about at the point of producing revenues,” says Roger Bates, director of DB eVentures. “We’re looking for companies which actually have a product, where we know the product is viable, up and running and is capable of driving revenues.”
| Packer: no uncertainty about the survival of multi dealer platforms | ||||||
Many banks continue to search for groundbreaking new technology, but some common themes to their investments are evident. One element they all seem to agree on is the longevity of consortium trading sites.
“There may be uncertainty about which multi-dealer platforms will survive, but at a broader level there’s really no uncertainty at all that such platforms will exist and that there will be increased price transparency on them, increased liquidity on them, and that it will change the way we do trading so that we have to provide automated instantaneous quotes and execution services,” says Michael Packer, managing director of Merrill Lynch CICG Direct Markets. “Once you acknowledge that the world really is changing in that way, what you have to build yourself really doesn’t change depending on whether platform A or platform B wins out. In that sense, I think all of us are starting to recognize that if we focus on those invariant changes that we need to focus on that we can really insulate ourselves from much of the uncertainty in the market.”
One such platform where Merrill has invested is Multex, a financial e-marketplace that connects buyers and sellers of financial services. Merrill distributes its research through the platform and has taken a financial interest, with Multex taking over a large proportion of the pre-trade information housed in the firm’s own electronic investment offerings.
Trading platforms have also caught the eye of UBS Warburg, which recently took a stake in EO, a UK-based distribution platform for private placements, pre-IPO and IPO equity shares. “We don’t have that capability right now, so it made sense. And rather than spend quite a bit internally in time and money developing that, we decided to work with a partner who had already built a platform and share some of the benefits,” says Nigel Dawn, UBS Warburg’s executive director of e-commerce investments. “We can’t do everything ourselves, therefore we have to be smart and work with good partners.”
| Dawn: “we can’t do everything ourselves” | ||||||
But though most bankers agree that trading platforms are here to stay, others believe these systems still face an uphill battle in their competition with voice brokers. They reckon a significant part of the investment community remains tied to the need for human contact and interaction when it comes to their money. According to UBS Warburg’s Dawn, in order to win over this part of the investment community, electronic platforms will need to have offerings that make them as attractive and personalized as investing through an actual broker.
But what about the trendier technologies such as Bluetooth and Wap, which have promised to reduce many day-to-day tasks to the push of a button? Bankers are notorious gadget-lovers. And though there’s something boyishly charming about the enthusiasm with which a debt capital markets banker boasts that his firm can update a client on the progress in bookbuilding his bond straight to his mobile phone, it’s hardly revolutionary.Earlier this year there was enormous excitement about the potential for Wap to transform financial markets.
Well, according to one banker, the consensus these days is that “Wap is crap”. The sense of excitement has certainly abated, though wireless remains an area where many securities firms have focused their attention. But they are looking at it from a new perspective.
According to Merrill Lynch’s Packer, investors’ cooling towards many of the technologies previously dubbed innovative should not be surprising and is simply a result of the realization that actually implementing them will not be as easy as was once imagined.
Though investors were initially taken by the novelty of new technologies such as Wap, most overlooked the question of how they could actually benefit their own companies. Many also ignored the fact that, with technological advances spawning new consumer products virtually every day, no one bank can lay down the law on the applications its customers will use. Because of that, applications such as Wap must be capable of supporting everything from simple internet access to Palm Pilots and several cellular technologies.
“What was clear a year and a half ago, if you thought it through, was that you would need help to support all of those platforms agnostically. I think where people got into trouble was where they focused on just one, rather than realizing that the real game was not Wap cell phones, the real game was wireless connectivity,” says Packer.
There has also been an awakening to the reality that implementation of many of the futuristic technologies will take some time. Denis O’Leary, executive vice-president of Chase.com. says: “Most people I know have not changed their mindset about the transformation capability of technology, that the technology that’s being developed is extremely powerful and has only been deployed to a limited degree. I think what has changed in the past six months is the expectation of the speed of that change and the mechanism of that change. The speed of that change needs such heavy lifting that in many cases doing these industrial-strength business systems requires both technology, people and process change. So a lot of these deals won’t be transformational overnight and may take several years.”
Filling the wireless gaps
When it comes to wireless enablers, the applications currently captivating the financial industry run the gamut. Among them are application service providers, voice recognition systems, independent connectivity, electronic communications networks (ECNs), data mining, risk management technology, payments systems and screen design tools.
And with each individual enabler making up just a piece of the overall puzzle, banks are all working to identify the combination of pieces that will best enable them to serve consumers through the multitude of wireless applications that have become an accepted part of everyday life.
“At the moment there’s no one company that provides the whole piece. The competition is not to complete the jigsaw puzzle, but to get from the top of the puzzle to the bottom of the puzzle,” says DB eVentures’ Bates. “You want to find little pieces that Wt that are going to get you there and whoever does get this full bridge across from the top to the bottom is going to stand to benefit enormously, because it’s going to be cheaper for people to come and find their solution rather than to try and reinvent that solution for themselves.”
The wireless arena is one that has proved equally appealing to traditional venture capital firms and e-finance specialists, but bankers believe it is their world that it likely to see the biggest changes and benefits.
“Wireless is a very busy space for everybody, but a lot of people feel some of the early applications that are most powerful in wireless will come out of financial services,” says Chase.com’s O’Leary. “Beyond basic outbound messaging, the more transactional services that give value to wireless will often be related to financial services. And if they’re related to shopping or commerce there’ll still be a settlement requirement on them.”
According to Packer, though no-one claims to know the exact direction the securities industry is moving in, there are key elements on which banks across the board are focusing. “You need content management systems, you need security and infrastructure systems around that, you need application software in terms of automated trading, auto execution, auto pricing, auto hedging and you need software that’s great at monitoring, to manage and monitor your website capabilities.”
| O’Leary: deals will take years to bear fruit | ||||||
One particular area in wireless that is seeing heavy development is electronic payment bidding services, with some e-finance venture capitalists saying they receive presentations from as many as 10 different systems in this space each week.
Spectrum is one company in this sector that has caught the industry’s eye, recently receiving backing from Chase.com.
An electronic bill payment platform owned by Wells Fargo, First Union and Chase, Spectrum uses imbedded messaging to ensure a straight-through, secure payment model. And though electronic presentation and payment of bills remains in its infancy, O’Leary says its widespread acceptance is just a matter of time, promising efficiency and cost saving for billers and consumers alike.
There have been around 60 companies created to deal with electronic payments in the past year alone, and identifying the winners will likely come down to finding the companies with the most industry support from users as much as financial backers. “What you haven’t seen yet is a lot of these companies that have the endorsement and the skill base of major institutions, but I think it’s likely you’ll see more and more of those over the next six to 12 months,” says O’Leary.
Widespread adoption of wireless platforms is also leading to increased consumer flexibility when it comes to remote monitoring and manipulation of their portfolios. According to Merrill Lynch’s Packer, it has long been clear that the key to electronic access lies in providing consumers with the greatest amount of personalization tools possible.
“When a year and a half ago we put acceleration to our institutional efforts to collect the clients electronically, one of the things we noticed was that the world of pre-trade – of research and analytics, inter-market commentary and all that – was moving very, very fast,” says Merrill Lynch’s Packer. “We could easily see that it was not just going to be serving up Adobe Acrobat PDF files and research to clients, but was quickly going to mean wireless and advanced integration between news, market data and the research content.” Even retail banks have realized the need to move beyond static sites for conducting single products such as current accounts. Many are now imbedding software to data-mine and profile customers, so that if, say, a customer has a certificate of deposit maturing in one month a bank can recommend an investment for the proceeds that fits a customer’s risk/return appetite.
| Bates: “there’s no one company that provides the whole piece” | ||||||
According to Packer, an important element in winning the wireless game will be partnering with the companies shaping the evolution of pre-trade information.
One company is this arena is Yodlee, an aggregation platform that enables consumers to designate data they are interested in, collect it from appropriate sites around the web and present it in a comprehensive format. Yodlee recently caught the attention and backing of Chase.com and is now being used within the bank’s own electronic offering.
Another company that has landed backing in this space is AlphaBlox, a web-based analytics platform that enables its users to pull information from virtually any type of database, analyze it and display it on a standard web browser. DB eVentures and Deutsche Bank’s asset management operation invested a combined $33 million in the product after employees in the firm’s US operation began using it for their P&L reporting for North American equities. Jim Sanger, chief technology officer for DB eVentures, says: “Once the firm noticed that the product was gaining popularity within its US operations, it quickly became obvious that there was potential to expand it to other parts of the business and to take it to other banking organizations as well.”
A key piece of the puzzle, and one that bankers are predicting as the next generation big thing, is software that enables translation of messages between different protocols and formats. With clients connecting to firms’ systems through a variety of outside channels – everything from basic computers to their own order-management systems – banks are seeking technologies that will enable them to feed all these platforms simultaneously and without the need for separate maintenance.
In a similar vein, another product that is generating attention is collaborative commerce: software that is able to aggregate information from combined online and offline sources, allowing for management through one online platform. The technology has been adopted by corporations such as Dutch electronics company Philips to aid in the management of supply networks. Imediation, a French ASP operating in this space, has received backing from DB eVentures.
“We thought for our work in the middle market, where we have a huge number of very strong relationships with companies struggling with multi-channel reseller relationships, this would be something that would Wt with our client base,” says DB eVentures’ Sanger. “These guys are the leaders in collaborative commerce.”
Itinerant traders
Though most bank investors are treading cautiously by seeking later-stage investments, they are not limiting their search to products already in use. In their search for wireless capabilities banks have also begun looking for possibilities outside the traditional box as well.
According to DB eVenture’s Bates, the firm is currently looking at a technology that will allow traders to move freely between desk positions, all the while maintaining the exact connections, services and information feeds they used at the last terminal. By recognizing individuals and the services they use, the wireless system is one the firm believes will prove a major cost-saving mechanism in environments such as dealing floors where traders are constantly moving around.
Another company that has caught investors’ notice is Intraspect, a software provider that enables service organizations to provide many-to-many services through a single platform. The software is currently being used by corporations such as General Motors, GTE and JP Morgan. LabMorgan has invested in the company.
For DB eVentures, another company that stood out is Fintrac, a market research, information technologies and technical consultancy firm that provides specialized products and services. The company publishes data including market surveys and price reports for organizations such as trade associations, as well as websites for private companies.
Chase.com is interested in Home Advisor Technologies, a deal between Microsoft, Freddie Mac and the residential funding corporation of General Motors to transform the US mortgage industry. For this project, Microsoft is contributing its MSN property for home listings and its customer relationship management platform for realtors and brokers. Freddie Mac and GM are helping to conform standards for some of the secondary elements of the industry. Chase’s role involves helping with the origination and servicing elements.
Another company Chase.com has backed is Tantau, a transaction management company that handles the back-end integration of wireless technologies to the core data engines of big companies. The company has developed software that enables companies to conduct high-volume, secure, mobile e-commerce transactions and maintain direct access to customers.
When it comes to trendy services making their way down the pipeline, one banker enthusiastically describes the credit card technology of the future, painting the picture of a wired card that will allow consumers to transmit their banking details to retailers simply by holding it in front of computers where their data will be wirelessly transmitted.
Yet while the tried and true offerings that are already operational may not be as glamorous, bankers believe that areas such as the plumbing of technology itself – back-end services such as security and storage systems – may very well prove the backbone and key to their success.
“Security is something everyone talks about a lot and obviously to banks it’s quite important,” says DB eVenture’s Sanger. “Securing transactions over the internet, over extranets, within marketplaces and security within the corporation for remote access: we think that there are significant opportunities out there and we are looking at those.”
While there is no one area that all banks have identified as hot, there are definitely areas they have begun to steer clear of. Investment banks involved in e-finance are not interested in funding research or the development of core technology, but maintain a focus limited to applications where they will be able to quickly realize benefits within their companies. They are also steering away from companies whose profits are driven by purely online activity, favouring bricks-and-clicks models, with companies reliant on advertising-driven revenues an obvious turn-off as well. According to bankers, there is not, however, any one category that is being shunned entirely.
Finding capabilities
Although most e-finance efforts from banks remain focused on the needs of their systems and building the most extensive offerings possible, it is areas such as security that are becoming more and more prominent on their radar screens.
“In strategic partnering we start with an idea that we need a certain capability. We’ll start with that idea and then we’ll go out and try to find people who have it,” says Merrill Lynch’s Packer. “We’re not really in the business of investing in business plans, we’re really in the business of finding capabilities for Merrill Lynch and its customers.”
Across the industry, banks have moved away from the one-time technical strategy of licensing software or simply paying outside companies to develop systems catered to their needs. Instead, they now realize any efforts they are making on the technology front within their own firms are probably shadowing those being made by their competition. And since it is inevitable that most banks will ultimately end up with extremely similar systems and supporting platforms, many have adopted the mindset that if they have to develop these technologies anyway, they might as well benefit from their investments by backing the companies they bring in to build them and by taking these platforms to the industry as a whole.
Banks are such big buyers of technology that when a bank sees itself becoming a big customer of a technology provider, and senses that its rivals may follow suit, it is soon tempting to take equity in the company.
“We’re moving toward a much more sophisticated view of how to partner with companies to co-create capabilities and accelerate their evolution so that you both benefit from it,” says Packer. And with such a mindset common among most e-finance investment arms, it should not be surprising that most e-finance investment efforts of securities firms begin with needs they have identified within their own organizations.
In fact, when it comes to identifying the most promising start-ups and young companies in technology, many e-finance venture capital operations have found that the knowledge and first-hand experience of the larger body of their firms has been crucial. According to DB eVenture’s Sanger, nearly two-thirds of the operation’s investment ideas originate within Deutsche Bank itself, either from employees’ experience with products or suggestions about technologies and offerings and how they could benefit the firm.
| Sanger: looking from ideas from within | ||||||
“What you need to do is have a really good relationship across your whole business and you have to stay in touch with all the departments in your organization to find out what is starting to make strategic sense,” says Sanger. “Our peers that have a very good relationship with the internal constituency of their banks have a very good advantage because what they’re going to look for are things that people are using in the organization but haven’t been advertised.”
Venture capitalists in e-finance are not limiting their internal searches to investment suggestions; many are looking within for investment opportunities as well. According to LabMorgan’s Maillet, the theme of grouping best-of-class technologies from within, spinning them out and commercializing them as separate companies is one that will become more common across the industry as a whole.
One example is cygnifi, a company LabMorgan spun off as a separate entity in February 2000, after it was initially incubated by JP Morgan. The company is an application service provider of internet and electronic access to derivatives services such as market and credit risk applications, independent valuations and portfolio stress testing.
“cygnifi is interesting because it is an example of taking a fairly complex and related set of technologies that we developed in house and use for our own derivatives businesses, repackaging that knowledge and those capabilities and turning them into a separate company that introduces a whole different kind of economics in terms of getting returns on those technology investments,” says Maillet.
Investors in e-finance are also taking advantage of the collective resources of their firms by utilizing the experiences of their global staff. Since most big firms have employees in the geographic regions where groundbreaking technology advancements are taking place – such as Scandinavia with it’s lead in cellular deployment – e-finance operations are also benefiting from first-hand connections to the most advanced companies in each area.
LabMorgan’s Maillet says: “e-finance is not a New York phenomenon and not a North American phenomenon, it truly is a global event. So we’ve got people spread around the world to help identify trends and how they are different. If you look at wireless development most observers would agree that Europe is ahead of the US and that Japan has increasingly interesting wireless capability, particularly in the retail space, and that’s an example of why we think it makes an awful lot of sense to have a global presence.”
High-level interest
To drive home the importance technology has within the financial industry, bankers note that investments in the area are now being actively supported and influenced at the CEO level. “Three years ago when people talked about these things, despite all the noise in the market, if you sat 10 CEOs down and said ‘talk to me about what your views are on the new economy or what your firms are doing’ it would have been a very patchy conversation,” says Chase.com’s O’Leary. “Today, you’d have quite an interesting discussion take hold. There are strong viewpoints, there’s strong knowledge, there’s full engagement and it’s a whole different model than it was three years ago and that’s a sign that this is on the strategic dashboard at the highest level in major financial institutions. People know that this world is going to change and that the sideshow of dot com valuations won’t affect that viewpoint.”
And though competition remains the underpinning of e-financing, with each firm struggling to finish the puzzle first, there is also a surprising willingness to team up in their efforts to back tomorrow’s technologies.
“If we want a company to do well in business that it’s doing with Deutsche Bank it actually makes sense to have other banks and strategic groups working with the same company to develop that business,” says DB eVentures’ Sanger.
