The Financial Services Club's Blog

Hallow MiFID's Eve: Trick or Treat?

‘Twas the nightmare before Christmas and Halloween Jack realised that MiFID was upon us and he had not budgeted nearly enough to make it happen. So he stole $35 million and plugged the regulatory hole through one massive computer upgrade that made all of the consultants and computer suppliers happy Christmas bunnies. 

That's the story we seem to be hearing anyway.  According to Accenture, the average large firm spent $35 million on MiFID.   That's about a third more than my original estimate of $22 million, but less that the $100 million I heard from one major market-maker.

Equally, it only seems to be here in London that they're forking out this moolah as most other countries have been confused about MiFID's implementation, as mentioned yesterday.  Many believe the transposition and implementation by Czech Republic, Estonia, Finland, Hungary and the Netherlands all in a whirlwind flash for November is baloney.  Meanwhile, Spain's Finance Ministry is saying they'll get it pushed through in December whilst Poland is being honest and stating that it is "impossible to estimate" when MiFID will be transposed. 

Maybe this is why 93% of UK companies believe that MiFID will not be "consistently implemented", according to a study by EA Consulting Group released last week.

The survey covered 85 of the UK’s largest investment and financial services providers, and other key results included:

• When asked "What is the biggest threat that MiFID poses for your business?", 40% answered a lack of certainty, 29% a distraction from ‘business as usual’ activities, and 6% the cost of implementation;
• When asked "What is the biggest headache that MiFID causes your business?", 29% said the costs of converting legacy systems, 25% the lack of awareness among management, and 6% the costs (seems like the same 6% as last time to me!);
• 65% see MiFID as an opportunity and 18% as a threat (former must be banks and latter Exchanges);
• 44% say management’s awareness is good whilst 8% think it's "very poor" (bet the latter's not an Exchange!);
• 34% think compliance will be the biggest cost (really!), 28% IT & systems, and 13% data capture and retention;
• 33% think investment banks will benefit most whilst 11% believe technology providers will (latter must be Accenture, SunGard ...);
• 25% reckon that a level playing field will be MiFID's biggest benefit, 20% think that it is passporting across borders, and 11% that Europe will be a more attractive marketplace for investing.

There's no real surprises here for me, as it's just another way of finding out whose cup is half-full and whose is half-empty.  To be honest, most will find their cup half-full if they really understood MiFID well early on and planned appropriately by either reducing tariffs and fees if they are an Exchange or deploying and delivering enhanced services to investors if they are a Broker.  The half-empty brigade are the Spanish and Polish who still don't seem to have much of a clue how MiFID will impact their businesses because their regulators have taken so long to transpose.

Meanwhile, there are those who thought their glasses would be brimming over but are yet to find a few drops of refreshment.  These are the multiplicity of vultures and hyenas who have been beating the MiFID drum loudly for a couple of years riding on the Fear, Uncertainty and Doubt (FUD) it was meant to create.  These FUD-feeders hoped that they would just get consulting, software and integration work through the very mention of MiFID. 

Oh, the day of the MiFID’s.  It’s going to cost you.  You should be worried. And guess what, we have a solution!  Come and get it.  Roll up, roll up.

Now some of them have earned their crust by being sober, rational and strategic.  Yes, you guessed it: the lawyers.  With all these new contracts for retail and professional investing clients, they’ve had a bonanza.  For the IT guys, there’s been some success too.  For example, I was reading with interest that a small wee firm from New Zealand – New Zealand? – has been making a mint.

The firm in question is Endace and they provide tech that measures the performance and security of telecom networks.  According to their latest half-year figures, profits and revenues surged as banks prepared for MiFID by investing in their new NinjaProbe product.  This box analyses network traffic at 10Gbps and generated over 20% of the firm’s revenues for the period, $1.7 million, which is pretty impressive for a product only launched in March.

Ah well, I could go on and on with the nuances of MiFID this week but back to the real world and again, feel free to read earlier MiFID blogs or the Book if you haven’t got to grips with it yet.

Meanwhile, ‘twas the nightmare before Christmas and Halloween Jack went trick or treating.  He treated those that had been planning for All Hallows Eve for over a year with the riches of Europe’s new pan-European investment markets riches ... but for those who only just woke up to his deadline, he tricked them of all their profits and gave them a darn good spanking.  And no, they did not enjoy it!

MiFID week is finally here

There’s lots being written on MiFID this week as it’s MiFID implementation week – hurrah! – so I thought I’d try to summarise some of the key things being reported during the week.  Today, I thought it worth a very brief recap of the key MiFID milestones    

February 1992: Maastricht Treaty signed by European Union’s Member States to create a Economic and Monetary Union (EMU)

May 1993: The Investment Services Directive (ISD) introduced, with the concentration rules for focusing trading through national exchanges which proves to be unsuccessful (hence the reason for MiFID).
January 1999: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain adopt the Euro as a trading currency.
March 2000: The Lisbon meeting of the European Council creates the Financial Services Action Plan (FSAP) to create a Single European Financial Market for banking and insurance which leads to some of the reasoning behind MiFID.
March 2001: The Lamfalussy Process named after Alexandre Lamfalussy, the chair advisory committee that created it, is created to ensure better regulation processes within the European Union for developing financial services directives.  MiFID is the first Directive to really test this process - it is not the first directive to use the process however, as the Prospectus Directive, the Market Abuse Directive and the Transparency Directive have also been through Lamfalussy structures.
April 2004: MiFID adopted by the European Parliament and Council (Lamfalussy Level 1), beginning a two year consultation process with original implementation date intended for April 2006.   As we now know, this was pushed back to November 2007.

May 2005: Introduction of the MiFID Joint Working Group in London, UK, joining SIIA’s FISD, the Reference Data User Group, the FIX Protocol Ltd and ISITC Europe, in a collaboration to influence the wordings of MiFID and reduce the impact upon technology structures.

November 2005: Introduction of MiFID-Connect, a collaboration of many groups including the Association of British Insurers (ABI), the Association of Private Client Investment Managers and Stockbrokers (APCIMS), the Association of Foreign Banks (AFB), the Bond Market Association, the British Bankers’ Association (BBA), Building Societies Association (BSA), the Futures and Options Association (FOA), the International Capital Market Association (ICMA), Investment Management Association (IMA), the International Swaps and Derivatives Association (ISDA) and the London Investment Banking Association (LIBA), to reduce the legal risks and to simplify the implementation of MiFID.

September 2006: After extensive consultations and changes to wordings, MiFID is adopted and ratified by the European Parliament (Lamfalussy Level 2) and now needs to be transposed into national implementation.

31st January 2007: Deadline for countries to transpose MiFID into national laws (Lamfalussy Level 3).  Only the UK achieves this on time.  Although many people say Romania and Ireland were also on time, they followed the UK in February and March respectively.

1st November 2007: Deadline for countries to implement MiFID as national law (Lamfalussy Level 4).  According to the European Commission’s September survey of member states, all countries will achieve this except for Spain and Poland who are yet to advise when Level 3 will be implemented.  The Czech Republic, Estonia, Finland, Hungary and the Netherlands are the last countries to achieve Level 3 in November 2007.

As many of you know, I pulled together a book on Europe after MiFID a few months ago, with contributions from most of the leading figures in the industry.  If you want to know more about MiFID’s background and implications then feel free to have a look at it as it gives you over 20 views of what MiFID means other than my own.

Meanwhile, I see the Financial Times is writing extensively about MiFID this week and thought the leader column from Jennifer Hughes yesterday entitled “Financial Services brace for confusion” was spot on.  As you’ll see from the link, it’s for FT subscribers only, but here’s a few choice lines:

“The UK financial services industry is braced for months of uncertainty and confusion as ... MiFID is due to become law throughout Europe on Thursday, but in spite of years of planning, many countries and companies are still far from fully implementing it.  This has left both business and regulators unsure about the scale of problems that could be thrown up by the directive.”

Old McCreevy had a Plan,  EU, EU, Oh!
   

The credit crunch explained properly

For those of you with ten minutes to spare and access to YouTube, if  you want a good laugh or cry, then here's the Bird & Fortune* guide to the credit crunch.  Brilliant!

 

* for our overseas colleagues, John Bird and John Fortune are viewed by many as being the best business comedians in Britain.

Chinese bank buys American bank

As someone involved in predicting the future, it amuses me how often we get things wrong. You've heard all the quotes: "a worldwide market of five", Thomas Watson of IBM's prediction for the global computer market back in 1953, or "640kb of memory is enough for everyone" from Bill Gates.  So, when you get one right, you can't help telling everyone.  And I got one right so I'm gonna tell you about it.

At the beginning of 2006 I began investigating the deregulation of the Chinese banking markets, writing research reports in the area in May 2006 with the prediction that three of the top ten will be Chinese by market capitalisation, and the expectation that a Chinese bank would buy an American bank before the end of the decade.

Now that's not a bad prediction I thought, but my American colleagues laughed at me and said, "No way". The report produced back then therefore weakened the message to four of the top ten banks in the world would be Asian.  That's a safe bet as, even then, three of the top ten were Asian based upon the Banker magazine's ratings ... bear in mind, Asia means Japan in this context though, rather than China.

I then presented these ideas around the US markets and elsewhere through the summer and autumn of 2006.  Again, the reactions were very negative and dismissive.  People didn't want to hear it.

Six months later, in October 2006, I was commissioned to write a report for a US Journal (BAI's Banking Strategies) and the US editor told me that he didn't believe my view that Chinese banks would be buying American banks but, as it was stimulating and controversial, they published it.

I even provided in-depth analysis on Finextra a year ago, and most people said, "interesting but not sure".

Then the Industrial and Commercial Bank of China (ICBC) had their IPO.  On October 20th 2006, ICBC hit the stock markets and were the largest IPO the world has ever seen.  The bank wanted to raise $19 billion,  a value which dwarfed the $12 billion raised from 53 IPOs in the second half of 2006 on Wall Street.  By the end of the first day of trading however, the bank had a market value of about $157 billion.  That was more than Goldman Sachs Group and Lehman Brothers Holdings put together and within striking distance of JPMorgan Chase.

A year later and Chinese banks are using their market capitalisation to buy stakes in US banks. They can easily do this because they are riding the wave of growth, buoyant in an economy growing by over 11% per annum.  Hence, China's CITIC Bank announced last week that they seek a stake in Bear Stearns. This follows China Minsheng Bank agreeing to buy a 9.9 per cent stake in UCBH earlier in the month and CIC's $3 billion in Blackstone, the American buyout firm, over the summer.

And it's not only US banks as China Development Bank took a 3.1% stake in Barclays in July for $3 billion, supposedly to help them through their attempted buy-out of ABN AMRO, whilst in the last week we also had the agreement for Standard Bank of South Africa to sell a 20% stake to ICBC.

On the one hand it's nice to know I'm right in forecasting that, just as with manufacturing and technology, China is now expanding into financial services to create global banking behemoths of the size of impressiveness of HSBC, Citi, JPMorgan and Deutsche.  That is their intention and it's starting to come through.  Although the dollars behind such investments are based upon a strong economy that can stretch a Yuan a lot further whilst we have a cheap and vulnerable Dollar.

On the other hand, and it is a point made in reporting the Standard Bank / ICBC deal in the Times of South Africa, is the potential culture clash as these deals come through.  The point made in the Times is that the Barclays / ABSA deal hasn't worked well due to the difference between the English and the Afrikaner cultures.  Now, we have a lot of Western banks buying into China and a lot of Chinese banks buying into the West.  The cultures are at opposites and it makes you wonder how well they'll really get along.

After all, I remember when the insurance group Clerical Medical Group launched in China and had to use their short name, CMG, as the Chinese were unable to pronounce their full name.  Similarly, when Coca Cola first launched in China, they used the name "Ke-kou-ke-la".  This had to change rapidly though as Ke-kou Ke-la translates into "bite the wax tadpole" or "female horse stuffed with wax", depending on the dialect.   They ended up researching 40,000 characters to find a phonetic equivalent "ko-kou-ke-le", and used the final translation "happiness in the mouth". 

It's not to say we cannot get along, but Coke's final translation still sounds like a line from a shady internet site and so I wonder how much research and effort both sets of banks will have to put into their Chinese investors and partners to find happiness in the wallet?

 

A banker's favourite smell is ...

Interesting supplement in today’s Times newspaper on careers with an 8-page supplement on careers in Banking.   A few choice quotes:

“Confidence in the world’s financial markets is shaky”

“Lehman Brothers, UBS, Morgan Stanley and Credit Suisse have all announced redundancies”

“Is now the worst time to consider a career in banking”

Mmmm … sounds a bit depressing doesn’t it?  But it goes on to quote Neil Owen who works for Robert Half International, a recruitment consultancy:

“We have seen various large banks talk about redundancies and job losses, but … we are seeing very little evidence of it.”

And states that the market turmoil is squeezing credit-related jobs in the front-office, but the rest is still all buoyant and brill.  Wa-hey.

Counteract this with the Bank of England’s Financial Stability Report that was released yesterday and you’d think again.  This report says that there are "serious fragilities" in the origination and distribution model that financial firms use to manage debt and that British Banks face a £150 billion bill if they are forced to set aside capital against their Structured Investment Vehicles (SIVs) and Collateralised Debt Obligations (CDOs).  Oh-no!

Back to the careers report and they then have a five question quiz on whether you’ve got what it takes to be a real banker.  Question five goes:

“The US sub-prime mortgage crisis:

a)      Demonstrates the hollowness of the American Dream (0 points)

b)      Was a clear risk that could have been obvious to anyone (0 points unless you can prove you said this before the crisis occurred in which case 3 points)

c)       Doesn’t bother me at all as I bought property in London in 1996 (increase value of current points by 199 per cent)

d)      Is why I’ve been encouraging clients to invest in China rather than America (10 points minus a 3 per cent pollution levy on all points)”

OK, so all of us UK bankers fall into category (c).  Wa-hey.

Except that the IMF says the UK property market is going to crash in the next five minutes, as do most other economists.  Oh-no!

So, I’ll stick with the Are you a real banker question (2), which is the most appropriate for the Finextra crowd:

“Your favourite smell is:

a)      Money (1 point)

b)      Cocaine (no points as you’re not able to count anymore anyway)

c)       Humans on the London Underground (-10 points as you must be mad)

d)      The burn of computer networks processing enormous transactions (2 points)”

Mmm-mmmmm … smell those mips.

Turquoise announce technology and CEO

After the disappointing outcome over Plus Markets, various factions are coming out and poking fun at Turquoise.  Unlike BOAT, Turquoise has little to show for its efforts so far, and are still looking for a Chief Executive.  What happened?

The big difference for me is that BOAT has strong partners led by the Markit team, who were selected way back in January.  As a result, they're ready for launch.

Meanwhile, Turquoise has been delayed and delayed, with launch pushed back  to summer 2008 (about the same time as Project Smartpool announced today) because they haven't been able to select the core platform.  Actually, not quite true.  They did select the core technology platform, OMX, in June but couldn't get it delivered in time due to contractual negotiations.

To circumvent all of this, Turquoise then made the bid for Plus Markets earlier this month, which would gain them not only OMX but a Chief Executive, Simon Brickles.

According to the reports, the reverse takeover fell apart because of an argument over whether the choice should be OMX or Cinnober.  Alternatively, it's because Simon didn't want to have the title "CEO of the failed Turquoise Exchange" on his CV (and who does?).  Alternatively, it's because one of the US banks in the syndicate didn't like the cut of his cloth and wanted their own man to lead the team.

Either way, it's about as interesting as whether England scored a try against South Africa in the Rugby World Cup or not (they did, but the video referee wasn't wearing his glasses fyi), as in the discussion is over and the decision was made whether it's the right or the wrong one.

The real winners are the survivors ready for next week's launch of MiFID. And they are ... the London Stock Exchange, Euronext and the Deutsche Bourse ... oh yes, and Chi-x.

Well done folks, you're MiFID-ready.  That doesn't mean you're MiFID-compliant or MiFID-preferred by the way, but at least you're in production, available and I can trade with you.

Meanwhile, should Project Turquoise be renamed Project Red, as in Red with embarrassment?

Don't bet on it, as last week the consortia seemed to be saying that they would shortly announce both a technology provider and a Chief Executive.   I'll be watching that space with interest ...

... funnily enough, later the same day and meantime, in another part of the city ...

Turquoise announced later on today that Eli Lederman of Morgan Stanley will be CEO.  Checkout my future of trading transcript for more on Eli.  And, shock-horror, Cinnober will be the technology rather than OMX.  Funnily enough, Cinnober is the same technology platform that BOAT uses.  Small world isn't it?

 

Mobile banking: have we got it right?

I am struck by the sheer number of announcements over the past 12 months related to mobile payments and mobile banking.  Nothing wrong with this, but times change fast and I'm already wondering how long mobile will be in vogue.

For example, just as the iPod is dead, so is the mobile.

What, you ask?  Heresy.  Immediately take him out and burn him at the stake.

OK, so I'm being a little bit radical, but there is an awful lot of dead electronics about to be chucked out of the consumer's home including DVD players (Blu-Ray and HD-DVD included), mobile telephones and iPods.

Let's take the DVD and TV stuff first.  On-demand TV sourced from high speed wireless internet connections will deliver HD-Movies and live events in real-time.  Bang goes the DVD.  This is why UK domestic suppliers, such as BT, Sky and Virgin, are all fighting hard to be the domestic broadband providers of choice and why they are continually seeking to add new services around media and on demand programming. 

In fact, the vision they have is that we will soon be social networking whilst watching TV, e.g. you stick on Desperate Housewives and begin picking holes in the script or bitching about how much more red Bree's hair has become to your friend who's watching it 200 miles away. And you do this through live video links to your pal through your TV, not through your PC or on the phone.

Now, let's take the iPod. The iPod didn't exist until 2001 and, as I often tell people, it didn't take-off to begin with.  For example, it was only 2003 when I tried to buy one through the UK's leading high street electronics store and the assistant turned to me and said "we used to stock those but stopped - after all, who wants to download music off the internet". 

That store doesn't exist today - it's now just an internet site - and the iPod sold the 100 millionth unit in April.  But already, the iPod is morphing into a phone and wireless internet access device.  Equally, many phones now have iPod style functionality.  The iPod is dead, long live the iPod.

Now to the phone and, particulary, the mobile phone. 

The phone is going to be killed by the internet.  All those big fat mobile telephone firms are going to be zapped by internet communications.  All those expensive 3G licenses will soon not be worth the paper they're written on.

Why do I think this?

Because I travel worldwide and am getting increasingly angry with VODAFONE (there, so sue me) because they charge me an extortionate rate for making calls home. 

First, they lock you into what they advertise as a cheap rate Passport for 75 pence connection fee and then local call rates apply.  That's fine if you're going to talk for 10 minutes or more, but my calls are short and sweet.  Result: I pay over double the cost of calls thanks to that 75 pence connection fee.

Second, they charge a whacking great £1:50 ($3:00) per minute when calling home from the USA or Hong Kong or other territories oustide Europe.  That is hugely expensive and, when you ask if they have a package designed for travellers like yours truly, the answer is: NO.

So why am I blogging about this on a banking technology site?

Because banks have finally woken up to mobile banking and are investing big-time, even though there are serious questions about whether customers want it, will use it, need it or will pay for it.  I've already talked about this a couple of times recently, with a specific review of US mobile banking developments back in July.

That was the entry that quoted a certain J S Hurst as follows:

"I'm a developer for one of the larger US banks and am currently in the pilot for the mobile personal banking rollout ... this is actually my employer's second rollout of personal mobile banking. They were the first major bank to offer mobile services (over a decade ago) but canceled the program because of lack of interest. Perhaps features looming on the horizon like 'contact-less payments' will draw more attention, but the response amongst most my coworkers on the pilot has been pretty ho-hum: kind of neat, but I don't think I'd use it very often."

But this is not where I'm coming from when I say mobile is dead.

Mobile is in a transient state and will soon converge with the internet.  It's already happening where I use my Nokia phone to google and surf.  But here's the rub. 

Due to Vodafone's high overseas call rates, I now make 90% of my calls from overseas using Skype.  My Skype calls are about a penny a minute ($0:02) compared to Vodafone's £1:50 ($3:00).  I cannot now fathom how any firm could expect to compete in the future based on a call charge that's 150 times more expensive than the new competition.  And the new competition is good.  For example, Skype just did a deal with MySpace so you can integrate social networking with calls.  Sounds like that fits with BT, Virgin and Sky's ideas of social networked entertainment.   

Vodafone have forced my behaviour to move towards Skype and IP-communications as a consumer.  Soon, all calls will be IP-networked and the mobile carriers will be dragging their heels with high call charges.   The impact upon them will be a similar impact to the one mobile originally had on fixed landline firms, e.g. where are they now?

The result is that banks will purely have two channels - direct and remote - human and IP-enabled - physical and electronic.  Today, most banks think they have about five channels - branch, call centre, mobile, internet, ATM.  This is the change as we actually have just two channels: physical and electronic.

That changes thinking because it means that all of the electronic connections will be IP-enabled connections.  So if I were you, banking strategists, I wouldn't bet the farm on mobile banking as it could be dead before it even got started.   Bet the farm on internet-based web service instead.  That's where I'm headed.

ACORD Leads In Standards for London Insurance Firms

London-based insurance firms have struggled, largely unsuccessfully so far, to work with each other through electronic channels.

ACORD, the US insurance standards organization which has been expanding into international markets, appears to be the leader in driving standards, the key to electronic business, into the London market and its global affiliates.

An ACORD-sponsored two-day forum in London 16-17 October, drew more than 600 participants – fortunately not all at the same time because the meeting room could not have accommodated them all. While market participants are using ACORD standards with counterparties as adoption expends, they are also finding value in using the standards internally, especially when dealing with far-flung offices in Asia.

Thomas Krapf of Swiss Re said his firm is looking at the whole scope of standards to improve the way it interacts with business partners.
“A standard has to be global and usable for business partners on a global scale. Therefore we have an interest in a strong global standard, and ACORD may be the strongest available now,” he said.

Tom Payne of RJ Kilin & Co., said his firm is using ACORD for internal communications.
“We are slightly different. We are a London market syndicate, predominantly out of Lloyds building. We also have operations in Southeast Asia, Europe and South Africa. We expect to see the standard as a way to act with partners and also to interact with our overseas offices. We are taking the work we do in London and using it as an internal standard. It would be silly for us to reinvent the wheel when something as powerful as this exists.”

Do banks really know their customers?

I recently organised two debates at the Financial Services Club entitled "This House Believes We Really Know Our Customers".  Both debates focused upon fraud and money laundering (AML) and the vote at the end of both debates resulted in a resounding rejection ... as in this house believes we really don't know our customers. 

I referenced this last week in my piece on Buyology but, having been through the debate a second time, I thought I'd share the logic I would propose to say that banks do really know their customers.

First, why do banks need to know their customers in the first place?  For a number of reasons which fall soundly into either a regulatory risk bucket or into a revenue and profitability bucket.  Both buckets are mutually inclusive by the way.

The regulatory part is to do with Wolfsberg, FATF, AML, the Patriot Act, KYC and all those good acronymns.  By law, banks have to vet customer to make sure they are not no-good, lowly criminal drug launderers, terrorists or other malcontents.  This has been the focus of several blogs, including the announcement of Lloyds TSB being accused of "knowingly assisting" money launderer Lycourgos Kyprianou last week.

The risk part is all to do with whether the bank could be risking business by allowing this customer to do business with them.  After all, you don't want bank robbers opening accounts with your bank do you?  Risk equally relates to the regulatory part.

Most of this focus on regulation and risk therefore is geared towards making sure the people you do business with, as a bank, are honest.  By law, banks are now forced to check that the client is honest upfront.  Are they who they say they are?  Can they prove it?  How far do they need to go to prove it ... driving licence, passport, birth certificate ... we'll soon be at the stage where opening a new account will involve not only bringing in these documents to your local branch (see, there are reasons to keep branches) but also your mother and father, brothers and sisters and anyone else who knows you to have them state you are who you say you are.  And maybe they'll need to bring in their birth certificates, passports and driving licences too.

Anyways, assuming you can get an account opened successfully, which is a painful process, you are then prime fodder for selling products to: Give 'im a credit card!  What about a loan or mortgage sir? With or without insurance?

This leads into the second part where, having overcome the regulation and risk aspects, you are now someone who banks can make money out of.  So, we start talking about CRM and cross-sell ratios; we start talking about retention strategies and calculating your propensity and profitability profiles.  Is he a black card prospect, gold card or green?  Is this guy a lemon, an apple or a pear?  What about kids - has he got any kids we can sell to?  Inheritances imminent?

It's all about leverage to the top line and you can only sell more to the top line if you really know your customer.

So, we need to know our customers to onboard them during account opening for both legal and internal risk management requirements, and then we need to continue that client knowledge through our relationship with them to know what to cross-sell them, to retain them and to make money out of them.

This leads to the second major area of knowing customers: once you know your customer, do you know them well enough? This is the critical part as it is the basis of all competition in financial services: the more you know about the customer, the more likely you are to be able to retain their business, cross-sell to them and make money out of them.  Whether retail, high net worth, corporate or institution, the banks that know more about their financial needs will get more business than the banks who don't.

So the question comes down to whether banks use customer information effectively because, if they don't, then others will.

This has been true since the foundation of banking, as demonstrated by visionary CEO of Citibank Walter Wriston, who stated in the 1970's: "Information about money has become almost as important as money itself".  In financial services, information is where the value lies.  It's all well and good having data, but you need to leverage that data into information about customers, and then into knowledge of customer habits and needs.  Walter Wriston's innate understanding of this turned Citibank into America's leading bank, much of which was on the back of technology innovations focused upon leveraging customer data.

Many others got the point though, as demonstrated by generations of management thinking from Total Quality Management with Tom Peters to Business Process Re-engineering with Michael Hammer; from 1:1 Marketing with Don Peppers to the Loyalty Paradox with Fredereich Reichheld; from CRM with Siebel to the Experience Economy by Joe Pine ... the point of all of these generations of management thinking is the same.  How do you use information about the customer to give the customer great interactions?

And here's the point. 

Banks do know their customers.  Banks know more about their customers than most partners and spouses.  Banks know your mother's maiden name, your birthday, how much you earn and how much you owe.  Banks know where you spend your money and who you spend it with.  Banks know when you're in financial wealth and when you're in dire straits. 

In this context, banks know more about you than anyone.  Who else can you point to who knows all that information?

The issue then is that I can only name one or two banks who recognisably use that information to demonstrate that they care; to show they know this information about you and who use it to create empathy, loyalty and intimacy to the level where you honest-to-goodness feel that you just love your bank.

The rest still need to go back to the drawing board as it's not about the data, the information or the customer ... it's about the culture of the bank.

The Future of Finanical Crises -Merton and Scholes at IAFE NYC

The International Association of Financial Engineers is bringing in two heavy hitters to discuss the future of financial crises -- Robert C. Merton and Myron S. Scholes (If you have to ask, this probably isn't for you), but:
Robert C. Merton is the John and Natty McArthur University Professor, Harvard Business School & IAFE Senior Fellow  and Myron S. Scholes is Chairman, Platinum Grove Asset Management L.P. & IAFE Senior Fellow.
Perspectives on the Current Financial Crises – Will This Keep Happening?
Monday October 29th, 2007, 5 - 6:45 pm

5:00 Registration, 5:30 Event, 6:45 Reception

Sponsored by International Securities Exchange

McGraw Hill Auditorium, 1221 6th Avenue (Entrance on 49th Street)

Free for IAFE Members and $100 for non-members.

Click <a href="http://www.iafe.org/member.html" title="here">here</a> to become an IAFE member.

Space is limited and is on a first come first serve basis – with priority going to IAFE Members.

Financial Insights - Top 10 Trends in Banking -- The Teaser

And the top three:

Information lifecycle management rather than just information management

Technology refresh, or Dynamic IT, which involves wrapping new technology around old legacy systems. Sounds like a new name for Saas. It also seems to me that wrapping legacy systems by itself, without a larger strategy for moving forward, risks getting stuck with high maintenance costs and significant opportunity cost. I have done a dozen stories in the last year or two about companies that have seen huge savings and huge improvements in speed by dumping their mainframes for much faster Wintel-based systems that cost far less. Whether you call it Saas or a new term like Dynamic IT, this could be a strategy of developing competitive DIS-sadvantage.

Data security concerns continue. And they won't go away, especially when staff and consultants download sensitive information to laptops which they leave in their cars, cloakrooms and restaurants.

The other 7 come out at the conference in Boston.

Tom Peters, Jim Collins -- Fairy Tales About Business -- IMD's Phil Rosenzweig

The Halo Effect Takes the glow off some of the most popular business books of the last two decades with an intelligently critical view of methodology.

            Two weeks ago I pulled “Good to Great” by Jim Collins off my shelf and began reading. An inspiring book about companies that had chugged along for years and then taken off on a hockey stick curve that led them to outperform the market by a substantial margin for 15 years, it included just 11 which made the grade, including Circuit City, Fannie Mae, Gillette, Nucor, Walgreen’s and Wells Fargo.

            The university research team Collins worked with found certain common features – Level 5 Leadership – CEOs who were ambitious for the company but personally modest; getting the right people on board and, equally important, getting the wrong people off the bus. Focusing narrowly – the hedgehog rather than the fox in Isaiah Berlin’s terms, a culture of discipline largely resulting from having the right people who can be counted on to do the right things, and using technology as an accelerator rather then being led by it.

            All very good until I picked up The Halo Effect, Phil Rosenzweig’s somewhat gimmicky term for a very real problem in heroic business books – the tendency to find winning companies and then collect the stories from participants and the business press to look back and explain the factors of success. A professor at IMD in

Lausanne

,

Switzerland

and a former employee at HP, he ruthlessly picks apart the results of some of the best selling business books over the last two decades.

            Although Collins and a team of researchers spent 5 years gathering information such as interviews with managers and loads of press clippings once they had identified the 11 public companies which met their cut, Rozenzweig contends the materials, such as business press articles, suffered from The Halo Effect – once a company is anointed a winner, all its history is written to explain its success. (As for Collin’s descriptions of the filing cabinets full of materials, the 6,000 press clippings, etc. it reminds me of what Charles Peters, founding editor of The Washington Monthly, says about bureaucrats who brag about the hours they work – when you can’t measure output, measure input.)

            Rozenweig sets his foundation with Chapter 2 about Cisco, lionized by the business press in the run-up to the 2000 bubble peak when for two weeks it had the largest market cap in the world, and then roundly criticized by the same publications, such as Business Week and Fortune just a year later, often on the same grounds such as its aggressive acquisitions and customer relationships that they had praised earlier. In just months, valuable strengths had morphed into obvious failure, as if Karl Rove had taken up business journalism.

            It’s enough to make you cancel your subscriptions. Especially since the business publications for the most part failed to understand the shortcomings of the research when they reviewed these books

            The best sellers, from “In Search of Excellence,” which Business Week debunked a year or two after its publication when it reviewed the performance of highly praised companies that had since tanked, to Built to Last or the Evergreen Project, directed by a McKinsey’ partner with William Joyce at Dartmouth’s Tuck School of Business and Nitnin Nohria at Harvard Business School, books supposedly cutting to the core of what makes a business successful suffer from pseudo scientific methodology masked by inspiring story-telling. Of the Excellent companies, only 12 managed to grow faster than the overall market in the 10 years after the book was published, and 23 failed to keep up.

            The late James Meindel at SUNY Buffalo conducted a series of careful studies that concluded we have no satisfactory theory of effective leadership that is independent of performance, Rosenzweig says.

            “So many of the things that we commonly think contribute to performance are often attributions based on performance.”

            He does find some studies that are rigorous, but they don’t make great stories. Marianne Betrand at the University of

Chicago

and Antoinette Schoar at MIT studied the impact of individual CEOs and concluded that they explain about 4 percent of the variance of company performance.

            “That’s a statistically significant finding, but it’s hardly a seductive story.”

            Nick Bloom at the London School of Economics and Stephen Dorgan at McKinsey tested specific management practices against results in a survey of 700 companies in a cross sectional, rather than retrospective survey and hid their aims by telling people the survey was about practices, not performance. They concluded best practices contributed about 10 percent to superior performance. While Tom Peters and Jim Collins can command around $100,000 for an appearance, Rosenzweig doubts that these academic researchers will get anything like that with their cautionary conclusions.

            What’s the alternative to business self-help books? He thinks success comes down to strategy and execution. Both require extensive, continual and critical thinking – not the mainstays of self-help books whether in dieting or business.

            But, he notes “You wouldn’t appreciate the risk nature of strategic choice if you read most business books.”

            He cites the Evergreen Project which said, “Whatever your strategy, whether it is low prices or innovative products, it will work if it is sharply defined, clearly communicated and well understood by employees, customers, partners and investors.”

            Sheer nonsense, comments Rosenzweig. “Good to Great” has nothing about strategic choice, competitors, positioning or risk. In fact, its index doesn’t list even strategy.

            “Neither or these books recognized a central fact: Strategy always involves risk because we don’t know for sure how our choices will turn out.” Competitors and technological change are also sources of risk. He mentions Clayton Christansen’s ground-breaking “The Innovator’s Dilemma” which showed through numerous case studies that listening to customers and refining existing products can lead a company straight to ruin, even while it seems to be doing everything right. For execution, he turns to Larry Bossidy of Honeywell who laid out specific areas of focus – accelerating new product development, improving the order-fill rates, superior inventory management, and better working capital management.

            So what is to be done, as Lenin so famously quoted Nicholai Chernyshevsky?

            First, contends Rosenzweig, give up the idea that you can manage to greatness with a couple of simplistic ideas. He prefers Andy Grove, former CEO of Intel, whose approach was explained in the title of his book, “Only the Paranoid Survive.” “…a thoughtful primer on strategic inflection points – moments of extreme risk when the company’s life is at stake.”

            The pop business books probably won’t do you any harm, unless you take them too seriously. However, before you settle down with the next one, read through “The Halo Effect” to sharpen your critical faculties. Success doesn’t come through managing by fairy tale.

            

The future of trading

I recently chaired a breakfast meeting on the future of trading with three key figures from the industry: John Serocold, Director, London Investment Banking Association; Wolfgang Eholzer, Head of Trading Systems Design, Eurex; and Eli Lederman, Managing Director, Electronic and Agency Trading Services, Morgan Stanley.  I thought you might be interested in their views, so here's the opening salvo from each speaker. A complete transcript is available if anyone wants one.  Just mail me.

CHRIS SKINNER:      The debate is on the future of trading and will there be any traders around in 15 years, or 10 years, or 5 years?  A report came out last year about algorithmic trading and latency, which said that nine out of ten dealers would be out of their jobs by 2015.  I have readily asked people that question, “Do you believe that nine out of ten dealers will be redundant within seven or eight years?” and everyone in the market tells me, “No, no, more like four out of ten, three out of ten, five out of ten” depending on what sort of company you work for so.  We will get into some of that discussion this morning by asking John to pick up on the theme.

JOHN SEROCOLD:  Thanks very much, Chris.  I should preface my remarks by reminding everybody that making predictions is dangerous, especially about the future.  It seems to me that the future of trading is going to be bound up with a number of existing themes some of which Chris touched on in his introduction and most of which will play out in either a major or a minor key over the next few years. The laundry list of themes includes security, end to end authentication and all of the issues around that.  I was interested to read this morning that the people who are trying to crack the system from the outside are now turning their attention to Facebook and Bebo as a way in to identify theft.

           My second theme is constant refreshment of the infrastructure and you only have to look out of the window of this room to see the physical manifestations of that.  That green glass building was built as the London Stock Exchange in the 1960s and it is just being refreshed as another landmark for the city of London.  All those cranes are contributing to the constant refreshment of the infrastructure just to accommodate the human beings.  What you can’t see from here that is equally important is the investment that is going in - invisibly, silently - all the time into hardware, software, communications and capacity.

           When buildings in London started to get taller the market leaders at the time thought they were going to be running with hydraulically powered lifts so an enormous network of relatively large tunnels was quickly built under the city of London to provide high pressure water to power the hydraulically powered lifts.  This was at a time when electricity was in its infancy and thought to present a fire risk.  Those hydraulic tunnels quickly fell out of use but then had a new lease of life in the 1990s when it was a very convenient place through which to throw large quantities of high capacity fibre optic cable to take advantage of the next turn in the technological progress.

           That leads me to my next theme.  Constant refreshment of the infrastructure costs money and the end to end cost of trading still needs to fill.  This is a major theme of LIBA’s work over the last few years and for now, in my introductory remarks, I will just divide those costs into two buckets.  There is the cost that the investment banks pay away externally to infrastructure providers which continue to be too high, and the second set of costs are costs about which the investment banks would dearly love to do more but they cannot, which is the cost of complexity - the cost of a broken Europe, the cost of the absence of a single approach to regulation, market microstructure issues, conduct of businesses issues.  The potential for a significant win in that area as a result of the Financial Services action plan is very much in the yet to be delivered box as far as the industry is concerned.

           Fourthly, I should mention attention to detail.  I think attention to detail as a theme will continue to be very important over the next few years and attention to detail not just in capturing business requirements in order to code them but attention to detail in terms of the details of the application of the laws of physics will be important.  We will come later on to the services that some of the major exchanges are offering called co location which is an attempt to work around the fact that there is a thing called the speed of light by allowing people to put very resource hungry applications very, very close to the exchange’s trading engines rather than have the tiny extra latency of sending large quantities of messages from the bank’s trading engine to the exchange’s trading engine.

           Along with attention to detail goes constant attention to the changing needs of the client.  The automation story, more or less all my life and for some time before that, has been a story which is fundamentally about simplification.  If you go back to Ford’s insight into the production line, if you look at robotisation of production, if you look at the prefabrication of buildings - and again you can see that out of the window - deskilling jobs, making them easier, making them easily replicable, making them easily exportable doesn’t necessarily fit very well with the changing needs of the client.  Clients’ needs have always been and will continue to be very, very heterogeneous.  I am sure that with 20 of you in the room we will have at least 25 opinions about the future direction of the financial market.  You are all at different stages in your lives; you all have individually different financial needs - scale that up across the population of Europe, scale that up across the population of the world.  The clients are always going to be heterogeneous and the challenge for bankers and investment bankers is to find ways of meeting those needs efficiently.

           So I think that is probably enough from me but that’s just to set the scene and give you an idea of some of themes which are going to influence the future of trading over the next few years.

CHRIS SKINNER:     Wolfgang from Eurex, give us a little bit more insight into where the markets are going and how technology in the markets and global integration of markets are coming together.

WOLFGANG EHOLZER: Yes, from my side we have heard a lot of, I would say, general principles which for sure will lead the way into the future.  From my side, looking a little bit more on the technology side of things, I can see for any place where trading really occurs, whether it is an exchange or trading venue, ECN or whatever, at least five criteria which will determine whether they will be successful.

           These days, obviously latency is one of those; that is an issue.  I think one has to be careful in talking about latency because there are different definitions and I think up front it is one of the important things, talking about things to try to define them.  So at least, in my high level and naïve point of view, when somebody enters his order to buy or sell whatever it might be until he gets the response, what really has happened to that order?  You send, “Buy me 100” and I get back, “Bought 50, 50 in the book”.  That is one part of latency which I think is important.

           More importantly, I think that achieving low latency is definitely not enough because I think what we’re seeing in the market situation at the end of February, beginning of March and also in August, is that a very high consistency is extremely important for the market.  So even in situations when there is a lot happening, all the people who trade whatever it is want to see the same behaviour of all the IT infrastructure; whether it’s from outside providers, exchanges, ECNs, they behave exactly in the same way which is a challenge for all the guys who are doing the technology side of things because volumes are up by a factor of three, four, five or ten maybe, and in a peak situation that is a challenge.  So I think consistency is extremely important.

           I think the third thing on my list is obviously high speed market data, so it’s not only knowing what your order has been doing - whether it has been matched or you’re in the book - but it’s also to know where is the market and that, of course, also consistently with low latency.

           I think the next two things, and one of them is probably mine -- I think there is a general trend that trading venues don’t want to have a large footprint on members or participant’s side, whether it is exchanges or ECNs, to bring down the cost so that there can be consolidation on the service side of things or technical infrastructure side of things.  But there is also one, I find extremely important, point and I’m pretty sure we will hear more of that in the future and that is really state of the art risk management.  If we see these days investment decisions being taken by machines with extremely high speed and we see order rates coming in at hundreds per second then the value at risk there is extremely high on very low time scales.  From my perspective it is quite clear that there will be drastic changes happening on this side because it can’t be only the trading side of things which speeds things up; it has to be the clearing and the risk management as well.  I think we will see a lot of that happening in the future.

           Now, from a derivatives exchange point of view, of course they are different investment strategies.  It’s not everybody who needs this ultra low latency and all the other attributes.  There are strategic investors who want to buy 5% or 3% of a company, maybe have a certain influence on certain decisions at that company, and they are thinking about a much longer time scale; they are not doing statistical arbitrage.  So there are very many different groups of investors and I think this is another generalistic thing we will see in the future, that there is more diversification also with respect to technology.  There are some people who need this high speed game, which in the end will also be at some cost to them because keeping up in this race for speed will and already leads to costs on the side of the people playing this game, so we will have a strong segmentation of the market.

           All of that said, obviously we see the electronic pits forming these days.  You used to have the pits with the traders; these days it is all the service moving close to the exchanges wherever it is around the globe and I am pretty sure that we will see this not only happening on the trading side but also happening on the clearing side.  Risk management has to be almost real time soon because the risk of all these guys sending their orders in at very high frequency is going to add up.  There is no point in knowing the risk two hours later or at the end of the day or whatever.  I think those people who take the risk, typically in the exchange business side, these are the clearers who have to know that in time.

           Now, long term, coming back to your question, I strongly believe in traders and human beings so I am pretty sure that we would see in the area of, say, more straight forward, plain vanilla, high liquid products less human interaction, so less people getting a job there - more machines or more people who know how the machines work and can be configured and tested and whatever.  But I think there will be plenty of other complex products like complex derivatives pricing which you don’t want to hand over completely to a machine and where innovation is extremely important.  Maybe it’s different kinds of people sometimes but personally I think there will be a lot of humans still involved on the trading side.

           I also think that we will see more of a move that more products will come on exchange or on large trading venues which are OTC at the moment to essentially in the end bring down the total cost of the process by means of standardisation. I am pretty sure derivatives will continue to grow at enormous rates in the future and maybe long term we will eventually also see that we get some global geographical clustering of exchanges.  If latency really is very important then that might lead to the fact that all the services of the exchange or trading venues -- look, for example, at the States’ equity markets; there are lots of trading venues there.  There is a natural centre for equities trading in the States.  New York.  For futures -- obviously that is Chicago.  That will be the next step.  If that concentration process goes on will there be only one financial centre in the States and everything moves to Chicago maybe, or here to London or to Frankfurt or to Milan or to Paris?  But you can’t rid of the laws of physics; there is the speed of light and on cables it’s not even the speed of light in a vacuum - it’s a little bit less.  So maybe that is driving things together so that in the end we have only one or two places per time zone on the globe where they at least say the bulk of the trading is really going to be conducted.

CHRIS SKINNER:     Let me just ask one question.  Looking at your background, you’re a physicist and when you look at the skill set in trading these days, the skill set is rocket scientist.  There are people who have mathematical degrees, there are people who understand quantitative analytics whereas 10, 15 or 20 years ago those skill sets didn’t have that value.  So how are the skill sets changing and is it going to be a future which is dominated by all these rocket scientists?

WOLFGANG EHOLZER:  Yes and no, of course.  I would say on this plain vanilla, high liquid stuff which will be highly automatic in the future and already is in parts, you will need people with a very solid IT background and understanding of the laws of physics, I am pretty sure.  On the other hand there will be a lot of complex products and I think the skill set that was good 10 years ago or 15 years ago to enter a job in the financial industry will still be good in this area, I am pretty sure.  So I think we will have more people with a natural science background moving in on one side of the trading product range but there is lots of space for, I would say, traditional people there, I am pretty sure.

ELI LEDERMAN:        I completely agree with that.  I think the demographics of who gets employed by investment banks has changed dramatically and much more so on the trading side of things probably than on the pure investment banking side of things.  There is certainly every reason to believe that that continues.  It probably goes some way in beginning to address your question about exactly how many traders there still are employed, first of all after banks report earnings this week and then looking a little bit further out 5 or 10 years or whatever.

           The question I think people on the inside would probably argue is maybe not completely relevant or answerable or other things without clarification. The reality is that the very definition of what a trader is is changing and you might more fairly ask how many people are going to be employed by operations that do trading because it really is all about building systems, designing systems, using systems and these are things fundamentally that humans do and humans who we call, and I think other people call, trading scientists as much as anything else.  It is certainly remarkable.  I usually don’t tell this to anyone although I think it may be in whatever kind of bio is in your folder, but I also have a PhD in physics.  I didn’t realise you did so there is at least something about the fact that four panellists ... we have 50% physicists up here.

           I think looking at the next, say, five years I see a few major trends playing out and they are in chronological order: proliferation, consolidation and rationalisation.  Looking at these I realise that if I put them in a different order it would be C, R, P and if I had thought of something that began with an A, I would know I was on the wrong track but in any event -- automation, thanks, very helpful.

           So, proliferation.  We are clearly on the cusp of some very dramatic changes in the trading landscape, the proliferation of trading venues.  We have now the Chi X platform from Instinet which is really very rapidly attracting liquidity away from the primary exchanges in Europe.  We have Project Turquoise which my firm and others in the city are involved in which will create a Pan-European MTF, or multilateral trading facility, which of course is promoted -- or that sort of competition is promoted by MiFID although it very likely would have happened with MiFID or without.

           When there are multiple liquidity buckets you inevitably get fragmentation. You have liquidity in bucket one, two or three and it becomes someone’s job to segregate that liquidity.  That, of course, is called fragmentation. The thing that happens immediately upon the creation of these alternative liquidity sources is fragmentation but the fact that the orders get smaller and smaller and people spend more time trying to hide what they’re doing in the various markets which itself leads to the proliferation of more data.  So something that used to be one order for 100,000 shares becomes 1,000 orders for 100 shares; as we’ve seen the trend inexorably lead in the US that will happen in Europe.  So you really have an exponential growth in data -and it’s entirely appropriate that COLT is buying the croissants today because they’re probably the only real beneficiaries of this - as people develop this sort of insatiable requirement for things like bandwidth and low latency, and of course right around the corner we will have digital news and so on as someone alluded to earlier.  Digital news driving investment decisions will lead to a whole new type of investment strategy and there will be more black boxes and they’ll do more insidious things when the markets get rocky.  So, anyway, as I say that’s the proliferation side of things.  It’s all about incredible complexity and the requirement, of course, for more people to design and build systems to deal with it.

           The next phase I would predict is consolidation.  People are going to look at this market place - our competitors; I hope not us and I don’t expect it will be us - and say this is an extraordinarily difficult, expensive business to be in.  Indeed, not just on the sell side but a lot of what I’m talking about is the buy side, who have invested very heavily in their trading operations over the last few years.  I think maybe it will be a market turn down or something but people on the buy side are, I think, inevitably going to look at the trading operations they have developed and ask does it make sense that there are one million trading desks in the world?  What is the right number?  Maybe there should only be 1,000; maybe there should only be 5.  I think it’s entirely reasonable to expect that there will be something a little bit - I realise there is some irony here - like the old world where people on the buy side looked to brokers to provide the science and the technology behind trading and we get into an environment where people are competing on the objective quality of what they’re doing because these things, after all, are measurable, are getting more measurable.  With all of the dark pools and all of the different things that you have to navigate through to do a best execution type of job, it’s entirely reasonable to imagine a world where there are only five or ten or whatever providers of such a service. It will be, in any event, extremely complex and people will have obligations to demonstrate that they have done as well as Morgan Stanley or Goldman Sachs or whoever the pre-eminent providers of these services end up being.

           So, anyway, that brings me to the last of these things and that is rationalisation.  I think it’s very, very important to pause, to look around and to see what’s happening and to remember what exchanges were built to do in the first place.  There could be some debate about this but in general terms they were designed to be places where people who cared about an asset and wanted to buy it were able to meet someone who cared about an asset and wanted to sell it.  What has happened, I think, beyond any possible argument after what happened in August -- what has evolved is actually a system of interconnected pools of liquidity that are effectively a playground for arbitrageurs and people who are not really fundamentally about investing in assets that they care about.  If that is the way things have been and if that continues to be the way things go, it makes it difficult to understand exactly why we all have to invest so much.  So there’s not some evil machine out there that’s lurking, waiting to gain the system or pick up the footprint of an institutional order to trade against.  I think in this last phase, it’s imminently reasonable to expect that market participants, either in concert or not, look at the market and say, “We’ve got to rationalise this” and look at crossing tools or whatever to reintroduce some order to the trading world.

           Finally, I would just say as we all talk about black boxes, even in August when they were in every headline when things started to go bad, people noticed and people turned off the black boxes and people decided when to turn them back on again so it’s not all as robotic as you might believe.

 

Stirring BOAT's waters

I am regularly hearing half-truths and inaccuracies to cause confusion and issue, and this is particularly true as the battle grows between the old and new exchanges, and the old and new players in the investment markets. 

One example is BOAT, formerly Project Boat.

Due to folks giving me duff information, I've reported on BOAT a couple of times only to be told afterwards that the information was naff ... so I thought I'd give you BOAT's side of the story.

First, I wrote about issues with BOAT's pricing model a while ago.  It turns out that the accusation of BOAT being expensive is a half-truth. 

The figures that were being quoted on that occasion gave the impression that BOAT's pricing was expensive.  The figures being used were most likely based upon total number of trades and not on the value of those trades.  Not all trades are equal in value and those that are of larger size are more interesting to the market, which is why BOAT's pricing looks at the value of trades.  Equally, no mention was made of BOAT's data being pan-European and that BOAT represents two-thirds of all of Europe's off-exchange share trading.

In other words, the figures were comparing apples and pears, rather than apples with apples.  As a result, the people who were at that event walked away with the impression that BOAT would be ten to twenty times more expensive than comparable players when the comparable players are not, in fact, comparable.

At Tuesday's Exchanges conference, a certain gentleman asked the question as to whether the fact that BOAT had not gained TDM approvals from the FSA would scupper their plans. In fact, the way he asked the question would have meant that the audience would get the impression that BOAT had been rejected for TDM status by the FSA. 

This is not true and BOAT's folks rang me yesterday morning to say: "The BOAT TDM application is in process.  The TDM audit is being finalised which is a key part of the information required by the FSA. BOAT will update the market in due course."

It doesn't change the question of whether the FSA's usage of TDM status is acceptable under MiFID, which was the point that was the greatest source of debate, but it does show how misinformation can be used to ill effect. For example, stating that BOAT isn't a TDM is different to saying BOAT's TDM application is in process.

And this is their key point.  BOAT has not had its application rejected, it is in process. 

BOAT also sent me the following announcement, just released:

As part of a marketing initiative to demonstrate the value, accuracy and breadth of its data, BOAT will offer its real-time dataset free of charge to both potential and existing clients until 1 January 2008.  In addition, following extensive consultation of potential clients, market data vendors, trade associations, consultants and user groups, BOAT will provide a delayed datafeed which will be made available free of charge as from 1 January 2008.

In summary, it's all well and good to deal out information to question firms and their plans, but such debate needs balance and a BOAT doesn't float without balance.

The alien world of Exchanges

Yesterday was interesting.  I was invited to speak at a conference for Exchanges  and the expected players were there: Deutsche Bourse, Reuters and the London Stock Exchange (LSE); and then there were the newer markets with the Prague, Warsaw and Bratislava Stock Exchanges; and then there were the others: NYSE Euronext, Euronext.liffe, Chi-x, Turquoise, Equiduct, Virt-x and PlusMarkets.

The interesting part it that most of the latter names didn't exist until a year ago.  Suddenly we are living in an alien world where, in the last year, we've seen an explosion of execution venues and players in the exchange markets thanks to MiFID. MiFID means that the traditional players - the LSE and Deutsche Bourse - are now just execution venues competing with Multilateral Trading Facilities (Chi-x) and Systematic Internalisers (Turquoise).

One of the key things I noted in my presentation is the recent news of the suspected reverse takeover of PlusMarkets by Turquoise.  Shares in PlusMarkets were suspended on 5th October with the firm valued at £88 million, as Turquoise rumours abounded, although it should be noted that these rumours are still not proven.

Why would Turquoise need PlusMarkets? 

First, to get the technology platform behind PlusMarkets - OMX.  The complex negotiations around this platform have already delayed Turquoise's launch by six months or so, and a reverse takeover would speed this up.   

Second, it would give Turquoise the ability to compete head-to-head with the LSE and others, as it would give Turquoise the status of 'Recognised Investment Exchange' (RIE).  An RIE can take primary listings which currently is the hallowed ground of the LSE and PlusMarkets (Chi-x is a secondary listing MTF), hence Turquoise would have serious bite. 

Finally, the takeover would give Turquoise a management team led by Simon Brickles, the enigmatic CEO of PlusMarkets.  For a long time now, we've all been saying that Turquoise is a good idea in principle but who's going to run it?  Now we may know.

If the takeover doesn't happen, it would be a surprise and a shame as it makes good sense for both sides.  Funnily enough, one person made the comment that this would take us back to the pre-Big Bang days where the main trading exchange is owned by its members ... those were the days!

Meantime, the other interesting debate was around the fact that the FSA has yet to approve Project Boat's application for TDM (Trade Data Monitor) status.  Boat announced (10 page pdf) in April that they would be applying for such status but the FSA has yet to process.  This could effectively constrain their success, as the FSA have made it clear that investment firms only have a 'safe harbour' if they use an FSA-approved TDM.  However, the core opinion was that this is an example of FSA gold-plating and that CESR will not recognise this layer of regulation around 'FSA-approved TDMs'.  After all, you cannot have a local ruling under a pan-European implementation, so this is discounted under MiFID interpretations as just being local noise.

Should be interesting to see if the markets view it that way.

Banks accused of laundering

After yesterday's news that Lloyds TSB and the Bank of Cyprus are accused of having "knowingly assisted" a money launderer, I do wonder whose job it is to police the financial markets for villains. Obviously, the banks will monitor fraudulent activity as they don't want to lose money, but your basic drug baron, mafia godfather, terrorist or white-collar thief?  For governments, the latter are critical to track and crack, but should it be the banks who cough up for these activities or should it be the government's job?

The only reason for posing these questions is that banks increasingly are caught out in the spotlight of being culpable for not being aware enough of what is going on through their own accounts.  Yesterday, Lloyds TSB and the Bank of Cyprus were accused of "knowingly" assisting a business man - one Mr. Lycourgos Kyprianou, founder and former chairman of AremisSoft - to launder his fraudulent proceeds  "well after the widely publicised downfall of AremisSoft and the indictment of Kyprianou and others for securities fraud".

The banks were charged with civil money laundering claims by the US attorney for the Southern District of New York, and face fines of up to $130 million for Lloyds TSB and $162 million for the Bank of Cyprus.  According to prosecutors, Mr Kyprianou laundered several hundred millions of dollars through his Lloyds TSB account, with over 200 transactions between June 2000 and January 2004.

Well done Lloyds TSB and the Bank of Cyprus.  You get to join the elite BBUA Club (Banks Blasted by the US Attorney) which includes AMEX's Private Bank (now sold off to Standard Chartered); SWIFT, who were subpoenaed and weren't happy; and UBS, who helped Saddam Hussein siphon off $650 million in cash during his reign.

This list is almost endless actually, but I throw these in as, in each example, I'm pretty sure the organisations involved weren't too happy at being slapped down by the US authorities for their participation in these misdemeanours. 

Now banks shouldn't be aiding and abetting criminals, should they?  That's why it is the banks duty to Know Their Customer and stop them money laundering.  And it's pretty easy to know if your customer is a bit suspect isn't it?

"Oh yes, that $300 million I deposited today via the Cayman Islands?  Dividends.  Dividends."

"Ahhh, the £124,052,497.12 transaction.  Yes.  Vaguely remember it but not sure what it was for."

"This one. €3 million in cash?  Bonus sir.  It was my annual bonus."

OK, this is exaggerated but it can't be far off the truth that clients who regularly move large funds around catch bankers in a quandry.  On the one hand, they are high net worth, premium private bank, black card, lick their shoes and wipe their ass major finger-snappers to their lackey bank manager.  On the other, they are also going to be the most likely to have some untoward activity that needs monitoring.  I mean, the US authorities aren't going to be watching folks like you or I are they?  (yes, this line was a joke too :)

So the real question should be whose job is it to Know the Customer, and how well should they know them?  This relates strongly to yesterday's thoughts on buyology, and whether banks have really worked out the customer's psychology and relationship. 

This was also the source of a healthy debate at the FSClub in London on 26th September entitled: "This House believes we really Know Our Customers".  At the end of the debate the assembled throng of bankers voted overwhelmingly against the motion, as in banks really don't know their customers.  Now why would a group of bankers and bank support agents vote this way?

I guess because, for the general mass market customer, they don't really know them that well. However, for the high net worth client moving millions through their accounts on a regular basis?  Do they really not know these customers? Surely, these are the one's that banks really should know, either because they are the premium customer or because they should be wary of the money moving through their accounts.

So the view has to be that the banks who are caught with high net worth clients moving millions through their accounts, after those clients have been indicted for fraudulent activities such as money laundering; for these banks, if they are then caught aiding and assisting those clients to continue to move those funds ... well, they are likely to get the book thrown at them.

The New Science of Buyology

Although Biology is a well-known science, there is a lesser known but of growing importance science that is also, by coincidence, called Buyology.

Buyology has been used in other context (google the word and you get just over 500 returns, most of which are for a US store chain), but I've started using it to relate to banking in the new world of freakonomics, where everyone is struggling to understand the methods to get customers buying.

My own view is that this term, in its purest form, is defined as:

Buyology: the Science of Understanding Business Relationships

Buyology is all about knowing why people buy.  How to create business encounters where purchases are made that can be replicated over and over.  It is the ability to create long-term business relationships, not just a one-sale stand.

Bankers are learning buyological processes because traditional selling and advertising no longer works.  People don't want to be sold to and they certainly don't believe corporate speak.  What they really want is to deal with businesses that demonstrate a true understanding of their individualistic wants and needs.  That is buyology.

Buyology: targeting customer experiences by their channel(s) of choice

Banks' understanding of buyology is a clear strategic imperative because business has become so transparent thanks to blogs, Facebook and other social media.  These networks now ensure that any cover-up of any issue is going to be exposed.  That is 21st century internet-enabled consumer power.  Social networks mean that banks must start demonstrating clear integrity to be trusted or the truth will out.

In effect, you cannot have a relationship without trust, so banks that don't demonstrate clear integrity will only have the one-sale stand or the partner abuser.

Buyology: the sharing of a meaningful trust.

Bank relationships are based upon trust and trust is easily broken.  This is just as true in the investment markets as retail for, in the investment markets, buyology has been moved to another extreme.  Buyology for investment banks means creating services the customer needs and wants, but doesn't understand.

The relationship has become one where the trust is in ignorance.  A little like a father-child or priest-confessor relationship, the institutional buyer has to believe the broker-dealer is looking after their best interests. Unfortunately, this is being called into question, thanks to the new regulations around best execution and transparency, which implies broker-dealers don't always act in their client's best interests (really?!).

This trust has also been tested by Enron, Worldcom, Parmalat and such like, and is being tested again in the credit crunch.   In fact, the recent admission by the Bank of England that they didn't understand the financial markets anymore, in light of the Northern Rock collapse, is shocking.  When the regulators and co-ordinators of the financial markets lose their understanding, something has to change.

Buyology: knowing the why, how, what and when ingredients of buying, and ensuring you position your business to always be there at the right time, with the right words ... there's a song with that phrase and the next line is "and you'll be mine".

That's not far from what this is all about as buyology focuses upon creating strong relationships, and that's a tough call.

The future buyer will not buy from those they do not trust or understand. They will instead use the power of social networks to find the truth and will morph towards those who deal with integrity.

A little like the Unilever's Dove product range is gaining plaudits and awards from consumers for their campaign for real beauty, we will soon see banks campaign for real banking:

• "The truth about bank charges"
• "How we calculate interest"
• "We don't rip you off, but here's the list of banks who have"
• "The Students' guide to which banks are fair"

In fact, the word 'fair' is interesting.  We have a campaign in the UK for "Treating Customers Fairly" created by the FSA.  Is that because banks treat customers unfairly?  We have "Know Your Customer" rules.  Is that because banks don't know their customers?

Buyology: knowing your customer so well that they are no longer a customer, they're a partner.

In relationships, you cannot have one side treated unfairly and, although on the first date you may not know each other, if you don't get to know each other well sooner or later that relationship ends.  That's the one-sale stand approach to business.  A bit like a one-night stand, if you have no interest or empathy then the relationship stops there.

Relationships are based upon understanding and compromise.  We talk CRM, but you don't have relationships with customers.   Customers are sold to; partners have relationships.

Banks that turn tellers into sellers or have big swinging d**ks in the dealing room will soon find that the truth will out.  Instead of sustainable sales, they'll get lots of one-sale stands.  The real partnerships based upon fair dealings with trust will be the long-term sustainable relationship businesses.

Buyology: the Science of Understanding Business Relationships

The future of banking will be based upon which banks are the best buyological scientists.

NYC Quantitative Modeling & Financial Market Dynamics

World renowned experts will be speaking at Quantitative Modeling & Financial Market Dynamics , to be held from 4-8 pm Oct. 31 at 7city Learning, 55 Broad Street. This first annual QuantDay event will be hosted by Numerical Algorithms Group (NAG), in conjunction with Wilmott magazine, 7city Learning and Quantstar.

Speakers at the QuantDay event include: Dr. Robert Tong – "Numerical Software, Market Data and Extreme Events."

Dr. Mike Giles (Risk Magazine’s Quant of the Year 2007 – “Multilevel Monte Carlo Path Simulation”

Dr. John Birge – “Dynamic Portfolio Optimization Using Decomposition and Finite-Element Methods”

Financial quantitative analysts and other financial industry managers can find more details on QuantDay seminars and/or register to attend this QuantDay event at http://www.nag.com/market/quantday2007.asp or by contacting Kurt Peckman, kpeckman@nag.com, 630-598-5216.

QuantDay is the first public Numerical Algorithms Group event for financial quantitative analysts to be hosted in North America, and is modeled after the popular NAG series for financial quantitative analysts in The City area of London.

Tom

Virgin to buy Northern Rock

We've had a long summer of discontent in the financial markets, with the run on Northern Rock in the UK being one of the biggest banking scandals (the last bank run was over a century ago in Britain). So it is interesting to hear the breaking news story from the BBC today that Virgin may be about to buy Northern Rock.

This would be interesting as Virgin currently offer financial products through partnerships and, because they are not a fully-fledged bank but a distribution focused retail brand, they don't have a UK banking license. Hence, their partner is Royal Bank of Scotland. They also partner with Abbey for Equity Bonds, MBNA for credit cards, the Share Centre Ltd for share dealings and many others. I wonder what it will mean for these and other Virgin Money partnerships around the world.

The other interesting thing is that this move could turn them from a distributor/retailer to a fully integrated bank with a banking license. It could therefore mean that they move to a manufacturer and retailer model of business, a signficant change of strategy to Virgin's usual businesses. Normally, Virgin operate with manufacturing partners they can work with who gain from the leverage of the Virgin promise of fun, value, friendly products. Nevertheless, gaining the Northern Rock branch network and rebranding it as Virgin Money could make sense.

Mind you, so far Lloyds TSB, JC Flowers, Legal & General, RAB Capital, Cerebrus, the APAX Group and many other private equity firms have been rumoured to be buying Northern Rock, so I'm surprised we haven't had ideas of who else might be buying the bank.

Howsabout Tesco, Sainsbury and Asda (Wal*Mart); or BT, Vodafone and Orange; or even wrestler and actor Dwayne Douglas Johnson. Now that last one's my favourite as he's the guy we know as the Rock, so he would be CEO Rock of Northern Rock.

Deutsche Bank: refreshing innovations

Funny how things come together as yesterday I noted RBS´s recruitment fair in Second Life and then I sat in a presentation from Deutsche Bank on Second Life. Actually, it was a presentation on how to emulate the bank experience in real life in Second Life, which is what Michael Tirpitz, Marketing Director, set out to achieve.

The first experiment however was how to innovate the real life experience in real life.  This has been an ongoing prototyping and innovation project he´s been running in Berlin called Q110.  Q110 is Quarter 110, as Berlin is divided into Quarter zones, and Deutsche´s branch on Felixstrasse has been transformed into a hub of innovation in branch store design. 

From the street, the front of store looks like a retail shop.  You look inside and yes, you can see banking products!  That´s because Deutsche have taken the traditional bank brochures describing their services and turned them into tangible tins and boxes.  Inside the box you find a description of the product, plus a coupon for coffee and a gift.  The coupon for coffee by the way, can be traded instore to encourage you inside to meet the sales folks (what used to be called tellers!).

They´ve also partnered with Harrods, who have no stores in Germany, and offer Harrods branded food ranges at the front of store.  Food in a bank branch?  You guessed it, this is no ordinary bank branch.  In fact, from buying your banking tins with coupons for coffee to walking through the organic food hall at the front of store - you heard me - you get into the main guts of the branch and that´s when you start finding mortgage, pensions, cashiers and so forth ... oh yes, and coffee of course.

There´s too much to tell here about the branch, so have a look online at www.q110.de. 

Then you ask me: where´s the Second Life link Chris?

Well, after rolling out the new innovations in Berlin last year, they´ve now copied the whole branch experience of Q110 and deployed this in Second Life in July 2007.  This includes everything - even the branch staff! You go inside Deutsche´s 110 zone online, and meet Olga who you know as the concierge in Felixstrasse.  She guides you to the same designs and layout of advice, information and service as you see in Felixstrasse. You can even get your virtual coffee and drink it ... virtually of course.

Unbelievable.  Check it out here.

Mind you, the cash machine proves a bit more of a challenge as my PC printed Linden dollars rather than euro´s ... ah well, can´t have everything.