When it comes to obtaining exchange connectivity, most sell-sides subscribe to a policy of “buy to standardise, build to differentiate.” This is a good philosophy to consider when looking at market access. Some firms believe that developing their connectivity systems internally helps set their firms apart. However, while this approach may seem reasonable at the surface, the reality is that it quickly becomes overly complex and expensive to maintain over time. Outsourcing connectivity, on other hand, makes sense because it offers banks faster, more cost-efficient access to the marketplace. It also allows staff more time to focus on customer-centric innovation that creates competitive differentiation.
To investigate the “build vs. buy” issue a bit further, we conducted interviews with a number of senior professionals running execution, prime brokerage and clearing businesses at both global, and regional specialist, sell-sides. Our interviews found a common theme. None of the firms currently have a standardised approach to market access, and all of them are looking for ways to simplify market connectivity. But they approach this in different ways. Below, you’ll find some of the insights we gained from our research. To read more, you can check out the research report recently published by Object Trading on how sell sides are shedding the complexity of market access infrastructure.
Choosing What to Outsource
Most of the large clearing firms we interviewed have dozens of distinct connectivity interfaces just for their global futures connectivity. This approach places a huge demand on the IT teams as they cope with non-standardised connectivity and vendor management.
Their market access infrastructure has developed and become more complex over time. In some cases, M&A activity brought in multiple silos with existing trading systems and connectivity. In others, firms have built one-off solutions for big clients, hoping to broaden that offering to other prospects later. As a result of both issues, IT teams are left with an unsustainable mix of vendor-provided connectivity, internally built gateways and interfaces, and direct market access.
Sell-sides are now increasingly looking for ways to simplify this approach and to narrow the number of distinct connectivity gateway points. As they evaluate options, they must choose which components they will continue to develop and maintain in-house, and which components they could source competitively from the vendor market. Ideally, whatever choices they make should be open and enable a flexible mix of solutions.
Weighing the Build vs. Buy Options
It’s important to carefully weigh the build vs. buy decision, especially when it comes to building market access. The decision has a substantial impact on time to market and total cost of ownership.
One large British prime broker we interviewed elected to build a standardised gateway system including pre-trade risk controls in-house because they viewed it as the only way to maintain control of their liability. They preferred not to cede control of development and QA processes to third parties.
Another global bank looked for vendors that could provide standardised multi-asset connectivity globally, and then decided to build the system in-house. But they underestimated the actual amount of effort required to on-board and support all the exchanges they needed. Unfortunately, that project has been ongoing for 24 months with hundreds of staff involved and no end in sight.
Some IT departments believe building gateways internally makes them more competitive, but in most cases, it does not. Instead, it leads to an endless process of development and QA, sort of like “painting the Brooklyn Bridge.” You start painting one end of the bridge, and by the time you reach the other side, the paint will have begun peeling off at your starting position, forcing you to immediately start over. Likewise, maintaining exchange gateways is a never-ending, resource-intensive job. That issue has a huge impact on total cost of ownership (TCO).
Focusing Internal Teams on Customer Experience
The head of global execution services trading and technology for a tier 1 global bank told us, “We wanted to focus on the important touch points – the functionality that touched the customer. So we elected to build the user interface in-house where we could control the customer’s experience and avoid educating vendors to the benefit of our competitors. But we had limited resources and knew there were a couple vendors that could deliver exchange connectivity much more efficiently than our internal team. This was the part the customers don’t see. So we outsourced that part.”
Today, sell-sides have viable, well-tested choices for connectivity, including experienced vendors that specialise in exchange connectivity. It also allows them to take advantage of economies of scale.
The decision to buy instead of build is driven primarily by six considerations:
- Wider choice of execution venues
- Ability to leverage the vendor’s experience with other clients
- Ability to free up in-house resources to better service clients
- Potential efficiency gains in cost and operational overhead
- The vendor’s ability to bring more specialised technical expertise than the firm’s internal resources
- Whether choosing a particular system will enable them to differentiate themselves on the street
There are big disadvantages to trying to build and maintain non-core or commoditised functionality in-house. For one, it drives up maintenance costs.
Using Commercial Systems for Lower TCO
There is also substantial evidence that internally built systems have a substantially higher total cost of ownership (TCO) than commercial solutions. In research on feed handlers conducted by Aite Group in mid-2012, they found that “There is no math that supports internal development over purchasing a commercial feed handler solution…. By outsourcing feed handlers, businesses can save US$500,000 to US$1.5 million annually.” Aite Group found that “Even firms with as few as five engineers pay more to support their internal feed handlers than a commercial solution would cost them.”
According to Aite Group research, a typical global sell-side firm spends approximately 75% of IT funds on maintenance.
If 75% of IT resources are focused on maintaining a patchwork of internally built systems, then those resources can’t focus on developing products and services that will help with competitive differentiation and attract more clients. This can also affect talent retention, as skilled technologists often gravitate to projects where they can build something new.
Establishing Competitive Differentiation
Several of the sell-sides we interviewed are actively looking for ways to focus their internal IT staff on projects that will enhance the customer experience, improve customer “stickiness,” provide differentiation, and increase profitability. To do this, they’re training some of their top resources to be business analysts and vendor managers – enabling them to effectively outsource and manage those areas that don’t offer competitive differentiation. Then they can focus their internal IT talent on interesting and revenue-centric projects.
In summary, simplifying the gateway infrastructure and using vendor-supplied and vendor-maintained systems can allow a sell-side’s IT team to focus on innovation. Differentiate based on service, market reach, and capital efficiency instead of spending time “painting the Brooklyn Bridge.”