Fintech Could Flop Without Big Banks
This post originally appeared in Money Stuff.
What is this Bloomberg Markets story about? The headline is "Wall Street's Big Banks Are Waging an All-Out Technological Arms Race," and part of the thesis is that, especially in equities, banks are no longer in the business of using their balance sheets to profitably intermediate trades for clients, but are instead in the business of providing technology platforms to those clients to do the trades automatically:
Constraints brought about by the financial crisis ended the leverage that had fueled the boom. Fixed-income traders felt the brunt of the changes, and in the years since, equities traders —especially those with a technology background—have enjoyed a renaissance. Their rise has touched off a battle for supremacy that’s come down to only three companies: Goldman Sachs, Morgan Stanley, and JPMorgan Chase. These rivals are now locked in a technological arms race to control a $58 billion-a-year industry.
But you could read against the grain of that story. "With the upgraded electronic system and revamped prime brokerage," begins one paragraph, and ... prime brokerage isn't a tech thing? Prime brokerage is, basically, we will lend you money so you can buy stocks, and we will lend you stocks so you can short them. And then:
Morgan Stanley hugged its quant clients close. Instead of merely offering to execute trades, prime brokerage provides all-important leverage and custody of assets. “Prime brokerage is really the lifeblood,” says ETL co-founder Michael Botlo. “This is the oxygen. This is what you’re immersed in. If all of a sudden prime brokerage becomes terrible, then you’re toast. If you can’t short anymore, you’re dead. If you can’t access your swaps, you’re dead.”
If you focus on the technological arms race, it might seem a bit odd that the only contestants are Goldman, Morgan Stanley and JPMorgan. Sure they all talk a good game about being tech companies, but, you know, there are actual tech companies in the world. Google or Amazon could presumably build trading algorithms, if they put their minds to it. Plenty of smart technologists, from banks and not, have gone off on their own to build trading platforms that will disrupt the banks and align with clients' interests and revolutionize trading and so forth. U.S. equities are about as electronic and open and all-to-all as financial products get; if you are going to disrupt the banks, this is the place to do it, and in fact the history of high-frequency trading is pretty much one of scrappy high-tech upstarts disrupting the big slow banks in stock trading.
If you focus on the prime brokerage, though, of course the race is among the three big banks. Quant funds want tech-y things, sure; they want low latency and fancy execution algorithms and so forth. Lots of tech-y companies can do that sort of thing. But they also want money, balance sheet, leverage and stock-borrow access. That's not a tech business at all. That's a banking business.
This is a frequent lesson in fintech. A tech person looks at a thing that banks do and says: "I could do that better. I am smarter and faster than a bank, and more trustworthy, and I do not have the legacy issues that the bank has." And then she builds an amazing product, and goes out and pitches it to clients, and learns that an amazing product is not what the clients want. The clients want access to the banks' network of customers, or to the banks' corporate clients and new issues, or just to the banks' money. Banks may be working to get an edge over each other through technology, but their edge over technology companies comes from something else.
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James Greiff at email@example.com