Pipeline Report March 2010

The Pipeline Report March 2010 The Pipeline Report is distributed periodically by clambresearch@gmail.com. You may re-distribute this report by email, provided you copy us on the email. I recently prepared a presentation for a private equity firm on the state of the financial feeds market for the capital markets, specifically for institutions. My SlideShare presentation can be found here. For those of you who did not have the benefit of hearing the presentation, here is my commentary on this important market. Since delivering the presentation, my thinking has also evolved, so this write up varies slightly from the slides. The real-time financial feeds market has many aspects. This edition of the Pipeline Report focuses on: ● Structured data feeds—as opposed to unstructured news feeds ● Financial feeds to institutions—as opposed to consumers, though changes in the consumer market are affecting the institutional market. Here are the highlights of my analysis: MATURE MARKET In 2007, Incisive Media estimated the US feeds market size at $7B. Oddly enough, there do not seem to be any market studies since 2007. Overall, the financial feeds market is mature, as evidenced by several factors. ● Legacy providers are consolidating, driven by institutions’ desires for fewer vendor relationships. Those who control distribution will carry the lion’s share of commoditized feed information to market. They also become the distribution channel for niche feed providers. An underlying assumption is that there is a bifurcation of the market between feed providers and feed distributors. ● Thomson Reuters and Bloomberg have leading positions, followed by Interactive Data Corporation (IDC), Dow Jones, and others. IDC is rumored to be in play, driven by Pearson’s reported desire to sell its stake in IDC. Since the beginning of 2010, Dow Jones has announced two reorganizations. This may be its attempt to keep pace with the front runners. ● While distribution is consolidating around the market leaders, a number of new providers are coming into the market. Sources of market data are exploding. Exchanges, Broker-Dealers, and Broker-Dealer consortia are all getting into the game. The market is like an accordion: consolidating on one end, and expanding on the other. ● Offerings are fragmenting. Niche products have been created to cover new asset classes, geographies, or both. One example is Markit’s sovereign credit index for Central Europe, Markit iTraxx SovX CEEMA. Markit is creating many other similar indexes. ● The economic and the business model for the feed market is rapidly changing. Especially for commoditized feeds—such as US equities—the monetization model is moving from a direct monetization model (aka subscription) to an indirect model, especially for alternative trading venues such as BATS Global Markets (BATS). Whereas thirty years ago, NYSE collected enormous subscrption fees for real-time (less than 20 minute delayed) feeds, their business model is eroding because of nimbler leaner competitors. ● The core market is under pricing pressure. ● There is a potential consolidation play at the meta-level, particularly for vendors who own the distribution channels to market. The leading distributors may drive further market consolidation. Though somewhat counterintuitive, the number of providers is large and exploding. Here is a partial list

Vendors  Bloomberg  Thomson Reuters  Interactive Data  Dow Jones  FactSet Research Systems  Markit  Morningstar  SIX Telekurs  SunGard Global Trading Exchanges  BATS Global Markets  Chicago Mercentile Exchange  Chi-X  Deutsche Borse  InterContinental Exchange  Hong Kong Exchanges and Clearing  International Securities Exchange  London Stock Exchange  Nasdaq OMX  NYSE Euronext  SIX Swiss Exchange  SGX Singapore Exchange  TMX Group  Wiener Borse Brokers and Broker Consortia  BGCantor Market Data  BondDesk Group  Essex Radez  GFI  Icap  MarketAxess  Tradeweb  Tradition  Tullet Prebon As noted above, the proliferation of niche and geographical feeds is driving this explosion. Various indexes are spreading like a rash, as it becomes easier to combine individual instruments into an ever evolving alphabet soup. There are several other market drivers. KEY MARKET DRIVERS ● Perception: Information yearns to be free, especially in business to consumer markets. A wave of free information annihilated other industries as they digitized: news, real estate, music, travel, entertainment—were built in the 20th century assumption of information scarcity. Almost invariably business models were based on information arbitrage. While institutions have needs that cannot be met by the tape-delayed consumer feeds, the changes in the consumer market are setting the tone, because they are resetting expectations. The days of information scarcity are gone. Since information has no physical cost, companies who have built the business models by withholding it, face annihilation in the world of information abundance.

Transaction information is the lubricant for market-making worldwide. Traditionally, all information intermediaries—realtors, stock brokers, travel agents—controlled market access by controlling market information. Now all of them are swimming naked as the tide rushes out. It is only a matter of time before the business model shredder known as digitization also overwhelms the financial feeds market. The essential dilemma faced by the legacy exchanges—NYSE/Euronext, LSE, and their ilk—is that they were built on what are now anachronistic assumptions: proprietary access, information scarcity, and huge barriers to building alternative trading venues. ● Alternative Trading Venues. Alternative trading venues, such as BATS Global Markets, have turned the legacy fee-based business model on its head by offering free market data to attract trades. In less than four years from its founding, BATS has captured over 10% of US equity market trades. Think of BATS at the Nucor Steel of this industry: it is a classic disruption play, starting at the bottom of the market and working its way up as its erodes competitors margins, and the competitors retreat to “protectable high margin markets”. The cycle repeats itself as the bottom-feeders erode the higher margin markets. Not only does the delivery of free market feeds disrupt legacy pricing models, but more importantly with 10% market share, BATS trade volumes produce a material tape history that must feed a consolidate tape to satisfy regulators. BATS has forced the incumbents to give it a seat at the table. BATS is just one example of alternative venues, which include multi-lateral trading facilities, dark pools, crossing networks. The legacy trading venues—the exchanges—hidebound and ossified, have been slow to respond, and may become the GM and Chrysler of this business. ● Free is increasing. Free may rule B2C, but it is spilling over to B2B. One example is Markit’s move to make its free BOAT data to be available on a fifteen minute delay, versus the previous two hour delay. This may be a minor example, but it is indicative of an accelerating trend. BATS, mentioned above, is another such example. ● The Great Recession. The recent near collapse of the financial markets has led institutions to prune their plant, consolidate their vendor relationships, and drive automation. This trend will continue even after the recession—and will play to the strengths of the distribution leaders. ● Regulatory Pressures are also driving major changes in the feeds business. Both Reg NMS and Mifid require brokers to execute orders on the market with the lowest price. This requirement, combined with the explosion of trading venues, creates an huge market opportunity for a reliable consolidated tape. In the short term, this is the single strongest driver for the financial data feeds business. ● Enabling technologies are the another major driver. XBRL (Extensible Business Reporting Language) is an example of an enabling technology—a lingua franca—that threatens to sweep vendor proprietary lock-outs into oblivion. Strictly speaking, XBRL will not be used (at least not in the short term) to report trades. (It serves another role.) But the advent and adoption of XBRL sets an industry tone: it is only a matter of time before standard—and open—symbologies emerge as the carrier for all trade data. KEY OPPORTUNITES ● Low Latency Feeds for high frequency traders. Low Latency Feeds, the opposite of a single consolidated tape, are direct market feeds providing sub-millisecond trade data. The low latency market is arms race, where high frequency traders attempt to front-run the herd, based on their proximity to trading venues or based on arbitrage between trading venues. Vendors with collocation and proximity hosting are in pole position to deliver this information. However, the vitality of their market depends on the viability of high frequency trading, which is coming under increasing regulatory scrutiny. ● Addressing the consolidated tape to satisfy regulatory requirements. As noted above, the splintering of trading venues provides an excellent market opportunity to “herd the cats” to satisfy the regulators. Only the largest vendors in a position to drive this market, with positioning rhetoric such as, “What set’s us part is how we tie it together.” It is the alpha dog that will successfully herd the cats.

● Niche markets, particularly in -Illiquid instruments - Complex asset classes, such as structured products - Emerging markets, e.g. Asia ● Automation, Efficiency, and Enhanced Workflow. The short term opportunity is focusing on cost control: doing more with less. The long term play is leveraging enhanced workflow to enable new business models with the broker-dealers. SUMMARY In conclusion: ● The major distribution channels are in pole position because they control access to the institutional customers. Expect to see further consolidation here. ● Feed sources will continue to explode. ● Regulation will be a major driver. ● The legacy feed market (e.g. equities, FX) will commoditize like crazy. The incumbent exchanges are particularly vulnerable, as their competitive advantages are breeched by alternative trading venues. ● Technical standards will also commoditize the business. About the Pipeline Report The Pipeline Report is a periodic report. In future reports, we plan to discuss: ● Bloomberg’s Open Symbology: what’s up with that? Has the vendor that built its business on proprietary systems suddenly become altruistic? In November 2009, Bloomberg announced an open symbology. Earlier this month, Bloomberg announced a deal with NYSE Euronext to bring this symbology to data feeds. What’s going on here? ● Google – Is Google about to enter the financial feeds market, upending the apple cart? If they do, Google may turn the legacy vendors into road kill on the information superhighway. Is this why Pearson wants to unload its stake in IDC? ● Let us know what topics you want us to cover. Till next time…stay tuned. The Pipeline Report is produced by Chris Lamb, a business strategy consultant in financial technology and web services. Previously he was at Thomson Reuters. The opinions expressed herein are his own. To contact Chris, please email him at clambresearch@gmail.com To unsubscribe, respond this email with Unsubscribe in the Subject Field. © 2010. Chris Lamb

Pipeline Report March 2010

by clambresearch on Mar 28, 2010

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