Digital deals

Death of an Investment Banker

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Traditional investment banking centers such as Frankfurt are facing a new digital challenge.
  • Why it matters

    Why it matters

    Traditional investment banks are losing business to innovative new digital trading and investment platforms.

  • Facts

    Facts

    • In some markets, 95 percent of trading is already conducted electronically.
    • New digital platforms such as Edgefolio and Algomi are making trades more efficient and easier.
    • Established players such as Barclays are developing their own digital platforms to compete with the startups.
  • Audio

    Audio

  • Pdf

Think of it as a kind of LinkedIn for the financial industry. Hedge fund managers are able to quickly and selectively seek out investors through a specialized social media network. No need for a prime broker, the section of investment banks that traditionally handles the needs of hedge funds.

London-based Edgefolio, founded by Leo Gasteen, is part of a new frontier of digital innovation that is revolutionizing the financial industry. Mr. Gasteen developed the idea while working for a hedge fund in Norway, where he experienced first hand how painstaking the process of gathering funding could be.

Financial-technology firms, known as fintechs, are all the rage these days. These new digital players have already begun to make a significant mark in retail and commercial banking, bringing things like crowd-sourcing to the lending market, offering online payment options and acting increasingly as middle-men steering customers to banks with the best loan and account offers.

But they have struggled to break into the more complex world of investment banking. In the hedge fund sector, 10 percent of companies control 90 percent of the assets.

While startups like Edgefolio cannot yet compete with the established players, they are making inroads into the niches and on the fringes of the capital markets, according to Will Rhode of the research firm Boston Consulting Group.

Mr. Rhode, however, believes these startups are like trojan horses; once they have their foot in the door, they will inevitably start conquering larger shares of the market as their confidence grows and the technology becomes more sophisticated.

“We still have some time before the attacks from the outside become stronger. We have to use this time to bring our costs under control in order to better compete with the new attackers.”

Anonymous London investment banker

But right now, the barriers to entry are still very high. In the aftermath of the financial crisis, regulations governing investment banking have been tightened. Financial institutions have to put more capital aside than before. For small startups, these requirements are next to impossible to meet.

“Young technology companies that are focused on the financial sector can mix more easily in the consumer credit markets,” an investment banker at a global institution, who asked to remain anonymous, told Handelsblatt. “In investment banking, it’s not so easy to find the entry door.”

“The bigger threat comes from established competitors,” the banker said. “We are observing them very closely in order to be quicker with innovations than they are.”

Take Gator as an example. Developed by Barclays, the online platform provides real time information on how much the British bank is buying and selling different currencies for.

Gator is also fed with exchange rate information from a host of external sources, offering traders a one-stop shop for conducting their business. Traders receive an assessment on whether or not an order is worth it. The concept is similar to rating hotels and restaurants on TripAdvisor.

According to Matt Clarke, the head of Barclays electronic foreign exchange, Gator was developed as a response to the growing fragmentation of the currency markets. The idea was to make the foreign exchange trade cheaper and more attractive by providing clients with a user friendly platform through which they can tap different sources of liquidity.

Gator is an example of how the big banks are trying to keep pace with startups by developing their own digital innovations. Others have taken the step of acquiring promising fintechs and incorporating them into their own businesses.

An example of the latter is Frankfurt-based 360T, a derivatives trading platform that was recently bought by the exchange operator Deutsche Börse. The online platform counts as one of the biggest successes stemming from Germany, where funding for fintech start-ups has been typically much harder to come by than in London or Silicon Valley.

“As a start-up in the Valley you can get fresh capital more easily. That doesn’t guarantee that you’ll have success but is does make many things easier,” 360T chief Carlo Kölzer told Handelsblatt.

Mr. Kölzer said it is tough for fintech companies to make it as a lone warrior in an established investment-banking world. The burden of regulation means that size matters.

“Fintechs have to consider carefully whether they can grow faster on their own or with the help of a partner. Many costs don’t grow linearly but are linked to certain size barriers – things like regulation or internationalization,” he said.

 

Foreign Exchange Market and Fintechs-01

 

It’s not necessarily a zero-sum game between investment banks and the new insurgents. Some startups are actually seeking to help the established financial institutions.

Algomi, developed by former UBS banker Stu Taylor, is similar to an online dating service. Instead of helping singles find each other, the digital platform brings together buyers and sellers who are interested in rarely traded bonds.

Algomi is not an alternative trading platform. It simply provides information about the trade in illiquid bonds, a business that to this day is still conducted mostly by telephone. Mr. Taylor’s platform doesn’t make investment banking obsolete; instead, it makes the branch more efficient.

The digital revolution has come a long way already. In some markets, 95 percent of trading is now conducted electronically, according to Andrew Challis, the head of electronic distribution at Barclays.

The remaining 5 percent will probably remain in the hands of real people, Mr. Challis said. Some clients still prefer to conduct business by phone, and there are deals so complex that only bankers can handle them.

But other experts aren’t so certain. An innovation known as “blockchain” could upend the financial industry’s traditional business model, according to Mr. Rhode.

Pioneered by digital currencies such as Bitcoin, blockchain is a type of database. In the financial context, it acts as digital ledger of transactions between computers. The accounting is done in a decentralized fashion and is saved on many different computers, reducing vulnerability to cyber attack and manipulation.

Bankers are aware of the danger these new innovations pose to the old ways of conducting business.

“We still have some time before the attacks from the outside become stronger,” said one London investment banker, who asked to remain anonymous. “We have to use this time to bring our costs under control in order to better compete with the new attackers.”

Mr. Kölzer of 360T puts a more positive spin on it. He likens the development to that of the pharmaceutical industry, where many established companies farm out the development of new medicines to smaller bio-tech firms that are more nimble and innovative.

“When the results are promising, the big players bring the new medications back into the fold and take over the expensive licensing and distribution costs,” Mr. Kölzer noted.

Perhaps that’s a model for investment banking going forward.

 

Katharina Slodczyk is Handelsblatt’s London correspondent. Michael Brächer and Michael Maisch of Handelsblatt in Frankfurt contributed to this story. To contact the author: slodczyk@handelsblatt.com

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