Rogue Implications: Once again the vulnerability of global financial institutions is illuminated by the operations of a single individual. Today's announcement of EUR5 billion in losses at SocGen adds to an ever-expanding list of Nick-Leeson style trading debacles - Chinese metals trader, Liu Qibing's copper loss of $100 million, a Mizuho broker's sale of 610,000 shares of J-Com for 1 yen, Allfirst currency trader John Rusnak's $691 million loss.
Whenever these events occur it conjures up an even greater anxiety - sabotage. We see the damage caused by simple incompetence and mismanagement. International financial markets are more vulnerable than ever to the influence of a single actor or group of actors acting within the financial establishment to bring down a particular institution or destabilize global markets. While no evidence exists that this has ever occurred, that high-profile financial debacles occur with alarming regularity certainly raises the question of whether it could.
In August, 2004, the U.S. Secret Service published "Illicit Cyber Activity in the Banking and Finance Sector," a report detailing the threat posed by the so-called "rogue insider" to financial institutions and, by extension, the financial system generally. The Secret Service concluded that the threat posed by rogue insiders is even greater than previously thought based on the fact that, historically, insider attacks have come from a broad spectrum of individuals with relatively modest access and technological skills. Most startling perhaps of all the report's conclusions is that the success of insider operations depended not so much on technological skills, but on skillful exploitation of existing or in some cases nonexistent supervisory procedures.
Monday, January 28, 2008
Monday, January 21, 2008
IBanks: Time for Evolution
These are difficult times for investment banks.
I will spare readers a painful rehash of the past three months, but suffice it to say that the days of the centrally-planned, highly conglomerated uber-IBanks are clearly numbered. To survive going forward, investment banks must embrace a doctrine of strategic differentiation. The future financial landscape will be bipolar in nature, comprised of giant pools of capital roaming the earth in search of above-market returns on one side, and the actors who facilitate its efficient allocation on the other. Quite simply, IBanks must embrace a new business model - either that of capital aggregator-manager by leveraging the traditional IB strengths of trading, research, and execution, or capital agent by devoting themselves to the traditional investment banking role of providing financing solutions and strategic advice. The ongoing competitive threat from hedge funds, pension funds, private equity, and boutique shops brought on by advancements in information and communications technologies ensures that the present business model is unsustainable.
Large investment banks are no longer powerful gatekeepers in the advisory/underwriting space. Value-added expertise – deal origination, design, and deployment of financial strategy - is increasingly the province of boutique investment banks. The reality is that for large IBanks, the business of advising, underwriting, and distributing securities offerings is no longer the high-margin business it once was, and the frequency with which companies choose to engage smaller boutiques that are willing to provide highly focused and personalized service is on the rise. While still viable and able to hold their own in the short term by virtue of their global franchise and enormous capital base, larger IBanks will find it increasingly difficult to compete with these smaller boutique shops in the advisory role. Moreover, the continued existence of real or perceived conflicts of interest will further drive clients away from the bulge bracket to smaller shops.
Technological innovation is making it easier than ever for capital to be independently managed and to flow freely between and among actors. It is technology that will ultimately provide the catalyst for the evolution of the modern investment bank. An intriguing question: will (has) a mutation occur(ed) in this process of differentiation which will ultimately drive this evolutionary process forward? Perhaps it is the strategic investment bank . . .
I will spare readers a painful rehash of the past three months, but suffice it to say that the days of the centrally-planned, highly conglomerated uber-IBanks are clearly numbered. To survive going forward, investment banks must embrace a doctrine of strategic differentiation. The future financial landscape will be bipolar in nature, comprised of giant pools of capital roaming the earth in search of above-market returns on one side, and the actors who facilitate its efficient allocation on the other. Quite simply, IBanks must embrace a new business model - either that of capital aggregator-manager by leveraging the traditional IB strengths of trading, research, and execution, or capital agent by devoting themselves to the traditional investment banking role of providing financing solutions and strategic advice. The ongoing competitive threat from hedge funds, pension funds, private equity, and boutique shops brought on by advancements in information and communications technologies ensures that the present business model is unsustainable.
Large investment banks are no longer powerful gatekeepers in the advisory/underwriting space. Value-added expertise – deal origination, design, and deployment of financial strategy - is increasingly the province of boutique investment banks. The reality is that for large IBanks, the business of advising, underwriting, and distributing securities offerings is no longer the high-margin business it once was, and the frequency with which companies choose to engage smaller boutiques that are willing to provide highly focused and personalized service is on the rise. While still viable and able to hold their own in the short term by virtue of their global franchise and enormous capital base, larger IBanks will find it increasingly difficult to compete with these smaller boutique shops in the advisory role. Moreover, the continued existence of real or perceived conflicts of interest will further drive clients away from the bulge bracket to smaller shops.
Technological innovation is making it easier than ever for capital to be independently managed and to flow freely between and among actors. It is technology that will ultimately provide the catalyst for the evolution of the modern investment bank. An intriguing question: will (has) a mutation occur(ed) in this process of differentiation which will ultimately drive this evolutionary process forward? Perhaps it is the strategic investment bank . . .
Mobile Finance Rising
Mobile finance is indeed on the rise, and all indications are that this industry will be at the forefront of transformation in global financial services. This is perhaps no more apparent than in development finance where mobile technology is leveraged to deliver financial services to the unbanked. M-PESA, for example, a money transfer service operating in Kenya, has reached the 1 million customer mark. The service is provided by Safaricom, which is jointly owned by Telkom Kenya Limited (60%) and Vodafone (40%). Clearly the opportunity here is enormous, and it is not limited to the conventional marketplace.
There are numerous financial technology companies positioned to benefit from the anticipated explosion in mFinance - particularly mBanking - with the majority being privately held and/or VC/PE backed. Some of these include:
There are numerous financial technology companies positioned to benefit from the anticipated explosion in mFinance - particularly mBanking - with the majority being privately held and/or VC/PE backed. Some of these include:
- Firethorn (US): Provides a single-source integrated application for bank transfers and bill payment.
- Pyxis Mobile (US): Provides wireless app software for financial services professionals. Backed by Ascent Venture Partners.
- Fundamo (South Africa): Provides a suite of mBanking solutions including P2P and bill payment, prepaid vending, and other services. Backed by VenFin Limited, Sanlam, and HBD Venture Capital.
- M-Com (New Zealand): Provides a suite of products including BankAnywhere, M-Billing, and PayAnywhere
- Clairmail (US): The company's focus is "2-way mobile customer interaction," and thus appeals to not only banking, but brokerage and credit card services as well. Backed by Norwest Venture Partners, Outlook Ventures, and Jafco Ventures.
- mFoundry (US): Provides a vertical solution for mobile banking, payments and other financial services which enables developers to create cross-platform, cross-carrier applications. Backed by Apax Partners, GRP Partners, Ignition Partners, Motorola Ventures, NCR Corporation, and Paypal.
- Danal (US, Korea): Provides BilltoMobile, a service which enables consumers to charge online purchases to their mobile phone bills. Backed by Morgenthaler Ventures.
- C-Sam (US): Provides a proprietary Mobile Transaction Platform which aggregates multiple financial and non-financial transaction solutions on a single platform enabling users to "execute transactions in the real as well [as] virtual worlds."
- CPNI (Canada) : Provides the PAT (Phone Authorized Transfer) suite of solutions which includes PATsend (money transfer), PATbuy (e-commerce via participating merchants), and PATbank (banking).
- ISTS (US) : Provides a comprehensive platform for mobile payment application development.
- Kabira (US): Provides high-performance transaction processing software, including their Payment Solution Suite which enables acquirers, payment processors and issuers to process secure electronic transactions in real time, and Kabira Trading which is marketed to algo traders and other liquidity providers. Backed by 3i, Sevin Rosen Funds, Crosspoint Venture Partners, Star Ventures, Saints Capital, Argo Global Capital, New England Partners, Innovacom Ventures, IBM, and Mitsui.
- Mcheck (US): Provides mchek/Payment, which enables mobile management of credit/debit cards, and mchek/PassCode, enabling mobile two-factor authentication.
- obopay (US): Mobile money transfer. Backed by Onset Ventures, Qualcomm, Redpoint Ventures, Richmond Management.
- TextPayMe (US): Money transfer via the Amazon Payments system operated by Amazon.com.
- Voice-Pay (US): Provides a payment system interlinked to voice biometric technologies.
- Fiserv (US): Provider of diversified payments, lending, investment technologies and related BPO. The company is publicly held (NASDAQ: FISV)
A Fintech Opportunity in National Security
In July, 2003, the Pentagon's Defense Advanced Research Projects Agency (DARPA) scuttled an ill-conceived terrorism futures market. While the project was a political failure, the idea underscores the ongoing need for innovative thought in the area of indications & warning (I&W). The construction of a terror futures exchange wherein market participants bet on events themselves is perhaps politically unpalatable, if not in poor taste, but conceptually the idea is grounded in rational thought. But rather than create an artificial market where explicit outcomes are at stake, a better analytic approach for purposes of intelligence analysis might be to translate existing financial and commodity data into finished intelligence.
Markets behave in a generally rational manner, particularly when factoring in the economic and financial implications of geopolitical uncertainty, and valuations represent a proxy for the beliefs of market participants. Financial markets are a form of communication, with the myriad data, transactions, and instruments comprising a distinct language. The challenge is to understand and interpret this language in the context of global security, and to divine the trends within markets which might suggest an impending terrorist attack or geopolitical crisis.
A financial I&W system would involve a comprehensive monitoring of global financial markets to uncover anomalous trading behavior in various asset classes. The difficulty here, of course, is establishing a general model of price/volume behavior based upon historical data which would enable analysts to discern anomalies from the general noise. Given the difficulty of this and the inherent imperfections in forecasting security prices, such a system would be valuable not as a sole-source of I&W, but as a piece of the larger I&W infrastructure which draws upon a variety of disparate sources and types of data. Financial I&W would serve well to clarify existing intelligence, or perhaps, as was likely the case prior to September 11, send up a red flag and initiate coverage.
Financial markets can provide intelligence analysts with valuable insights. Data could be useful in determining whether a bias exists toward the potential for a major geopolitical event, or whether there is deliberate activity within financial markets indicating trading designed to profit from a future event, suggesting foreknowledge. How do we effectively parse market behavior in an effort to understand how valuations might reflect the risk of an impending terrorist attack? Unfortunately, markets often overshoot the target, sometimes quite dramatically. However, for purposes of terrorism I&W it would not be necessary to accurately predict the correct valuation for a given asset or asset class, only to divine the trend and the underlying reason for the trend, to strip away the drivers underpinning the movement.
It is generally accepted that prices reflect all information that is known or knowable. By the same token, then, it should be possible to discern the information which is factored into prices and, by process of elimination, identify those factors as they relate to potential geopolitical events.
Markets behave in a generally rational manner, particularly when factoring in the economic and financial implications of geopolitical uncertainty, and valuations represent a proxy for the beliefs of market participants. Financial markets are a form of communication, with the myriad data, transactions, and instruments comprising a distinct language. The challenge is to understand and interpret this language in the context of global security, and to divine the trends within markets which might suggest an impending terrorist attack or geopolitical crisis.
A financial I&W system would involve a comprehensive monitoring of global financial markets to uncover anomalous trading behavior in various asset classes. The difficulty here, of course, is establishing a general model of price/volume behavior based upon historical data which would enable analysts to discern anomalies from the general noise. Given the difficulty of this and the inherent imperfections in forecasting security prices, such a system would be valuable not as a sole-source of I&W, but as a piece of the larger I&W infrastructure which draws upon a variety of disparate sources and types of data. Financial I&W would serve well to clarify existing intelligence, or perhaps, as was likely the case prior to September 11, send up a red flag and initiate coverage.
Financial markets can provide intelligence analysts with valuable insights. Data could be useful in determining whether a bias exists toward the potential for a major geopolitical event, or whether there is deliberate activity within financial markets indicating trading designed to profit from a future event, suggesting foreknowledge. How do we effectively parse market behavior in an effort to understand how valuations might reflect the risk of an impending terrorist attack? Unfortunately, markets often overshoot the target, sometimes quite dramatically. However, for purposes of terrorism I&W it would not be necessary to accurately predict the correct valuation for a given asset or asset class, only to divine the trend and the underlying reason for the trend, to strip away the drivers underpinning the movement.
It is generally accepted that prices reflect all information that is known or knowable. By the same token, then, it should be possible to discern the information which is factored into prices and, by process of elimination, identify those factors as they relate to potential geopolitical events.
African Financial Reform: A Strategic Opportunity
China's policy of extending loans to impoverished nations in Africa as a means to secure natural resources contracts has drawn considerable scrutiny. In November, 2006, Beijing pledged $5 billion in preferential loans and buyers credits, and most recently, at a June meeting of the African Development Bank, unveiled a $20 billion loan package. China’s approach has drawn criticism from the international development community, which argues that it places already heavily-indebted countries further in debt, and undermines debt forgiveness efforts. According to the World Bank, debts of 27 Highly Impoverished Poor Countries (HIPC) declined from $80bn to $28bn since the program's inception in 1996.
While policymakers debate the propriety of this strategy, the controversy underscores an emerging opportunity for financial services companies. Africa is increasingly of strategic importance to the United States and the West, and calls for aid and intervention have reached a fever pitch. But sustainable economic reforms are only possible with sound financial systems which ensure connectivity to the global economy. We believe that a significant opportunity exists in the design and implementation of financial systems crucial to credit access, orderly capital flows and liquid financial markets in African economies. For a comprehensive account of the the state of African financial development, see the World Bank's Making Finance Work for Africa.
While policymakers debate the propriety of this strategy, the controversy underscores an emerging opportunity for financial services companies. Africa is increasingly of strategic importance to the United States and the West, and calls for aid and intervention have reached a fever pitch. But sustainable economic reforms are only possible with sound financial systems which ensure connectivity to the global economy. We believe that a significant opportunity exists in the design and implementation of financial systems crucial to credit access, orderly capital flows and liquid financial markets in African economies. For a comprehensive account of the the state of African financial development, see the World Bank's Making Finance Work for Africa.
World Bank Strategy Means Dealflow
World Bank president Robert Zoellick has told the Financial Times that the bank plans to solicit private sector contributions to the International Development Association. This is the tip of the strategic iceberg, the first of what will likely be several important moves by Mr. Zoellick to encourage and increase private sector investment in international development generally. Mr. Zoellick has made references to financial innovation and capital markets strategies as a crucial part of Bank strategy going forward. Toward this end, the Bank merged its Finance and Private Sector development research units, a move which "reflects the centrality of finance to private sector development and vice versa."
A renewed World Bank commitment to capital markets-based development solutions will generate a marked increase in development-related dealflow. In particular, we expect opportunities in financial technology to increase dramatically as access to financial services will depend on highly mobile technologies to reach the many remote communities in Latin America, Asia, and Africa. Moreover, we expect that the next 3 to 5 years will see a solidification of microfinance as a legitimate asset class as the trend toward "greener" investing increasingly includes development finance.
A renewed World Bank commitment to capital markets-based development solutions will generate a marked increase in development-related dealflow. In particular, we expect opportunities in financial technology to increase dramatically as access to financial services will depend on highly mobile technologies to reach the many remote communities in Latin America, Asia, and Africa. Moreover, we expect that the next 3 to 5 years will see a solidification of microfinance as a legitimate asset class as the trend toward "greener" investing increasingly includes development finance.
The Lure of Global Infrastructure
Fueled by the explosive growth of emerging markets and the never-ending maintenance curse in developed economies, infrastructure appears poised to be one of the main growth engines in capital markets for the foreseeable future. It represents an attractive opportunity for both the sell and buy sides.
Debt ceilings and political pressures have steadily eroded conventional approaches to public capital formation. Perennially cash-strapped states and municipalities have driven the development of innovative ways to design, build, maintain, operate and finance critical infrastructure improvements. One highly successful innovation is the Public-Private Partnership, or “P3" - a unique hybrid organization which provides a quasi-privatized approach to infrastructure challenges, enabling oversight by a public organization while benefiting from the market-based incentives and efficiencies of a private sector model. P3s have been particularly popular in Europe and Asia, and are gradually gaining legitimacy here in the United States. Notable U.S. P3s include Chicago's Skyway Toll Road, the Indiana Toll Road, Virginia's Pocahontas Parkway, and Texas State Highways 130 121.
Given recent market gyrations and the liquidity crisis in fixed income, we expect that in the near term we will witness a pullback in infrastructure-related deals. Long-term prospects, however, are bright, particularly in light of continued trends in public finance, and the need for pension funds and institutional investors to seek out higher yielding instruments while minimizing risk. A potentially symbiotic relationship exists between infrastructure funding needs and pension liability matching. The recent "repricing of risk" will drive institutions to find low-risk, cash flow-dependable investments and thus will encourage growth in the infrastructure space.
See Infrastructure 2007: A Global Perspective from Ernst & Young.
Debt ceilings and political pressures have steadily eroded conventional approaches to public capital formation. Perennially cash-strapped states and municipalities have driven the development of innovative ways to design, build, maintain, operate and finance critical infrastructure improvements. One highly successful innovation is the Public-Private Partnership, or “P3" - a unique hybrid organization which provides a quasi-privatized approach to infrastructure challenges, enabling oversight by a public organization while benefiting from the market-based incentives and efficiencies of a private sector model. P3s have been particularly popular in Europe and Asia, and are gradually gaining legitimacy here in the United States. Notable U.S. P3s include Chicago's Skyway Toll Road, the Indiana Toll Road, Virginia's Pocahontas Parkway, and Texas State Highways 130 121.
Given recent market gyrations and the liquidity crisis in fixed income, we expect that in the near term we will witness a pullback in infrastructure-related deals. Long-term prospects, however, are bright, particularly in light of continued trends in public finance, and the need for pension funds and institutional investors to seek out higher yielding instruments while minimizing risk. A potentially symbiotic relationship exists between infrastructure funding needs and pension liability matching. The recent "repricing of risk" will drive institutions to find low-risk, cash flow-dependable investments and thus will encourage growth in the infrastructure space.
See Infrastructure 2007: A Global Perspective from Ernst & Young.
African Financial Reform: A Strategic Opportunity
African Financial Reform: A Strategic Opportunity: China's policy of extending loans to impoverished nations in Africa as a means to secure natural resources contracts has drawn considerable scrutiny. In November, 2006, Beijing pledged $5 billion in preferential loans and buyers credits, and most recently, at a June meeting of the African Development Bank, unveiled a $20 billion loan package. China’s approach has drawn criticism from the international development community, which argues that it places already heavily-indebted countries further in debt, and undermines debt forgiveness efforts. According to the World Bank, debts of 27 Highly Impoverished Poor Countries (HIPC) declined from $80bn to $28bn since the program's inception in 1996.
While policymakers debate the propriety of this strategy, the controversy underscores an emerging opportunity for financial services companies. Africa is increasingly of strategic importance to the United States and the West, and calls for aid and intervention have reached a fever pitch. But sustainable economic reforms are only possible with sound financial systems which ensure connectivity to the global economy. We believe that a significant opportunity exists in the design and implementation of financial systems crucial to credit access, orderly capital flows and liquid financial markets in African economies. For a comprehensive account of the the state of African financial development, see the World Bank's Making Finance Work for Africa.
While policymakers debate the propriety of this strategy, the controversy underscores an emerging opportunity for financial services companies. Africa is increasingly of strategic importance to the United States and the West, and calls for aid and intervention have reached a fever pitch. But sustainable economic reforms are only possible with sound financial systems which ensure connectivity to the global economy. We believe that a significant opportunity exists in the design and implementation of financial systems crucial to credit access, orderly capital flows and liquid financial markets in African economies. For a comprehensive account of the the state of African financial development, see the World Bank's Making Finance Work for Africa.
Falling Dollar Implications
Falling Dollar Implications: In today's Financial Times Yale professor Jeffrey Garten provides an interesting perspective on the implications of a falling dollar as well as a mix of policy recommendations to prevent the current dollar drop from turning into a rout. Among his recommendations is a proactive Treasury policy of engagement with foreign sovereign wealth funds in preparation for a potential onslaught of foreign acquisitions of U.S. companies. Garten makes the point that the falling dollar could bring about a rise in nationalist-protectionist sentiment as U.S. firms are increasingly targeted by private sector and sovereign suitors.
We expect an increase in financial-services industry targets here in the United States, particularly originating in the oil-rich Middle East. We have witnessed already a strategic shopping spree by the U.A.E., with the DIFX/OMX/Nasdaq/LSE deal, and AbuDhabi's stake in Carlyle. With other sovereign funds such as Qatar Investment Authority, Temasek, newly capitalized China Investment Company Ltd., the stage is set for some compelling political-economic theater.
We expect an increase in financial-services industry targets here in the United States, particularly originating in the oil-rich Middle East. We have witnessed already a strategic shopping spree by the U.A.E., with the DIFX/OMX/Nasdaq/LSE deal, and AbuDhabi's stake in Carlyle. With other sovereign funds such as Qatar Investment Authority, Temasek, newly capitalized China Investment Company Ltd., the stage is set for some compelling political-economic theater.
On Strategy and Investment Banking
On Strategy and Investment Banking: The past 35 years have seen extraordinary changes within financial services. The advent of powerful, low-cost information and communication technologies has dramatically altered not only the means by which financial products and services are delivered and deployed, but the very nature of the products and services themselves. We are now witnessing a shift in the nature of financial innovation as we migrate from the "individualist" period characterized by retirement accounts, cash management, and discount/online brokerage services, to the "macrostrategic" period wherein financial innovation emphasizes institutional transformation and globalization.
While dealflow will continue to originate within the traded markets, increasingly deals will originate within the nexus between geostrategy and global finance. We believe that in this era of intense integration and hyperdependence opportunities currently exist and will continue to develop within this macrostrategic space. The global financial services industry is entering a period characterized by the need to control rather than simply mitigate risk, to foster growth through the production of a secure global economy. Opportunities in financial services will stem from the industry's tighter integration into the fabric of global affairs, whether through the development of the ailing markets and states of Africa, the Middle East, and Central Asia, the modernization of emerging capital markets, or the establishment of radical new funding vehicles to foster global health, environmental protection, and the privatization of key government functions.
The financial landscape of 2017 will be radically different from that of 2007. An entirely different set of challenges will surely confront financial services over the coming decade. In order to position themselves for success in the future, investment banks and other financial institutions must understand the underlying driver of financial dynamics going forward. Whereas the past was characterized by the strategic capital deployment of nation states and multilateral institutions, the 21st century will be defined by the strategic capital of the non-state and the globally networked enterprise. Increasingly, financial institutions and in particular investment banks will need to devote themselves more fully to this change in the allocation of capital. By recognizing this shift now in its early stages investment banks will be poised to fully integrate themselves into the coming framework.
While dealflow will continue to originate within the traded markets, increasingly deals will originate within the nexus between geostrategy and global finance. We believe that in this era of intense integration and hyperdependence opportunities currently exist and will continue to develop within this macrostrategic space. The global financial services industry is entering a period characterized by the need to control rather than simply mitigate risk, to foster growth through the production of a secure global economy. Opportunities in financial services will stem from the industry's tighter integration into the fabric of global affairs, whether through the development of the ailing markets and states of Africa, the Middle East, and Central Asia, the modernization of emerging capital markets, or the establishment of radical new funding vehicles to foster global health, environmental protection, and the privatization of key government functions.
The financial landscape of 2017 will be radically different from that of 2007. An entirely different set of challenges will surely confront financial services over the coming decade. In order to position themselves for success in the future, investment banks and other financial institutions must understand the underlying driver of financial dynamics going forward. Whereas the past was characterized by the strategic capital deployment of nation states and multilateral institutions, the 21st century will be defined by the strategic capital of the non-state and the globally networked enterprise. Increasingly, financial institutions and in particular investment banks will need to devote themselves more fully to this change in the allocation of capital. By recognizing this shift now in its early stages investment banks will be poised to fully integrate themselves into the coming framework.
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