Navigating the Crisis

In our survey, Waters readers reveal how they are handling the choppy seas, their tactics and their forecast for the future. By Emily Fraser

For Wall Street, 2008 has been worse-by far-than anyone could have foreseen even a year ago.

Bulge-bracket sell-side firms considered financial bastions at the beginning of the year have either been acquired or gone bust. The financial services industry has been stifled by a lack of availability of short-term credit. And now many hedge funds-which appeared to be faring better at the beginning of the crisis that began in earnest in September-are facing what amounts to a run on the bank in the alternative investments sector, as investors pull their funds. One industry insider told Waters the hedge fund industry could contract by half.

Recent reports suggest that Wall Street is bracing for a new round of lay-offs before the year is over. A report from the Federal Reserve Bank of New York predicts that the current financial crisis could lead to an overall contraction in Wall Street employment of 12 percent to 17 percent-The Financial Times estimates that a total of up to 78,000 Wall Street-related jobs could be lost, on top of the 10,000 jobs that were lost between March and August.

At press time, financial giant Citi announced it would lay off more than 50,000 employees worldwide.

Budgets for 2009 are being scrutinized with extreme caution and many firms will have less money at their disposal to do the things they need to do.

 In a 360-degree survey of industry participants carried out by Waters last month, a third of sell-side firms and a quarter of buy-side firms report that their budgets will be smaller next year compared to 2008. A small number of respondents from each group say that their firms' IT budgets will be cut by more than 25 percent.

These findings are echoed in several analyst reports, which predict double-digit reductions in technology budgets. Bob McDowall, senior analyst for TowerGroup, expects budgets to be cut by 10 percent to 20 percent and says many firms will place a moratorium on discretionary and strategic spending until the second or third quarter of next year. "Some projects will be delayed for six months and then may or may not go ahead," he says. Most industry observers agree that long-term projects are being put on hold, as are international expansion projects. Returns on investments are being looked at with even more scrutiny-if such a thing is possible.

Find The Fat

Ironically, after years of record profits inside investment firms, there is currently little fat in IT budgets so it will not be easy for firms to cut technology spending dramatically. Most firms Waters has interviewed over the last couple of years say that between 70 and 80 percent of their technology dollars are spent on just keeping the lights on. That includes carrying out daily systems maintenance-sometimes of legacy systems that are up to 30 years old-fixing bugs, paying for the electricity to power these systems, and the staff to maintain them. Some firms will cut maintenance costs by severing certain business units, says McDowall.

 Alternatively, firms may place a continued focus on trying to reduce maintenance costs by making things more efficient. However, many projects that are hit hardest by budget cuts are in fact initiatives that aim to increase technology efficiency.

Twelve percent of respondents to the Waters survey report that their firm was suspending service-oriented architecture (SOA) projects. Twenty percent of respondents say back-office modernization is being cut, and 30 percent point to infrastructure refreshes as an area where spending would decrease. Green IT initiatives, which would eventually help reduce energy bills-some firms spend more on energy than they do on staff, according to one source-are another clear loser in the current climate, with 20 percent of respondents reporting that green projects were being cut.

Each of these types of projects aims to make firms more efficient in the long term, but lengthy lead times mean that they are generally on hold. Meanwhile, firms are looking to make their IT assets sweat more-to prolong their working lives-and they are looking for better terms and financing deals from vendors, says McDowall.

Bespoke vs. In-house

As banks roll back their budgets, the broader industry that supports them feels the effects. Some predict a shift in the build-versus-buy ratio. Trading technology vendor Portware claims it is benefiting from reduced IT budgets and that it has seen a sharp increase in demand from firms-in particular long-only asset managers. "I think we will see more of a flight to buy-versus-build," says Ary Khatchikian, Portware's president and CTO. It is beneficial to be able to offer clients the functionality of multiple systems in one, he adds.

The slowdown could prove beneficial for lower-cost providers, but even they are concerned. So says David Wynter, managing director of STPenable, a London-based vendor focused on data management solutions. "We are concerned about the slowdown in spending. To a point, because we are at the low end of the price range for our software, the slowdown would have been good, as customers become more price-sensitive. Also, our current focus on using the reference data we manage with real-time trading data for real-time risk measurement would benefit from increased regulatory pressure, if or when it comes," he says. "But the current outcome seems so extreme we are concerned about customer spending drying up all together."

STPenable is developing an application service provider (ASP) product that will allow firms to load and cleanse information from end-of-day market data feeds from various data providers with the new open standard MDDL-derived security master of reference data. The product aims to make once-expensive security master databases available on-demand to smaller buy-side firms via a rich Internet application (RIA) front end. It will also offer a module that takes the FIX contracts from the trading system and runs custom risk analysis rules against the security master data.

Some vendors hope that budget cutbacks will lead to increased adoption of hosted software-as-a-service (SaaS) or ASP technology. Many bulge-bracket firms have been hesitant to use SaaS or ASP technology as they do not like to send important data outside their own firewalls, but as money gets tighter, it may start to seem a more appealing option. Tim Lind, managing director at post-trade, pre-settlement technology provider Omgeo, says ASP solutions have come a long way toward mainstream acceptance. Many mainstream investor accounting systems that contain a lot of sensitive information, as well as some major order management systems (OMSes) and books and records systems are hosted on an ASP basis, he says.

Opportunities for SaaS providers will depend on the total cost of moving to a new service, McDowall says. "It's not just that it's cheaper on an ongoing basis, but the cost of moving to that kind of service has to be considered as well," he says.

Firms have already cut wasteful spending throughout 2008 so it will be hard to make further reductions in 2009 without shedding entire business units and teams. It would be convenient to simply dial everything down for a bit and wait for the storm to pass, but that is not an option. The year 2009 looks set to bring a host of new challenges-and a continuation of some old ones.

Risk Tops The List

Risk is at the head of every firm's agenda and a lot of money in the budget is being made available to risk departments for technology and staff, according to Craig Stephenson, a headhunter for Korn/Ferry International. Risk managers also increasingly have access to a firm's budget and the ears of more senior management, according to Mary Price, head of the financial technology practice at headhunting firm Russell Reynolds Associates. "Many risk officers report directly the the CEO," she says.

Half of the respondents to Waters' survey report that their firms are focused on beefing up their risk technology. Twenty percent say their firms are undergoing minor adjustments to existing systems; a further 20 percent say major adjustments to existing systems are underway, and 7 percent report that their firms are overhauling their systems entirely.

Yury Dubrovsky, chief risk officer (CRO) at Lazard Asset Management, says it is unlikely many firms will overhaul their risk systems entirely. Ripping out one system to replace it with a slightly stronger offering may marginally improve functionality but is not worth the cost.

There will certainly be investments made in risk management technology, Dubrovsky says. Organizations that don't have any risk management systems will implement them as a response to this crisis. Those that do have risk systems in place will likely try to upgrade to newer versions to streamline information delivery to decision-makers, in some cases integrating one vendor's analytics with another vendor's risk engine, he adds.

"None of the risk systems will ever answer all of the risk management questions so if you don't have an experienced person analyzing the results it doesn't really matter what the systems say. No system can substitute an experienced human being," he says.

Only 38 percent of respondents to Waters' survey report their firms had adequate systems to begin with and do not anticipate any upgrades. In what is hopefully the exception rather than the rule, seven firms report having had little by way of risk management technology to begin with and that they were doing little to remedy this.

Managing credit risk and exposure to counterparties in particular is set to be a huge priority for firms in 2009, and the automation of over-the-counter (OTC) credit derivatives processing is going to be an important focus as firms attempt to get more of a handle on operational and counterparty risk. Vendors are tailoring their offerings accordingly, and a significant amount of private equity and venture capital money is being channeled into small companies building risk software, Price says.

Says Omgeo's Lind: "This industry has been running on the premise that some banks and brokers are too big to fail for some time, and that whole belief has been shaken to its core over the last two months." Having deleted one firm after another from their counterparty lists over the last two months, buy-side firms will have a particularly close eye on over-the-counter (OTC) transactions. Firms will look more closely at how they assess the value of those transactions, the credit risk to a counterparty, and how they manage that risk and exposure, Lind says. "It's a combination of valuation, transparency and operations," he adds.

Despite being labeled "financial weapons of mass destruction" by Berkshire Hathaway CEO Warren Buffet and-rightly or wrongly-being held widely responsible for causing much of the recent financial meltdown, derivatives such as credit default swaps (CDSes) are not going away. "If you have a large fixed-income position, the CDS market is an effective way to directly hedge those investments," says Geoff Harries, vice president, product strategy for payment processing solutions provider CheckFree, a part of Fiserv. However, "firms will be looking to understand their exposures better, value their portfolios and to do this they need better integration of data from various systems," Harries says.

Much of that process is currently manual, according to various sources. Keeping track of OTC products using spreadsheets might work when a fund's portfolio is small, but at a certain point this is no longer practical and funds expose themselves to operational risk, says Harries. Even firms that have moved to electronic platforms may not have actually automated their processes, he says.

Lind says that Omgeo has seen increased buy-side demand for collateral management solutions, in particular to manage their counterparty exposure in the OTC derivatives space. Firms are starting to look for tools to help them communicate with their brokers and understand what outstanding positions they have between them, to help find reliable sources for the valuation of those positions, as well as to help them mitigate that exposure through the pledging and acceptance of collateral.

This process is very immature at this point, says Lind. "A lot of position information exchange is handled by spreadsheets that are sent via e-mail. Business applications that import current positions, and show the value of those positions and the credit arrangements with a counterparty-systems that take all that information and determine the value of the position versus the value of the collateral and determine how best to remedy that exposure-are fairly immature on the buy side," he says.

Real-time risk is the new Wall Street mantra and complex event processing (CEP) technologies are being used more often to help compare real-time market data against historic reference data to gain deeper insight into the viability of a trade.

New Oversight

As the dust settles on the US presidential election, which delivered significant victories to the Democratic Party-a party that tends to favor regulation over deregulation-lawmakers in the US Congress are expected to get to work soon on new regulations for the financial services industry. Whatever shape the new rules take, compliance is almost certainly about to get more costly-one industry observer predicted it would be felt far more deeply than Sarbanes-Oxley or any other regulation that has passed in recent history. New regulations passed during the administration of Barack Obama will likely require additional reporting, which means having a greater handle on enterprise data.

Data management is also becoming increasingly important vis-à-vis risk management. "Overnight, our conversations with data management clients and prospects have evolved from supporting performance analysis and client reporting to how the Eagle Investment Systems can also help with managing risk and reporting issuer and other risk exposures," said John Lehner, president of Eagle Investment Systems, a subsidiary of the Bank of New York Mellon.

Portware also claims to see increased interest because of its ability to provide firm-wide views of global positions. Portware provides what it calls state management, which allows firms to see a global firm-wide view of their positions in all currencies in real time.

However McDowall says he is unsure to what extent new rounds of enterprise data initiatives, while increasingly important, will come to fruition, particularly in the first few months of next year. A global firm-wide view of data is nice to have but even if it is mandated by new regulation it could take a long time, he says.

The Continuing Arms Race

Meanwhile, trading volumes continue to place demands on systems and capacity like never before. Like it or not, firms are still competing in a trading technology arms race. Market data volumes will not decrease-in fact the Options Price Reporting Authority (OPRA) data feed is expected to double from just over 1 million messages per second to over 2 million per second between now and the end of 2009, according to Tabb Group and Financial Technology Forum (FTF) figures. Volatility like that seen over the last few months puts extra pressure on data transfer, processing and storage.

Growing trading volume places capacity demands on all aspects of the trade lifecycle. Trading systems must receive ever-growing amounts of data, process it, and then trigger smart order routers to look for available liquidity according to trading strategies that from now on are going to take a sharper look at real-time risk-and they must do this a few microseconds faster than the next person. And these high-speed, low-touch technologies are used more and more in multiple asset classes.

Clearing and settlement happens at a more pedestrian pace, but the market's ongoing volatility has caused volumes to be staggering. Broadridge Financial Solutions clears and settles for 60 percent of the primary dealers in the US for fixed income and a significant number for equities. Due to excessive volatility-one day in October, transaction volumes were 50 percent higher than the previous one-day record set in June this year-Broadridge has had to take advantage of capacity on demand from IBM in order to be able to process all the trades, says Charlie Marchesani, president, securities processing solutions in the US for Broadridge.

Managing latency will be a key trend for 2009 as firms seek to gain a better understanding of where exactly latency occurs. As mentioned in Rob Daly's column, The Daly Close, in the September issue of Waters, most firms have already eliminated much of the network latency in their environments by taking advantage of collocation services and using high-speed cables. Attention now needs to be paid to application latency-the view is that it doesn't matter how fast you deliver market data to your trading engine if that system takes too long to process it.

Venture capital is currently flowing to technology vendors such as Correlix, a provider of latency monitoring software, which secured $8 million in a funding round led by Sequoia Capital in September, and just recently secured additional funding from Vernon and Park Capital. "Managing trading latency is critical to seizing market opportunities and maintaining a competitive advantage. The need to be first, both to receive market data and execute trades driven by it, is increasingly important for firms to maintain and increase their profitability," says Jim Ginsburg, managing partner of Vernon and Park Capital, in a statement. "We expect to see increased demand from users within the buy-side, sell-side and exchange, ECN and alternative trading system (ATS) trading firm communities," he adds.

Despite the potential for a deep global recession, firms must spend a significant amount on technology in order to remain competitive-and to manage risk. Fortunately, not every firm will see budget cuts. In Waters' survey, of those who report they work for sell-side firms, roughly half say their IT budgets will stay the same or go up in 2009. A third of buy-side respondents report that their IT budgets will remain unchanged and a handful more say their budgets will go up.

Jumping Ship

Technologists inside financial firms are split about whether to stay or go. Only half of those who responded to our survey report feeling secure in their jobs. Just over a quarter are worried about their jobs but don't know where else to go. Twenty percent would consider leaving the financial services sector for another industry but 14 percent feel that their skills are too industry-specific to do so.

Mary Price of headhunting firm Russell Reynolds Associates says that some technologists in the industry are still "in denial" and although the financial technology job market is suffering, many still believe that there is more money to be made on Wall Street than elsewhere. This perception may start to change next year if things do not improve, she says.

On the whole, most technologists could move fairly easily to other industries, she says. "The infrastructure guys-those working in LANs, WANs, datacenters, IT security-could transfer easily," she says. "Those that build specific trading systems don't transport as well."

As 2008 comes to a close with dire news for global capital markets, those technologists who still have jobs will have no shortage of work to do. -->