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September 14, 1998

New Problems, New Solutions

Online trading and corporate mergers have Wall Street rethinking how it does business

By Bruce Caldwell

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FINANCIAL SERVICES

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With data from Hoovers Online

The pace of change on Wall Street is unparalleled, as anyone with an eye on the recent financial market gyrations knows. But hidden behind the hyperactive stock averages are more profound changes that have IT professionals at securities firms scrambling.

The proliferation of online trading via discount brokerages has full-service firms on alert. A frenzy of mergers and acquisitions has traditional securities firms preparing to integrate their systems with those of banks, insurers, and other investment firms. Companies are building global IT infrastructures to support increasing volumes of cross-border trading. The magnitude of the year 2000 problem has forced the securities industry to postpone several regulation-driven changes that require IT development.

The consolidation trend alone is enough to overwhelm even the most energetic IT professionals. For example, BankAmerica acquired Robertson, Stephens & Co. last year, and then sold off the Robertson, Stephens investment banking unit to BankBoston this year, after BankAmerica agreed to merge with NationsBank, which had acquired Montgomery Securities last year.

The consolidation of banking and investment activities "will change the way that both securities firms and banks look at their clients and market products to them," says Lawrence Tabb, an analyst with the Tower Group, a financial services IT consulting firm. And those firms will look different to their clients as more and more business can be carried out on the Web, he adds.

Meanwhile, cross-border trading and the shift toward fully electronic exchanges are also at play. Merrill Lynch, for example, continued its international expansion through acquisitions, buying the brokerage operations of Yamaichi in Japan and Midland Walwyn in Canada. Nasdaq and the Philadelphia Stock Exchange agreed to merge with the American Stock Exchange, and the Chicago Board Options Exchange will merge with the Pacific Stock Exchange.

Electronic exchanges threaten the "open outcry" tradition, where traders physically meet to strike their deals, says Robert Gach, a partner in the financial services practice of Andersen Consulting. Fully electronic stock exchanges will lead to global exchanges, Gach says. The German and London exchanges, for example, have already agreed to merge.

The popularity of online trading is also shaking the industry's foundations. About 100 online trading firms now compete with the full-service firms, Tabb says, and the number of online accounts has been growing about 90% a year. By year's end, Tabb projects, there will be 5.5 million "active" online accounts-customers who trade securities at least once a quarter-out of a total of 70 million. The number of online accounts is projected to grow to 13.3 million by 2000. Most of these will be with discount brokerages, though the full-services firms will also offer online trading by then. Merrill Lynch, for example, plans to make online trading available to its clients by the end of this year.

But the online discount brokerages aren't standing still. E*Trade Group and Fidelity Investments began offering research reports last year, and Charles Schwab is moving in the same direction, directly competing with full-service firms. "Competing just on price or relationships is no longer going to make it," says Andersen's Gach. "Clients now go where the ideas are." That's fostered an increased interest in the use of Web sites and E-mail for delivery of research reports, as well as groupware to pull together a firm's expertise, Gach says.

The full-service financial firms say the Web will only magnify their strengths in providing advice and guidance. When the Vanguard Group, a mutual fund company in Valley Forge, Pa., launched its Web site in 1995, it posted about 1,200 pages of information about its funds, compared with an industry average of 40 pages or so of marketing information. In July, the company debuted the Access Vanguard Web site, increasing the number of different transactions that investors can execute over the Web, such as opening a mutual fund account, purchasing and redeeming fund shares, and obtaining electronic account statements and fund reports. Today, 80% of its client transactions can be done on the Web, says Robert DiStefano, managing director of IT at Vanguard.

"We couldn't have invented anything better than the Internet for communicating with our clients," DiStefano says. The Web also helps lower Vanguard's costs, which in turn helps it keep commissions down, he adds.

Smart Spending, Saving
The financial services industry remains one of the biggest spenders on IT, lavishing between 7% and 15% of its revenue on IT, according to the Tower Group. More than a third of Vanguard's operating budget is spent on IT.

But the industry also knows how to save money-and often cooperates to do so.

The rise of cross-border trading has inspired cooperation on global "straight through processing" and middleware for carrying out trades electronically from the trader's desk to the back-office processors, with no intermediate manual steps. Over the next six to eight months, the Global Straight Through Processing Committee-an international group of fund managers and broker-dealers-will complete its design work and vendor selections for a global transaction manager application and network services.

Middleware will make global straight-through processing a reality sooner by eliminating the need for systems to conform to a single standard, says committee member Art Thomas, senior VP of global operations services at Merrill Lynch. Global straight-through processing is essential for the industry to realize its goal of settling trades in one day, instead of the current industry standard of three days, Thomas adds.

"The focus is on efficiency," analyst Tabb says. "Firms are being pressured by increasing trading volumes and decreasing spreads between bid and ask, so there is less opportunity to profit from trades except by doing more volume." About 25 transactions constitute a simple buy order trade, he adds, and the complexity is increased when shares are purchased overseas.

Other industry initiatives-including a system for auditing trade orders and modification of systems to accommodate pricing stocks by decimals instead of fractions-have been postponed until after 2000 because of the constraint on technical resources. But not so with global straight-through processing. "We could not wait until we crossed the century mark to deal with this," Thomas says, "because cross-border is growing incredibly."

Equipped For Change
Solving big problems such as year 2000 and global straight-through processing is what the securities industry does better than any other industry, Thomas says. "It's a matter of creating a Desert Storm type of alliance with a clear set of objectives, an environment that can support this rapid pace of change."

The Securities Industry Association has fostered and supported an industrywide effort on the year 2000 date-field problem since 1996. Most recently, dozens of SIA members participated in trial runs of industrywide year 2000 testing that will be carried out in earnest next March. In a test run last month, 90% of some 40,000 trades simulated for the last three days of December 1999 and for Jan. 3, 2000, were completed successfully. (The dates were chosen because it takes three days for a trade to be settled, and Jan. 1 and Jan. 2, 2000, fall on a weekend.) The SIA also sought and received clearance from the Department of Justice for members to share year 2000 compliance information about IT vendors without fear of antitrust actions by the vendors.

Members of the mortgage banking industry are also cooperating with one another on millennium-bug issues, but the year 2000 is still a resource hog, draining staff and funds from some other IT initiatives. At Freddie Mac, for instance, about 10% of IT employees have been working full time on the year 2000 problem, which is slowing down its efforts with object technology, says James Thompson, chief computer scientist at Freddie Mac.

Still, other projects are forging ahead. Freddie Mac is building a data warehouse to increase its understanding of how interest rates, the economy, and other factors affect the mortgage securities market. It's developing a message broker infrastructure using IBM's MQSeries middleware to help tie Web applications with its legacy systems. And it's looking at rehosting some client-server applications on its mainframes. IBM's CMOS processors have brought costs down, Thompson notes, and the mainframe is more open with TCP/IP support, "so some of the things that drove us off the mainframe are no longer an issue."

Worldwide Standards
Global IT infrastructure issues have been a subject of ongoing activity at J.P. Morgan & Co. The investment bank recently completed global standardization on Lotus Notes, on Lucent's Intuity for voice mail, on Netscape for its intranet, and on Microsoft Office for productivity software. It has begun a global rollout of Computer Associates' Unicenter management software, and major business applications, such as its risk-management application, are also being standardized globally, says Peter Miller, managing director of IT at the bank.

J.P. Morgan's two-year-old contract with Pinnacle Alliance, a group of outsourcers that includes Andersen Consulting, AT&T, Bell Atlantic Network Integration, and Computer Sciences, is paying off, Miller says. Because Pinnacle is settling down to running Morgan's day-to-day IT operations, the IT organization retained by Morgan has been freed up to innovate, he says.

For example, the bank this month is rolling out a single risk-management application for its swaps portfolio, building on a securities-risk management application already used in 20 locations. Swaps are the trades that clients make among themselves when they want the interest rate or cash flow of another client's bonds or securities without having to buy the bonds or securities themselves.

In addition to furthering the investment bank's globalization goals, the application is a breakthrough for IT cost-performance because its client interface is being rewritten in Java. J.P. Morgan has already moved to control network costs, implementing a usage-based billing system developed by Predictive Systems Inc. to track wide area network usage, providing information to the business units to help improve capacity planning.

The firm has been using Smalltalk, an object-oriented development language, and an object-oriented database from GemStone Systems Inc. to support new derivative products. These products, which can involve combinations of currencies, interest rates, securities, and commodities, are complicated and require advanced valuation calculations. In the past, modeling new derivatives with spreadsheets took several days, and manually integrating the new products into the portfolio risk-management system took several months. The object technology supports same-day modeling and integration, says Mike Ashworth, managing director of the fixed-technology group at J.P. Morgan.

So many challenges and so little time to adapt: The dilemma of most every IT professional is magnified in the financial services industry.

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