Frenemies at the gate
A curious cultural shift is taking place when it comes to problem-solving in the financial services industry, writes Joe Channer
The sector is not renowned as a home for co-operation: competition is intense, the stakes high, and individualism rewarded. Yet the industry has recently seen a marked increase in collaborative ventures. The post-crisis environment, with regulations driving transparency, is forcing firms to focus resource on areas where there is less competitive advantage, such as risk management or reporting. As a result, fierce rivals are beginning to buck the trend, putting aside their differences to mutualise solutions to problems regulatory, logistical and technical. Consortiums, industry groups and open source projects abound.
Only last month, 13 major banks announced joint backing for an effort to create a utility to reduce disputes over the margin used in swaps trading. This comes soon after the world’s largest swaps dealers began discussions on the creation of an open source model for calculating margin for bilateral derivatives deals. Both moves are a direct response to new rules requiring dealers to post more margin in order to mitigate counterparty risk.
The proliferation of new multi-lateral trading facilities (MTFs) is another case in point. Take the Plato Partnership announced last year. A consortium of asset managers and broker dealers, the partnership is currently working to create a new, not for profit trading utility that is planning to launch a platform for large equity trades in anticipation of MiFID II, particularly Broker Crossing Network and dark pool reforms.
Conditions for collaboration
Current market challenges are clearly driving this shift. Alliances are most attractive when a) there is common, sizable challenge to be met, perhaps within a tight timeframe, and b) when there is limited or no competitive element to the solution. And as the examples above show, the volume and focus of regulation post-crisis is making these conditions increasingly prevalent. From Basel to MiFID to AIFMD, firms are being forced to commit significant amounts of scarce resources into ‘hygiene factors’ – commoditised elements of the business where it is important to get things right, but little commercial gain to be had. Better to pool resources than for firms to replicate efforts via unwieldy in-house projects.
The increasing cost of meeting regulation, and challenging market conditions, are also conspiring to severely squeeze margins, which gives firms even less incentive (and ability) to pursue mission-critical-yet-non-competitive projects on a unilateral basis. The other contributing factor is the fast pace of technological change in the industry, destined to accelerate given the recent explosion of fintech innovation. Mass adoption of new technology often requires a collaborative element – for instance, around setting and agreeing standards.
Types of collaboration
It’s important to distinguish between different sorts of collaborative ventures, as the risks and considerations vary. Most can be categorised along a spectrum:
On the far left of the spectrum sit ‘consortia’, of which Plato is a good example. These involve the creation of joint infrastructure to mutual advantage.
On the far right of the spectrum come ‘standards’, such as where the mass adoption of new technology requires a mutual agreeing of definitions and the creation of protocols to be effective. The recent announcement from SETL, which is looking to introduce blockchain technology to disrupt existing post-trade infrastructure, provides an example of the latter. As does the AltExchange Alliance’s ongoing project to define commonly accepted data standards for communication between Limited and General Partners within the private equity industry.
What makes for a successful collaboration?
Collaborative projects are far from straightforward. Troubled projects litter the sector’s history: indeed the latest swaps utility is designed as a replacement for an earlier, failed initiative. So what are the ingredients for success?
Where a project sits on the above spectrum can make a difference to this answer. But regardless of its position there are few universal ingredients necessary for a successful endeavour:
- Independent facilitation
- Legal framework and commercial commitment
- Well-managed participation
Let’s take a look at these in more detail:
The importance of having the project mediated and facilitated by a skilled (and neutral) third party cannot be overstated. While the logic behind a joint venture might be straightforward, the reality of shepherding one to completion is anything but. Even when interests are aligned, it’s still a case of getting tens, maybe hundreds, of rivals to work together on what will likely be a highly complicated task.
The mediating party must – in addition to having the right level of industry expertise – possess a strong head for diplomacy, authority, pragmatism, as well as the capacity to spot and craft compromise. A good facilitator will at all times take care to be both attentive and sympathetic to the requirements of all those involved, even when they cannot all be met.
This third-party must also able to provide rapid access to the right skills and experience necessary to support the entire life-cycle of the consortium project. Typically this can include setting up and delivering a Project Management Office, providing advisory services for corporate structuring, commercial negotiation, business case development, marketing, and delivery capability.
Legal framework & commercial commitment
Importantly, and before any serious work is undertaken, a mediator can encourage participants to agree the scope, objectives and guiding principles of the project – no assumptions should ever be made here. These should be developed together with a well thought through collaborative business case and plan necessary to establish a realistic and clearly understood initial funding requirement.
Gaining early commercial commitment to pursue the project in accordance with these agreed guiding principles and objectives is often best achieved through a commercial Letter of Intent, which importantly should also commit an identified minimum investment to ensure the consortium is well-funded through to its next investment stage.
With the above commitment in place work can start on setting up a full legal corporate structure and commercial framework. It is imperative that all consortium members understand, from the outset, how their respective commercial interests are protected, how reserved matters will be handled and how decision making is achieved pari-passu. Without this in place, members will feel uncomfortable making hard decisions and the project will become protracted.
It’s critical that the right people are involved in the project, in the right way, at the right time and with the right delegated authority to take decision for the firm they represent. A common misstep is to try and bring everyone to the table right at the start in an attempt to demonstrate wide collaboration from the get go. It is often much better to identify an initial core that can get the project going, and then pull a wider number of participants in as the project evolves. Failure to manage this will almost guarantee delays. That said, it is important that the consortium progresses steadily towards critical market representation to ensure fuller adoption.
Consortia require strong stewardship, so early appointment of a credible ‘CEO’ is advised. This will almost certainly shorten decision-making cycles, allow the project guiding principles to be upheld, and provide strong direction as well as a clear ambassador for the project. Appointing independent non-executives is advised for providing independent perspective and helping to manage deadlock situations.
In summary, a third-party facilitator should be able to ‘manage’ a project, moving it forward efficiently. All too often a group of rivals will attempt to go it alone. This can leave a project lacking on all the above, partly due to the fact that these businesses will have plenty of their own day-to-day distractions and priorities, and partly because members will be uncomfortable with a competitor calling the shots.
Variations to consider
The relative importance of these universals varies depending on where a project sits on the competitive spectrum. Projects on the left-hand side of the spectrum – consortia – tend to be the most ‘political’, with the highest level of friction between collaborators in terms of project direction and outcome. These projects will typically touch on aspects of commercial advantage, which can make balancing the interests of various players very tricky. Here, the importance of a mediator with strong diplomatic skills and leadership is paramount.
By contrast, when it comes to defining standards or driving an industry utility there is often zero competitive advantage to be had, and all those around the table share a common goal. The challenge here is not about balancing interests but rather a logistical, technical one – how do we agree the standards as quickly as possible and drive mass adoption? Here, the mediator’s organisational, project management and consulting expertise come to the fore.
The type of venture also makes a difference to the positioning the mediator will need to do. The more competitive elements are involved, the more important it will be to allay fears that the project benefits some more than others, and emphasise the group benefits. Where competitive elements are absent (creation of standards) it is still important to position the venture as a genuine cross-industry push with real momentum behind it, as opposed to an optimistic-but-doomed suggestion from one corner of the market.
The direction of travel within the industry indicates that joint ventures within financial services are here to stay. Regulators are on a mission to gain a much clearer, more detailed view of the market – and are encouraging the industry to work together to do so. At the same time, globalisation is continuing to drive market complexity. Put simply, the industry is growing up and going through a process of standardisation, while new technology will continue to disrupt. All of this is creating a perfect environment for consortia and alliances. There will be successes. There will be failures. Firms can do a lot to ensure that their projects fall into the former camp with the right assistance and approach.