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Pan-European internet brokerage
The subject of e-commerce has been broached so often throughout the UK's industries recently, that the consumer population is in danger of believing that everything they need is now available at their fingertips via the Internet. However, it is easy to mistake what is available in the UK and Europe with the more advanced technologies and state of readiness evidenced in the US. This is no less true for e-brokerage than for on-line grocery shopping or flight booking.
Recent research shows that while banks are better prepared for e-commerce than the rest of industry, still only 64 per cent of the 250 European banks polled have an e-commerce strategy and 15 per cent have a 'head of e-commerce'. Only 12 per cent of banks currently gain more than 1 per cent of revenue through e-commerce. It is the case, however, that brokers and banks in the UK and Europe are fast developing their service offerings. Those who are not able or prepared to do so will be left behind as 46 per cent of banks polled now expect to be generating more than 25 per cent of annual revenues from e-commerce within five years.
The impact of the Internet on financial services to date, however, must not be underestimated. In general terms, the Internet is already opening new territories for economic development, liberating the flow of capital and spurring economic growth. It is continuing to increase the deployment of more advanced financial products and services, and is opening the market for any financial innovation to 5 billion potential customers.
There is also a significant impact on the capital markets in particular. Electronic commerce networks (ECNs) now take 20% of the OTC equities market and are attacking fixed income. Off-exchange crossing and electronic matching systems are eating into market making margins, and there is growing direct access for the end investor, from traditional players to on-line entrants and clearing brokers. These factors are resulting in compression of the trade cycle, extension of trading hours and facilitation of cross-border capital flows.
At the front end, there are a continually increasing number of e-brokerage services available, with new and existing brokers rushing to get their offerings to market first in order to be in with a chance of competing. Internet players such as E*trade and Charles Schwab have entered the market, breaking the mould of the traditional brokers. Established financial players have developed their on-line applications and added new instruments, while even non-financial Internet-based businesses such as Freeserve have leapt on the bandwagon to provide securities trading and clearing services in the UK.
There has also been a huge surge in the volume of equity trading, mostly in the US and Europe, although this is now also spreading to the Far East. In addition, one-third of all retail trades in the US are now Internet-based, a number which continues to increase. However, while these figures are encouraging, the exceptional growth is putting a strain on many processing systems which were not designed to keep up with this sort of volume. Even the larger players are beginning to find that new strategies are needed.
E-businesses are discovering another problem - the price they are able to charge per transaction is decreasing as competition becomes tighter, especially in the retail market. Therefore, in order to make money, they must scale to volume and make the processing of this volume very efficient. This again is leading to a revaluation of current systems. If a business is still costing several dollars per transaction, it must charge a higher rate to customers in order to make any profit. Yet it will be impossible to cut the charges unless the company has an efficient processing system.
Although figures show that e-commerce is proving to be successful beyond the current level of preparation of many players, competition will continue to force an improved service across the board. Some consolidation of e-brokerage firms is likely in Europe (it is already taking place in the US) and a number of companies who have failed to make themselves distinctive or who have failed to control costs will be forced out of the market.
Stronger offerings will necessitate an expansion of services from today’s basic order booking and account management services to areas including private banking and portfolio management, as companies search for more ways to make a profit as margins continue to decrease. This necessity will also lead to a wider market in terms of product, with the requirement of extended instrument coverage.
Despite a few problem areas, the future for e-brokerage continues to look bright. It is expected that European Internet users will triple in the next three years, and the private investment market will continue to grow as European countries' public pension schemes fall further into deficit. The more aware among the financial institutions will be able to leverage this market increase to make a profit in e-brokerage, despite the falling margins. If it comes to pass that retail brokerage services are forced to deliver virtually at cost, companies will need to use retail trading merely as a method of bringing customers to its web site in order to sell a wide and more profitable range of other financial products, such as pensions or insurance.
For those companies looking to move into e-brokerage, the system requirements are a major factor. The first point of contact for potential clients is through the web site. This should be scaled so that it is able to deal with a lot of users at once in a timely manner. For example, it should have good response times on screen. The organisation must be prepared and the business integrated so that customers don't encounter problems. For example, although mutual funds, equities and insurance come from different divisions, customers will only want to fill in one form.
E-brokerage companies must have a high rate of straight through processing (STP), especially in equity trade flows. Orders, once captured, must be routed dynamically to the execution point, and the whole process through to the settlement and reporting stages must be as efficient as possible in order to reduce costs. All systems must be integrated, from the web-based ordering to the final delivery, in order to give a high level of product quality and customer service. Within the web site, the company must also have basic portfolio management and accounting attributes, and the system should be fully scaled.
Although STP must be evident throughout the transaction flow, it is not imperative for the on-line broker to own the whole transaction flow on a proprietary basis.
Outsourcing is an option; start-ups and even mature firms see this as a popular choice, as either a bureau service or even as operational outsourcing, both of which provide cost-effective solutions. These companies have the choice to outsource their data centre, software, machinery and operations staff, each of which will provide cost reduction and give brokerage firms the ability to extend their facilities and services. Outsourcing can also be done on a components basis. A firm which wishes to build on some or all of its proprietary system can choose to outsource certain components, such as order management, which can be interfaced to their own systems via middleware. This reduces their time to market as no further proprietary building is needed. The outsourcing company chosen should be adaptable to change, as the trend for extended services increases.
The range of small and large players flooding the market have different scalability needs, and both are interested in outsourcing. It is very expensive for a start-up operation to build a back office, data centre, et cetera, and pay-back can be delayed by some years. If the firm chooses to outsource, the pay-back is almost immediate as they both pay and gain a profit for each transaction. For the large player, outsourcing allows a drastic reduction in time to market. It side-steps the difficulties of trying to mobilise an internal organisation, and allows the company to focus on what its business really is by outsourcing the processing. The large firm also feels the benefits of cost efficiency, especially as its volumes increase.
The vendor response to the challenges evidenced by the vast and rapid growth in Internet brokerage has been limited so far. Most have added HTML front ends, but have not fully addressed scalability issues and future business growth by both volume and product. Vendors must respond with lower STP costs per transaction of the entire flow in order to address the issue of increasingly tight margins, and also by offering an extended service.
To meet market needs, vendors should also offer their services as an outsourcing bureau model. This would take the fixed cost away from the client, and replace it with a transaction-based cost that must be lower than the revenue. Outsourcing providers and in-house or vendor systems must be able to adapt to new technologies, such as Java and dynamic HTML. They should also be developing technology for new innovations, such as Wireless Application Protocol (WAP). As the take-up of e-brokerage continues to increase, companies will also need to provide constant access to their services, with an Internet connection that will be constantly on. This will broaden the facilities that can be delivered to clients, such as constant up-streaming pricing.
Vendors should be continually developing new technology. Their front-end offerings should fit onto mobiles and palm-tops, so that people can be connected wherever they are. Vendors should also have the solutions to deal with tomorrow, be it in terms of technology, low cost, scalability or products. Customers must see significant value-added services, and technology that offers reliability, flexibility and security.
Once a business has an offering to get to market and guaranteed cost per transaction through outsourcing, it can then build a business case which will offer the company significantly greater confidence that it will have a future in a market where only the best-prepared will survive the e-revolution.
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