Before we get to my thoughts, Max Bowie wrote that as markets for trading stock in privately-held companies become more prevalent and exchange-like, and potentially attract more investors, this will impact fully-fledged exchanges and their offerings, which could lead to M&A activity. That opinion piece is based on a 4,200-word yarn about the data and infrastructure challenges that exist, which have kept private stocks opaque, illiquid, and behaving differently from public markets, though that’s changing.

That’s some good, smart content…let’s get to my dumb ideas.

Encryption evolves as Big Tech’s influence grows

While it’s not something that we covered, this week it was announced that Nasdaq is using Intel’s Xeon Scalable platform “to significantly speed up computation for its high performance advanced homomorphic encryption (HE) applications.”

As technology advances, so too must security controls. Homomorphic encryption essentially combines the best of both worlds—it allows users to perform computation on data that is always encrypted. As Intel puts it: “The data never needs to be decrypted, helping reduce the risk from cyber-threats. HE offers developers and enterprises new ways of gaining insights from sensitive data across organizations, and Intel’s platform improves performance to support end-to-end data encryption.”

The ability to process data without having to reveal the data has long been a concern for cryptographers, as Jo Wright and Josephine Gallagher explained in a two-part, very deep-dive look at homomorphic encryption in late 2019. (Part 1 looked at the tech itself, while Part 2 explored some of the real-life applications in development at the time and the main roadblocks to its adoption.)

Encryption tech is rapidly evolving, and financial services firms are exploring these new tools—both of those are excellent developments. At the same time, while still relatively early days, banks and asset managers are moving more workloads to the cloud—that’s also a good thing. Where this might get messier is when a handful of companies control both cloud and security for the global financial system.

For this co-engineered project with Intel, Nasdaq is using HE in a series of experiments involving artificial intelligence and machine learning datasets, as well as for its anti-money-laundering (AML) and fraud detection tools.

“HE is performance-intensive and poses usability challenges for large, enterprise-size datasets,” said Nikolai Larbalestier, senior vice president of enterprise architecture at Nasdaq, in the release. “For Nasdaq, we have been exploring and experimenting with HE in strengthening our technology solutions that focus on financial crime detection while also complying with data privacy regulations. The performance improvements achieved with Intel’s latest Xeon platform will support our efforts in wider adoption of HE, particularly in improving data analysis and insights, as well as product innovation around areas such as anti-financial crime.”

Also this past week, our Reb Natale caught up with Likhit Wagle, general manager of global banking and financial markets at IBM. The two spoke about how, among other things, IBM is making advancements in the confidential computing space.

As Reb wrote in a deep-dive feature in February, confidential computing leverages a piece of hardware, called an enclave or trusted execution environment, to secure data in use, as opposed to its other two states: at rest and in motion. Information concealed in an enclave is encrypted on a pervasive basis, meaning that even if there were some breach and the data were made public, it would remain encrypted and unknowable to anyone except whoever held the encryption key, the data owner. It cannot even be known to the underlying cloud provider.

IBM is pushing its security prowess as it looks to grow its financial services-specific cloud, which was first announced along with Bank of America in 2019. Other banks have joined the ecosystem recently, including BNP Paribas, MUFG, and Luminor. And that connects to IBM’s confidential computing endeavors, as IBM launched its Hyper Protect Cloud Services in 2018. Google started dabbling in the tech last summer, and Microsoft Azure rolled out its own offering, Attestation, in February this year.

As I seemingly always write in this space, I think that the application interoperability movement is the most important trend facing the capital markets today. But looking ahead, there’s a looming battle brewing between capital markets firms and the Big Tech providers—for our purposes, we’ll say the major cloud providers: Amazon, Microsoft, Google, and IBM.

Right now, everyone is playing friendly as banks and asset managers are moving more data and workloads to the cloud, usually via a public-private hybrid model. And as Big Tech gains more cloud converts, they’ll look to increase their importance by providing the much-needed security tools to protect, transport data, and analyze data. Now don’t get me wrong, it’s great that capital markets firms are exploring cutting-edge encryption tools…it’s the responsible thing to do. But what happens when banks and AMs rely on, essentially, four companies for both cloud and security? Again, right now it would seem like everyone is happy with the setup, but it’s also very early days. Over the next decade, I wonder if some harder questions are going to be asked by the trading firms of their Big Tech counterparts.

While trading houses aren’t complaining, regulators—especially in Europe—seem to be taking notice of these new developments. Perhaps regulatory bodies will serve as a collective cooling saucer when it comes to Big Tech’s expansion in the capital markets. While the motto in Silicon Valley was “move fast, break things,” in the capital markets, regulation and bureaucracy have essentially created the environment where innovative Big Tech companies could come in and disrupt the banks and asset managers. Will the likes of Amazon, Microsoft, Google, and IBM have long-term staying power if financial regulators look to exert more control of their business operations?

Right now, this is more a philosophical exercise, but here’s how I’ll wrap it up: encryption tech is rapidly evolving, and financial services firms are exploring these new tools—both of those are excellent developments. At the same time, while still relatively early days, banks and asset managers are moving more workloads to the cloud—that’s also a good thing. Where this might get messier is when a handful of companies control both cloud and security for the global financial system. While that’s an overwrought sentiment at this point, it would appear that financial regulators in Europe are becoming increasingly concerned about Big Tech’s growing importance.

Or, maybe I’m being overly skeptical—I’d love to hear your thoughts on this subject: anthony.malakian@infopro-digital.com.)

Finally, speaking of hearing one’s thoughts, Nasdaq’s Larbalestier and IBM’s Wagle have both recently joined the Waters Wavelength Podcast, and they’re a joy to listen to. You can listen to Larbalestier talk about cloud adoption and streaming real-time data by clicking here; to listen to Wagle talk about cloud and containerization, click here.

Bank tech is a flat circle

Two of my all-time favorite movies and TV series both involve the concept of time being a flat circle, the theory of which states that all things are repetitions of past things and particular events must occur for time to move forward. The movie is Denis Villeneuve’s absolutely brilliant Arrival, and the TV series is the third season of Nic Pizzolatto’s True Detective (though many people look at season one as being the time-is-a-flat-circle package, I think season three is a more perfect encapsulation of the concept). When executed well on-screen, the results are equal parts beautiful and haunting. At the conclusion of Arrival, I went on a two-hour walk to collect my thoughts, and I’ve watched season 3 of True Detective three times, start to finish.

The idea of circular time crept back into my head this week after Max Bowie and I broke the news about a new bank consortium called Project Octopus, though that name will change once the consortium officially goes live.  (Project Octopus…why does everything coming from Wall Street gotta sound like something out of a Bond film?). The consortium—which sources say is being led by Citi, thanks to a project it was working on with low-code platform provider Genesis Global Technology—is building a collateralized loan obligation trading solution in a bid to prevent existing fixed-income platforms from cornering the nascent electronic CLO market and charging what the banks see as high fees for trading and market data.

The two vendors that the banks are looking to get ahead of—according to sources—are Tradeweb and MarketAxess. And here’s where the flat circle gets placed down. Tradeweb and MarketAxess were created by dealer-led consortiums. After they survived and proved effective, they were sold, and the dealers cashed out. The companies then grew and, in the natural process of things, raised prices. The dealers complain. They partner once again to build a new platform that they can control. Rinse and repeat, ad nauseam.

As Howard Cohen, head of leveraged loans at MarketAxess told us, there is “fantastic growth potential” in the CLO market, and the vendor is indeed looking to expand its presence in the space. S&P Global Market Intelligence is predicting a bumper year for CLOs after a contraction in 2020 marked by volatility, loan downgrades, and higher defaults, leading to lower issuance. Overall, between 2008 and the third quarter of 2020, the outstanding balance of CLOs more than doubled to $845 billion.

Cohen welcomed the competition that could come from Project Octopus, as more players in the space will help the market to evolve electronically more quickly. And there’s reason to think that Project Octopus will ultimately get off the ground and running.

Sources tell Max and me that the key piece of this consortium will be that the banks involved will switch off their proprietary platforms and migrate all CLO trade flow to the new system. While it sounds like Citi, which has its Velocity platform, made the first move when it started working with Genesis—of which it is an investor—Bank of America, which runs the Instinct platform for electronic trading of syndicated loans, is also joining the project. Citi and BofA have approached five other banks with large footprints in CLO trading, sources say, but it is unknown at this time which dealers have signed on.

While Citi, BofA, and Genesis, did not talk to us for this story, the sources that we did speak to say they expect an announcement about the new platform coming soon. So it is that we’ll simply wait and see what the plan is for the Octopus going forward. But, if you happen to have any details or opinions about the project, let’s chat: anthony.malakian@infopro-digital.com.

UPDATE: After this column was published, Citi and Bank of America put out a press release confirming the project. While the release is light on details (as is this Bloomberg story). What we missed was that this platform will also cover syndicated loans and that Citi is backing this effort through its Spread Products Investment Technologies (Sprint) group, within the Citi Markets FinTech Investments program. If we get more information, we will certainly follow-up. 

The photo at the top of the page is Katsushika Hokusai’s “South Wind, Clear Sky, from the series Thirty-six Views of Mount Fuji” via the Cleveland Museum of Art’s Open Access program. I picked this photo in honor of Hideki Matsuyama, who won the Masters, becoming the first Japanese male to win a major championship in golf. That was exhilarating—thank you, Hideki.