Accelerating innovation in fintech

Chicago showcase brings fintech startups into derivatives industry

5 December 2019


There is a bid and an ask in every market, even in the market for innovation. FIA is narrowing that spread with its annual Innovators Pavilion.

Each year, FIA invites a small number of startups to Chicago to introduce them to the banks, brokers and trading firms that attend the annual Futures and Options Expo. The purpose is to help these startups pitch their ideas to potential users in the industry, while at the same time giving industry executives an efficient way to assess the innovative solutions on offer from the global fintech community.

The goal is to accelerate innovation in the derivatives industry by giving young firms access to key players. These meetings are only one step on the long road from bright idea to commercial success, but an important way to lower the barriers to entry.

This year's Expo hosted its fifth Innovators Pavilion. Since its launch in 2015, more than 90 startups have participated in the showcase, which provides them with a place in the exhibition hall to demonstrate their offerings and network at the Chicago conference, the largest annual gathering in the global derivatives industry.

Twenty startups were chosen by the FIA's selection committee for this year's Pavilion. The group included four trading platforms, five data companies, five companies targeting industry-specific operations and compliance problems, three companies in the digital asset space, and three companies specializing in hardware and software for low-latency trading.

Participation from Hong Kong, Israel and Spain

Although the majority of the startups in this year's group came from within the U.S, a significant minority travelled from other parts of the world to connect with the derivatives industry.

One example was Blue Fire AI, a company based in Hong Kong that produces risk signals on publicly traded companies. The company uses a combination of natural language processing and a proprietary "sense-making" technology to sift through publicly available information and detect unforeseen risks to a company's profitability. An added feature is that Blue Fire's engine can perform this type of analysis on documents in Mandarin as well as English, giving its risk signals additional value as China opens its financial markets to the outside world. Blue Fire's primary customers are investment managers, but the company sees potential applications on the sellside as well, particularly for banks and brokers in the equity derivatives and structured products businesses.

Another example was Raft Technologies, one of two Israeli firms in the Pavilion this year. The company has built a transcontinental communications system that uses shortwave radio technology to reduce the latency in long-distance trading. The company says its system can transmit market data and order messages between major trading centers such as London and Chicago much faster than fiber optic cable. I also claims to have an edge over microwave systems, currently the fastest technology available, because it does not require line-of-sight transmission between relay stations. Raft believes its solution will be particularly attractive to the proprietary trading firms that provide the majority of the liquidity in exchange-traded markets.

Still another international firm was Seven Solutions, a Spanish company that has built a system for ultra-accurate time synchronization for data transfers within a network. The protocol was initially developed by the scientific research community for use with particle accelerators, and Seven Solutions is applying this protocol to synchronize data in a trading network at a sub-nanosecond accuracy. One of its first customers was Deutsche Börse, the German markets operator, which is using its system for accurate timing in its trade monitoring infrastructure.

Fintech for operational efficiency

One of the key themes across this year's group of innovators is that the majority are enablers rather than disrupters. In contrast to more consumer-focused sectors of fintech, most of these companies are not aiming to displace existing market participants, but rather to help them achieve greater efficiency in their internal operations. That fits into a larger trend in capital markets; after many years of heavy investment in post-crisis compliance, many financial institutions are now focusing on using technology to reduce costs and improve their return on capital.

For example, Mosaique, a Chicago-based startup founded in 2017 by several futures industry back-office experts, is targeting a common problem in futures brokerage. With clients using multiple brokers to execute and clear trades, information about trades is scattered across multiple parties and processing platforms. Mosaique estimates that this results in as much as $500 million in fees outstanding at any one time. To solve this problem, the company is developing software that consolidates data from multiple sources and provides the information needed to make net fee settlements across all counterparties.

Arcus Partners is tackling a different aspect of the same problem. The New York-based company has built a cloud-based system that can capture customer-related information from multiple sources and optimize the organization of that information for reporting, analysis and business intelligence. Its particular focus is on the securities and derivatives brokerage industry, and one of its solutions provides futures brokers with a central repository for information from all of the documents that flow through the firm. That includes client clearing agreements, regulatory disclosures, new account applications, and the certificates, invoices and confirmations associated with physical deliveries.

Another startup targeting operational inefficiencies is EZOPS, a company founded in 2014 by several industry executives with experience in derivatives processing. Their vision is to combine the technology of machine learning with domain expertise in derivatives to achieve "intelligent process automation" for the derivatives industry. In practical terms, that means using machine learning to detect patterns among trades that cannot be processed automatically, and then using the results to predict trade breaks before they happen. The company went live with its solution in 2017 and has onboarded several banks as clients.

Technology diffusion

This year's Innovators Pavilion also included several companies that are replicating certain highly sophisticated technology solutions developed in-house by top banks and trading firms and offering them as a service to the industry as a whole. This lowers the cost through economies of scale and benefits the industry by making sophisticated capabilities more widely available.

Hivemind was one example of this type of innovation in this year's Pavilion. The founders originally worked at Winton Capital, a well-known systematic hedge fund based in the U.K. They started working on a project to solve internal data problems and came up with a novel way to combine machine and human intelligence. The project proved so successful that in 2018 they spun it out as a separate company, and it now has backing from Barclays and Fidelity International. 

Another example is BMLL Technologies, also based in the U.K., which has built a platform for market data analytics. The firm, which grew out of a research project at Cambridge University, has collected terabytes of historical order book data from all the major exchanges and makes that data available through a cloud-based service. The firm also provides the analytics needed for order book simulation, execution applications, algo testing, and many other functions that banks and trading firms typically build in-house.

Customer profitability analytics is another area where startups are replicating in-house applications at top tier firms. DataDock Solutions, a New York firm established in 2018, came to the Pavilion to show how its software can help banks and brokers measure the profitability of their institutional sales and trading businesses client by client, trade by trade. The two founders worked on the equity derivatives desks of Bank of America and Goldman Sachs, and they know from experience that many brokers are looking for an efficient way to make data-driven decisions on who they trade with and where they commit capital.

The industry is also benefitting from the diffusion of advanced technologies from pure-play technology companies such as Levyx, a firm that has developed a novel approach to ultra-low latency data processing. The company, which is based in southern California and works closely with Intel, came to the Innovators Pavilion to show how its software can dramatically accelerate data processing performance by allowing computer systems to get the performance of random-access memory out of solid-state memory storage. This is particularly useful for handling large computational workloads in real-time, for example, when back-testing a trading strategy with millions of simulations or running real-time trading analytics. Although the company’s founders came out of the software industry and have no background in financial services, Levyx has attracted funding from OCA Ventures, a Chicago-based venture capital fund founded by derivatives traders from O’Connor & Associates, and several top-tier banks are now testing its software.

Blockchain and cryptocurrencies

This year's Pavilion also included three companies that are leveraging the explosion of interest in cryptocurrencies and the underlying technology of distributed ledgers.

DrumG, an early stage company based in New York, is attempting to use distributed ledger technology to transform the way that pricing data are collected in OTC markets. Early in 2020 the company plans to roll out a data collection network supported by several leading banks. The network will generate a consensus price, similar to what traditional market data vendors provide, but with one crucial difference: the banks that provide the price information will not lose ownership or control of that data.  

BlockFI is taking the traditional banking functions of making loans and paying interest on deposit and applying them to the cryptocurrency world, giving people a way to receive interest on their holdings or use their holdings as collateral for a loan. Currently it accepts bitcoin, ether and GUSD, a stablecoin issued by Gemini Trust. BlockFI launched its interest-paying accounts in March 2019 and within six months the assets in those accounts had grown to more than $250 million in value. Next up: the company is preparing to issue a credit card that rewards users with bitcoin instead of miles or points.

Inca Digital Securities is solving another pain point in the cryptocurrency markets—the need for comprehensive market-wide data on cryptocurrency trading. The company, which is based in Washington, D.C., gathers data on more than 200 digital assets traded on more than 90 venues and delivers both historical and real-time data alongside analytics and charting capabilities. The company also provides technical analysis of blockchain addresses and transactions as well as sentiment analysis extracted from news and social media. Although the company is only two years old, it already has several institutional customers, including ErisX, the recently established cryptocurrency futures exchange, and the Securities and Exchange Commission.

Regtech for capital markets

Another hot area for innovation is in the area of compliance. Many companies in the derivatives industry are looking for ways to transition from manual to automated processes in order to deal with the large number of new regulations that have been implemented since the financial crisis. This has opened the door for a wave of startups that are leverage data science, cloud computing and other emerging technologies to tackle various aspects of the compliance process.

One example in this year's Pavilion was Cappitech, an Israeli company that has built a data aggregation platform for regulatory reporting. The company's cloud-based platform allows companies to ingest data from both internal and external sources and manage reporting requirements in multiple jurisdictions through a single dashboard. This saves money by avoiding fines for non-compliance, and it also gives companies what Cappitech calls "compliance intelligence," meaning that the information it aggregates can be used to improve performance in areas such as best execution. 

Vigilant, a New York-based company founded in 2015, has developed a system for monitoring public records to help compliance teams monitor political risks. A typical use case is monitoring employee contributions to U.S. politicians at all levels of the U.S. political system in order to comply with the so-called “pay to play” regulations such as SEC Rule 206(4)-5 and CFTC regulation 23.451. Vigilant’s service was launched in mid 2018 and now has dozens of customers including banks, brokers and hedge funds.

The growth of bitcoin trading also has sparked interest in compliance solutions. Solidus Labs, a New York-based company founded in 2017, came to the Pavilion to show off the market surveillance solution it has developed for digital asset markets. The company’s founders previously worked at banks as IT specialists for equities trading desks, and now they are transferring that expertise to this new asset class. Solidus asserts that traditional compliance tools do not work in the digital asset space because of the differences in market structure, data formats and even the types of market manipulation that needs to be detected. The company also emphasizes that its solution uses machine learning to improve the detection of anomalous behavior and reduce the number of false positives. The company raised $3 million in a February 2019 funding round that included David Krell, the co-founder of the International Securities Exchange and a well-known figure in the U.S. options industry.

Competition for exchanges

Last but not least, four startups in this year's Innovators Pavilion are determined to disrupt business as usual by taking aim at the most powerful incumbents in the industry—the exchanges.

24 Exchange Bermuda, the latest brainchild of electronic trading entrepreneur Dmitri Galinov, is setting up an offshore liquidity pool that aims to dramatically reduce trading costs compared to traditional exchanges. Galinov, whose experience includes founding several successful off-exchange trading networks, is working with several banks and non-bank market makers to provide liquidity for the first set of products, non-deliverable FX forwards, and plans to add U.S. cash equities next. 

OTCXN is attempting to build a radically different infrastructure for trading, clearing and settlement. The San Francisco-based company has built a trading network that combines distributed ledger technology and asset tokenization to achieve instant settlement of trades with zero counterparty risk. Two crypto-friendly custodians have joined OTCXN's network and the company is now in the process of onboarding clients for trading in digital assets and foreign exchange.

The Small Exchange, a Chicago-based startup backed by Citadel Securities and Jump Trading, is taking a more traditional approach, but in its own way it is just as disruptive. The company's founders, Tom Sosnoff and Donnie Roberts, are well-known leaders in the U.S. retail brokerage industry, and they believe the incumbent futures exchanges are not meeting the needs of retail investors. The exchange has created a new set of retail-sized contracts and has signed up two leading market makers—Citadel Securities and Jump Trading—to support the market as soon as it goes live. The next step: regulatory approval from the U.S. Commodity Futures Trading Commission. 

The fourth startup in this category was the American Financial Exchange, the latest venture from futures industry legend Richard Sandor. AFX launched in December 2015 as an electronic marketplace for short-term loans between U.S. financial institutions, with the idea that data from that market's trading activity would provide an alternative to Libor for measuring the cost of funding in the U.S. interbank market. AFX has now reached critical mass, with approximately $1.8 billion in notional value traded on average each day, and the data from those transactions are the foundation for its Ameribor benchmark. This summer AFX introduced futures on Ameribor, with trading on Cboe and clearing at OCC, giving market participants a new way to manage short term interest rate risk in the post-Libor world.

Venture capital in fintech

A key ingredient for all this innovation is capital. Startups need funding to build their prototypes and develop their business models. Banks, brokers and trading firms typically get interested when a viable product is ready for use, but it may take several years before the startups reach that stage. That is where venture capital comes in.

Many of the startups in the FIA Innovators Pavilion are backed by investment firms that specialize in funding early stage companies. Three companies are particularly active in this space: Illuminate Financial in London, Credit Suisse Next Investors in New York, and Jump Capital in Chicago. These three companies see hundreds of proposals every year and they have extensive experience in assessing the potential for a startup to succeed in institutional markets. All three firms participated in the selection committee that reviewed this year's applications to the Pavilion and helped FIA encourage aspiring entrepreneurs to come to Chicago. 

The fintech ecosystem also includes a wide range of programs designed to support startups. One of the best known is Fintech Sandbox, a non-profit based in Boston that has worked with many of the startups in the FIA Innovators Pavilion. Fintech Sandbox is tackling one of the biggest challenges that startups face in the capital markets sector of fintech—the need for data. Startups that are seeking to innovate trading, clearing and other market-related functions need access to market data to build their prototypes and test their models. But market data are very expensive, and startups rarely have sufficient revenues, or even any revenues at all, to spend on this key component.

Fintech Sandbox solves this problem by partnering with leading data providers such as CME, Factset, IHS Markit, Refinitiv and S&P Dow Jones Indices to provide data at minimal or no cost to a small number of startups each year. Some of the most exciting and innovative companies in this year's FIA Innovators Pavilion participated in the Fintech Sandbox, highlighting the importance of data to innovation in capital markets.

  • MarketVoice