FIS recently announced the acquisition of Sunguard. PR articles educate us by pointing, correctly so, that both companies provide services and products to the financial services industry in a complementary manner. Both companies sell core banking products, systems of record, systems that assist in the accounting of what a bank, a broker/dealer, an asset manager, a capital markets participant does when trading, investing in or facilitating trading or investing of financial assets – as well as payments services and products.
So far so good, especially for the PE funds that owned Sunguard I assume.
Let’s peel off the onion a few layers deeper shall we?
First, the astute reader will have noticed that banks are under assault and are furiously trying to reinvent themselves as “digital” banks. The astute reader will also have noticed that to become a digital bank means much more than reinventing distribution channels – a necessary exercise but not a sufficient one. Indeed, to become a digital bank, one has to reorganize how one works and this includes revamping one’s processes, workflows and how data flows vertically and horizontally, in and out of the organization. Phew, quite the endeavor! Oh, and I forget, one has to, eventually, at some point, in the future, replace its core systems. And this, astute readers, is a Herculean endeavor.
Most experts will tell you that banks core systems are antiquated, date back to the 1980’s at best, may be older in some cases and are woefully inadequate for today’s challenges. Most experts will as tell you the price tags to replace said core systems are astronomical. Several leading consultancy firms have therefore crafted very sophisticated strategic roadmaps advising for incremental change. I call this strategy “passing the buck”, even though I recognize the intractable nature of the problem.
So far, FIS and Sunguard, along with all other vendors in the space, have not been able to come to market with innovative core systems or software platforms that adequately address the new “digital” paradigm banks are faced with, either on the retail or wholesale side. (This does not mean they will never succeed or that they are not trying as I write this post.) In any case, the incumbent vendor side of the industry has fallen short of adequate responses technology wise and the banks have had to scramble by patching disparate products and service together in suboptimal ways.
Let’s peel the onion one more layer shall we? Sunguard powers many of the custodial accounting systems of the current securities settlement architecture. These systems are the very targets that distributed ledger platforms will eventually replace. I must admit to a certain level of cockiness on this call. Still I am sticking to my prediction. (I have skin in the game – my firm is an investor in Ripple Labs, the developer of a distributed-ledger protocol.) It is also telling that most if not all top tier banks and capital markets participants are dabbling with distribution ledger and blockchain technologies. I know this first and second hand. What I have not heard yet is if FIS, Sunguard and their competitors are also experimenting.
FIS/Sunguard is faced with a double dilemma: a) innovate internally to deliver a more modern array of products to its finserv clients while mitigating cannibalization of current revenue streams across the company, and b) stay relevant in the face of emerging technologies on specific areas.
Astute readers will remind me that on the one hand FIS is a $6.5b revenue company and that Sunguard is a $3b company and that both have strong cash flow and a roster of marquee clients and on the other hand the distributed ledger ecosystem is at best 18 months old and is in the early stage of pipe dreams and pilot projects. True, but these arguments miss a few key strategic aspects. First large financial services incumbents have no other choice than to change the way they do business. Consumer behavioral changes, regulatory pressure, market structure changes are ensuring change cannot be avoided. Second, financial services incumbents are aggressively engaging in strategic cost cutting to deliver higher returns on equity to their shareholders – top tier bank CEOs have mandated significant cost cutting over the next 5 years to counter the drop in ROE since the great recession. The twin consequences of these key drivers leads to reengineering and experimentation, and this does not bode well for large finserv infrastructure service providers. They also will have to adapt and feel the pain of changing operating environments.
I assume the seven PE firms that purchased Sunguard in 2005 – prior to the great recession – are well aware of the long term changes the financial services industry is facing. This looks to me like a timely and shrewd sale.