Show Me the Money

finance  money  Once upon a time, the people with money were the nobility. If you wanted to borrow some money to finance a business venture, you had to plead to your local king/queen or duke/duchess. There wasn't necessarily a choice of who you could deal with, and even a good business proposition might be turned down on a whim. Even if you got the money, there was no guarantee that you could afford the amount you would eventually be expected to pay back. This kind of environment is a discouragement to people who have good ideas but not the money to bring them to reality.

Later on there were money lenders, which at least gave you choice, but there was a lot of legwork to do in order to find the best deal. There was also no guarantee that a good deal would be available later if you didn't accept that deal immediately.

Financial markets Financial markets developed as lenders came together in one spot where haggling could take place. While there is a disadvantage to the lenders in having to offer competitive terms for finance, there is the advantage that potential borrowers are drawn to such markets so they can get a better deal. The attraction of markets to both lenders and borrowers is that each gets greater access to the other, and each knows that is better for business.

To Market, To Market

Stock markets  risk   Stock markets change the traditional lending story by sharing ownership (and risk) among a large number of investors, each of whom own a small part of a company. You don't need have to have enough money to buy a company just to be able to invest in a company, and you can split your investments across multiple companies so that your fortunes are not too closely tied to the fortunes of one single company. Although people often do not think of it this way, when they buy shares, they are lending their money to a company, in the belief that the company will pay them a fair return for the loan (either through dividends or a growing share price).

liquidity  market makers  The unseen part of markets is the market makers, who buy your shares when you want to sell and sell them on when someone else then wants to buy. They provide liquidity to the market, without which buyers and sellers would have difficulty matching themselves to others who want sell/buy exactly the same number of shares in a single transaction. The ability to buy or sell immediately (albeit at the going market price) is what makes a market attractive to investors. Shares have much greater value if you are able to sell them whenever you want or need to.

Taking a Risk

risk management  risk portfolio  In industrialised countries, almost all of us borrow money at some time or other, particularly for a car or house. None of us ever consider ourselves to be a bad risk, but each of us is a risk. Each of us might one day find ourselves in a circumstance where we cannot repay the money that we owe. For large money lenders, the cumulative risk can be enormous. Much of the complexity that is seen in the financial world today is because of the need for risk management. If the institution that loaned you money is taking too great risks, you might find they will suddenly have to forclose on your loan to cover their losses, and so you will be forced to pay back early. You may not be able to, and you might be bankrupted. So the need for lenders to manage their risk portfolio is as important to borrowers as it is to the lenders.

government bonds  investment  risk analysis  Modern risk management is based on a surprisingly simple result which comes from risk analysis. If you have access to both a low-risk investment and a high-risk investment, you can choose the level of total risk that you are exposed to by controlling how much you invest at low risk (and low return) versus how much you invest at high risk (and high promised return). In the financial world, low risk is provided by government bonds, which are treated as a more-or-less zero-risk investment.

futures  options  Risk management has also led to options and futures, where you pay for a guarantee that you will be able to buy or sell something at a particular price in the future. Large institutions use these to protect themselves against large swings in prices. Sellers of futures and options make money when the underlying prices do not move sufficiently for those large institutions to want to buy or sell.

exotic financial instrumentsThere are many exotic financial instruments with complex conditions (understood only by lawyers with mathematics degrees, or vice-versa) that exist to offer alternative new risk strategies that can be used within a risk portfolio to spread the risk as evenly as possible. In the end, all of this contributes to a sharing of the total risk among all players, which increases stability. Businesses tend to flourish best in stable predictable conditions, so markets needs to take this stable and sustainable approach to risk.

Extra, Extra, Read All About It

central bank  financial news and information  interest rate movement  If you are taking calculated risks, you need to continuously evaluate whether those risks are working for or against you. This makes the financial community a voracious consumer of financial news and information. The latest and most accurate news and information, delivered as quickly as possible, is what is required. As an example, Reuters once scooped an interest rate movement announced by a central bank. It was a whole minute before our competition reported the event. During that one minute alone, one of our customers made enough money to pay for its news and information for the following 1–2 years. When single trades are tens of millions of US dollars or more and the margins are narrow (as is common in areas like FX trading), you need to be sure that you are trading based on what correct right now, not based on what was happening five minutes (or more) ago. It is a lot easier to lose money than to make it.

FpML

FpML is a set of financial specifications which is initially focussing on transactions of over-the-counter financial instruments. These are financial products which are not traded via an exchange, but directly between two financial institutions, such as banks.

over-the-counter financial instrumentsTraditionally, over-the-counter deals are agreed by telephone, where only the most important details are discussed. After this, each party faxes and couriers the full details to the other, and the details are then compared to make sure that both parties were actually agreeing to the same thing. Time pressures mean that the full details cannot be agreed during the telephone phase of the negotiations. As such, the process of confirmation, comparing what both parties believed the they had agreed to, is manually tedious, and this makes it a good candidate for automation using XML . FpML messages each have a known and predefined set of defaults which are be overridden explicitly by either party as required. This makes the process of not specifying something explicitly a well-defined one, and allows the confirmation to be done in a fast semi-automatic fashion where only mismatched information is brought to the attention of humans.

forward rate agreements  interest rate swaps   FpML currently covers interest rate swaps and forward rate agreements, and is being extended to equity derivatives, FX spots, FX forwards, FX swaps, non-deliverable forwards (NDF), simple FX options and FX option strategies. Transactions which are currently exchange-based, such as "sell 1000 Reuters shares on the LSE for no less than £15 per share", are out of scope at present.

Refer to the FpML talks from this conference for more details.

XBRL

XBRL is a financial specification which is initially focussing on company filings and reports. On an international level, the major complexity with company reports at present is that each country has its own accounting standard. In the USA , the US GAAP is used, while in the UK it is the UK GAAP , Australia has an Australian GAAP , etc. Each accounting standard requires a different XBRL "taxonomy". What differs in each case are:

• company filings and reportsthe list of defined accounting items;

• the rules on how lower level items are added/subtracted/multiplied to give higher level items.

XBRL allows companies to add their own items by extending their local XBRL taxonomy. This allows those items which are important to a company's understanding of its own business to be directly related to the standard accounting terms required in its annual filing and report.

The US GAAP (Commercial & Industrial) was the first completed XBRL taxonomy. It contains thousands of items. The UK GAAP is taking a different approach, and is limited initially to hundreds of items. It is hoped that this will significantly reduce the learning curve, and thus speed the uptake of XBRL in the UK . Reuters is the first UK company to start publishing its results in XBRL (using a taxonomy based on the UK GAAP ). The UK and Australian GAAP taxonomies are based on the IAS GAAP taxonomy, and EU corporations will be required to submit company reports in IAS form from 2005.

Refer to the XBRL talk from this conference for more details.

MDDL

MDDL is a financial information specification produced by the FISD , part of the SIIA . MDDL 1.0 was released at the start of November 2001, and supports the publication of snapshots and historical time-series of equity prices, financial indices, and mutual fund data.

equity prices  financial indices  historical time-series  mutual fund  snapshots  Many of the world's major financial companies have contributed to the development of the MDDL 1.0 vocabulary, which guarantees that MDDL contains the items that are really used every day. A goal of MDDL is to stimulate the development of new and innovative applications of financial information by providing a common and flexible language which can be used to pass information between applications.

MDDL has features which can be used to help reduce its bandwidth requirements. Commonly used fragments can be written once in the <references> section at the start of the document, and then referenced wherever required in the remainder of the document. Most MDDL elements can have property elements as children, but property values are also inherited from ancestors, which helps reduce the need to inline the same values multiple times. Another MDDL 1.0 feature is an optional <other> element which provides extensions points throughout MDDL documents, so that there is plenty of scope for augmentation of the standard MDDL information.

Future versions of MDDL will extend the range of supported financial information, and may eventually address real-time updates as well. Development of a financial query language is also envisioned.

Refer to the MDDL talk from this conference for more details.

IFX

IFX is an XML messaging specification which supports commercial and personal banking. IFX messages can be used to manage accounts and specify transfers of money between banks, businesses, and customers. IFX also handles billing and payments. This is an important part of commercial banking, but not investment banking, so IFX is a commercial rather than a financial XML format. IFX is based in part on OFX .

OFX

OFX is an earlier commerical and personal banking specification that has migrated from SGML to XML (by removing support for implicit end tags). It has been extended to support tax forms, and there are also plans to extend it to support financial planning and insurance.

ebXML

While ebXML is a general e-business XML specification, and not specific to the financial industry, it is likely to play a growing role in the financial world. Financial services are often divided into "view" (information) and "do" (transactions); the "do" half of financial XML is about financial transactions. Due to the sums of money and the risks involved, financial transactions typically have more demanding requirements for speed, validation, authentication, and security than do general business transactions. However, once the global ebXML infrastructure is in place, it would be very surprising if that infrastructure were not suitable for at least some financial transactions, and the migration could well continue from there if the needs of the financial world drive the performance and functionality of ebXML implementations. So, expect to see ebXML take a not insignificant role in financial transactions in the future, though be aware that it is too early in ebXML 's life to say where the first uses of ebXML for finance might occur.

You Are Only As Good As Your Tools

XML is a great technology, but the tools are still immature, in the sense that they tend to demand that users have an understanding of how XML works, and of how to make it work best. Ideally, companies want business analysts to be able to write XML schemas ( DTD s/ W3C XML Schemas/ RELAX NG /Schematron/whatever) without having to train them up at IT specialists. It should be enough for analysts to be domain specialists, which means that XML tools need to be as approachable as word processors or diagramming packages.

Who's the Boss

XML has added another dimension to data modelling, one that can complicate the process if not managed properly. Once upon a time, the database gurus designed the database schemas, and they were in charge of data modelling, as well as transactions and reports. Then came 3-tier systems, and the object-oriented code gurus insisted that their object models were the real data models, while the database was just a place where objects could be parked overnight. Now your XML gurus will tell you that the XML defines the data model, and that object models and database schemas are just necessary evils whose task is to support the needs of the XML .

There is a need for tools that make it easier to integrate these data models without any of the three (database, object, XML ) looking like an awkward mechanical creation. These tools need to be multi-directional, because you can never be sure which of the data models will be the most appropriate one to modify directly, but once you do change one, you need to be able to propagate the changes to the other data models. There is a need for harmony between how you store your information in a database, how you serialise it for transmission using XML , and how you represent it as objects in memory.

Remember too that financial corporations have invested heavily in developing legacy financial models which tend to be implemented in "big iron" relational databases. These existing models are not going to go away quickly, because too much has been invested in them, so the easier it becomes for new XML formats (and their underlying data models) to be integrated with the legacy models, the easier it will be for those XML formats to get corporate acceptance.

Refer to Dave Carlson's talk from this conference for details of one technique for integrating UML and W3C XML Schema, which is a good start in this direction.

The Schema Dilemna

The use of XML for financial transactions is made more difficult at present by the differences between XML Schema processors. XML Schema is a natural choice for financial applications, because it provides strict datatyping that DTDs do not. When your XML documents represent transactions of millions or hundreds of millions of dollars, you do not want to take any chances with the interpretation of data types. However, as it now stands, a corporation can validate an XML message against an XML Schema with one validation engine and then send it, only to discover that the receiver rejected the message as invalid because the receiver's (different) validation engine found the message to be invalid against the same XML Schema. This is a major challenge for financial applications, where go/no-go decisions on correctness are preferred to "best effort" methods, but missing your chance to buy or sell can be disastrous. It is to be hoped that the W3C XML Schema Test Collection will help to sufficiently address this problem.

The Port 80 Legacy

The textual nature of XML , and its consequent raw size, can make it infeasible to deliver large amounts of financial information (and deliver it in a timely fashion) over the many lower bandwidth connections which exist even in industrialised countries. The world is still a long way from having the network capacity for on-demand digitial video at every desktop, and as a consequence the delivery of news and financial information in XML often requires compression (the best case), or the (expensive) development of compact binary transmission formats, one per schema, which can carry the same information more succinctly (the worst case). Bandwidth issues would have existed even without XML , because the number of trades reported daily from the world's markets is growing exponentially. The desire of end users to receive XML , however, is compounding the situation, and will continue to do so in the short to medium term. This means there is a need, and hence a market opportunity, for tools which can transparently squeeze the most XML through the available bandwidth.