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June 30, 2002

Saving Millions on Data

By Kent R. Lazarus

Trading desks at the big firms depend on high quality market data, timely delivery and the skills of in-house teams to maintain an orderly flow. In today's highly-competitive market, these are under intense pressure. Consider a few major issues:

* Data quality: Reliable data is the rocket fuel' of zero tolerance trading applications. As arbitrage competition intensifies, the benefit of incrementally better data is evident. A study sponsored by Reuters, TowerGroup and Capco noted that, on average, 30 percent of trades fail to settle due to erroneous reference data.

* Increasing data demands: Growing global market complexity is producing new trading opportunities for the arbitrage industry. Firms that can respond to these opportunities faster realize time to market' benefits. These firms gain critical competitive advantage in exploiting them.

* Staffing and budget: Wall Street is like other industries, determined to cut costs and improve staff management. In particular, personnel aren't directly involved with the core services of a firm are on the firing line. Data services groups are no exception. Most important, the fallout hurts trading desks that must wait for data. That's assuming it's available.

When trading services can still be provided by data teams that have had resources reduced - a scenario frequently characterized by long waits in a queue - too often the data is of dubious quality. This is risky and causes delays for traders.

A study by Celent Communications, sponsored by Iverson Financial Systems, suggests that outsourcing market data management to expert providers can produce a great return on investment.

Celent identifies three major categories of value that professional market data management - and especially data cleansing - can bring to the firms that either build or buy such services.

Firms equipped with the most accurate, reliable data enjoy distinct competitive advantages. Traders are exposed to additional arbitrage opportunities, can build more reliable trading applications, and gain precious timing advantages in creating and/or unwinding positions.

The benefits can be substantial. An average $60 billion trading operation focused on developed market indices, Celent noted, could realize a $12 million annual savings. That's if the superior data provided by an outsourced expert provider is used.

For a hedge fund systems trading portfolio of $10 billion - where this benefit would be even more crucial - the potential annual saving climbs to $50 million.

In the largest firms, trading huge positions with accelerating turnover, seemingly small reductions in data error/omission risk can provide multi-million dollar returns. Such risks include trading based on erroneous data, and the tracking error in basket trades and indexing performance.

Celent found a source of dramatic bottom line benefit. For an $80 billion proprietary trading operation, where data integrity processes reduce the risk of trading on erroneous or missing index data, the value can reach $8 million annually in loss avoidance.

Finally, firms can enjoy significant, virtually immediate, improvements in their cost structures through outsourcing to experienced, more efficient service providers.

This benefit accrues to the entire firm - and not only the trading desk - and can easily exceed $1 million annually. That's using conservative assumptions.

Celent uses two specific scenarios in considering the total impact of outsourcing market data management: A global index trading operation can expect a return on investment of about 700 percent over five years; a hedge fund systems trading operation can realize substantially better.

These scenarios make highly conservative assumptions about the price of the outsourcing alternative, as well as the level of incremental improvement in data quality realized. Actual returns are likely to be much higher.

Kent R. Lazarus is president and coo, Iverson Financial Systems, which is based in Sunnyvale, California.