Strategic partnerships pave the way for capital markets innovation

Capital markets organizations are increasingly adopting strategic partnerships so they can fulfill customers’ growing demands for more niche investment products, instantaneous services and around-the-clock market access. Exchanges, clearinghouses and broker-dealers are entering into partnerships to support 24-hour trading, access to private company shares and digital asset exchange-traded funds (ETFs), among other services.

Strategic partnerships are expected to increase as capital markets organizations ramp up investment in artificial intelligence for improvements in both client service and operations. Outsourced technical resources, cloud infrastructure and computing power are essential to develop effective AI models.

Although third-party partnerships enable exchanges, clearinghouses and broker-dealers to quickly meet customer demands without having to build out highly technical solutions from scratch, reliance on third parties increases operational, geopolitical and reputational risks. Organizations must consider and address these issues through a robust third-party risk management program.

Customer demand drives partnerships

Recent reports from public companies reflect the trend so far; capital markets organizations’ earnings calls from the second quarter of 2024 show increased demand for niche products is a major driver for organizations to look to outsourcing and partnerships.

The initial public offering market has been slow in 2024 and is expected to remain so through the end of the year, compared to the boom of 2020 and 2021. As such, we expect investors will continue to look to private markets as an alternative investment opportunity.

There are examples of strategic partnerships beyond the public markets, too. Nasdaq Private Market recently partnered with Pulley, a provider of capitalization table management software that enables private companies to manage and track investor equity and investor relations. With the Nasdaq Private Market partnership, companies using Pulley can also initiate and manage liquidity events. When a liquidity event occurs through Nasdaq Private Market, the private companies’ capitalization tables will update automatically. Nasdaq Private Market is positioned to capture more market share of private company liquidity events as more transactions between accredited investors and private companies will be completed through their platform due to the ease of market access for private companies via Pulley.

As we wrote earlier this year, retail investing is also growing, a trend continued from the pandemic. As retail investors mature in their investing capabilities and knowledge of the markets, they seek the ability to deploy their assets instantly, 24 hours a day, five days a week. Robinhood, a leading retail broker-dealer, uses Blue Ocean ATS to support 24-hour trading and address the challenges of continuous operation, such as regulatory compliance, scalability and global market accessibility. 

However, this partnership has not come without challenges. Robinhood has faced new operational risks when the Blue Ocean platform has malfunctioned, creating trade processing issues for users.

Along with around-the-clock services, more experienced retail investors are also seeking to add digital asset-based investments to their portfolios without investing directly in cryptocurrency, given the regulatory uncertainties associated with those digital assets. The number of digital asset-based ETFs launched continues to rise year over year, and is expected to continue growing as investors keep diversifying their portfolios.

Traditional asset managers and broker-dealers are looking to partner with digital asset organizations to offer crypto-based strategies and ETFs, without the need to hire and develop digital asset expertise internally. Historically, such roles have been difficult to fill, given digital assets are still relatively new to the financial services ecosystem.

Although these outsourcing arrangements allow organizations to tackle various milestones involved with launching a new product, it’s also paramount to address related risks, especially when using software developed by a third party. Many ransomware attacks are the result of vulnerabilities within third-party risk strategies, and RSM survey data shows opportunities for middle market companies to improve those controls.

Capital markets organizations must ensure they can meet specific security incident regulatory reporting requirements and that the platform or software is developed with strong cybersecurity protocols to avoid security vulnerabilities and incidents that could have both operational and reputational implications.

The role of technology infrastructure

When looking to capture future infrastructure-related cost efficiencies and system flexibility, exchanges, broker-dealers and clearinghouses are shifting from on-premises infrastructure to integrated cloud solutions like Google Cloud Platform, Microsoft Azure and Amazon Web Services. In fact, 41% of trading desks are focusing on migrating internal data to the cloud and making applications cloud-compatible, according to Bloomberg, highlighting that this shift is a key element of most strategic roadmaps. 

Shifting to cloud-based platforms also simplifies compliance monitoring for ongoing regulatory requirements, which is important given the stringent regulations exchanges, clearinghouses, and broker-dealers face. Though cloud platforms can ease the burden of compliance monitoring, the shift does not come without risk. Organizations using cloud solutions must ensure the technology is properly secured and governed to prevent breaches and potential operational disruptions. Sound access management and vulnerability management processes are foundational.

Partnerships to implement AI

Lastly, as exchanges, clearinghouses, and broker-dealers aim to implement artificial intelligence to enhance client service and operational efficiency, they may look to partners to deploy this new technology. To deploy AI effectively, they need to hire data scientists and AI prompt engineers—both highly sought after.

Demand for data scientists is projected to grow 36% from 2023 to 2033, compared to 4% average growth for all other occupations, according to the U.S. Bureau of Labor Statistics. The crop of workers with AI expertise and experience is extremely limited, even as demand for these skills grows rapidly. Other sectors are also turning to data analytics, AI and automation to enhance decision making, further increasing hiring competition for skilled candidates.

As a result, organizations may turn to third-party providers to fill gaps in talent and expertise for AI deployment. Building large language models from open source can be cumbersome and costly in terms of computing power. Though working with a third party can supplement AI expertise, ensuring investor privacy is an emerging risk. Organizations must understand a third party’s usage, handling and storage of potentially sensitive data to avoid reputational risks associated with improper data handling.

Middle market implications

Middle market companies in particular can benefit from third-party partnerships to stay competitive and efficient in product offerings and delivery strategies. Middle market organizations, when compared to their upstream counterparts, are often more resource constrained, which further increases the importance of relying on partnerships for support and to keep up with the speed and technical nature of investor demands.