Sample market feasibility approach and assessment for electronic trading platform in financial services industry

1. FrontLine Partners Viewpoint Series
Market Feasibility Approach Adjacent Markets
Examples of Work Conducted in the Trading Platform Market
Structured Finance Market Extension:
Approach to Build / Launch / Execute
www.frontlinepartners.net
Work Examples – Market Feasibility 1

2. Define the Market and Its Size
Defining trading markets requires an understanding of the market and its products
EXAMPLE MARKET SIZING
CAPITAL UNDER MANAGEMENT INVESTMENT BY INDUSTRY SECTOR
50 45.6
Computer
Software
40
32.3 15%
30 26.3 26.2 Internet Specific
24.9 39%
Communication
$BN
20.0 5%
20
14.0
5%
8.0 6% Consumer
10
2.3
20% Related
1.0
Medical and
0 Health
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Other
CAPITAL COMMITMENTS TO US VENTURE FUNDS RETURN ON EQUITY(1)(%)
40 25%
35.1 21.4% Average
20%
Return
30 16.1% 16.7% (17.4%)
15%
ROE (%)
18.7
$BN
20
10%
10.4
10 6.3
5.2 5%
3.3 3.8 4.0
0.6 1.0 0.3 1.2
0 0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1998 1999E Expansion and Seed and Early Stage Balanced Diversified
Mezzanine Fund Fund Funds
Work Examples – Market Feasibility 2

3. Define the Market and Its Products
Defining trading markets requires an understanding of the market and its products (cont.)
EXAMPLE PRODUCT DEFINITION
PRODUCT DEFINITION REVENUE POOL / MARGINS
• Venture capital is money provided by professionals who invest alongside management in young, rapidly growing • The venture capital market is similar to a mutual fund industry in terms of revenues:
companies that have the potential to develop into significant businesses. Venture capital is an important source of
» Main revenue is the potential increase in the value of the firm resulting in a return on the equity invested. This is
equity for start-up companies
normally realised through exit of the venture investment by means of a merger, acquisition or an initial public
• Professionally managed venture capital firms generally are private partnerships or closely-held corporations funded offering (IPO)/private placement
by private and public pension funds, endowment funds, foundations, corporations, wealthy individuals, foreign
» In addition, as an investment manager, the general partner will typically charge a management fee to cover the
investors, and the venture capitalists themselves
costs of managing the committed capital, usually 2-3% per annum of the capital raised
• Venture capitalists generally:
• The 10 year average return on equity for venture capital investments are around 17.4%
» Finance new and rapidly growing companies
» The seed and early stage funds return 21.4%
» Purchase equity securities
» Expansion and Mezzanine funds showed a return of 16.1%
» Participate in Management and Leveraged Buyouts (LBO & MBO)
• The European average return is 11.6%
» Assist in the development of new products or services
» Add value to the company through active participation
» Take higher risks with the expectation of higher rewards
MARKET SIZE, GROWTH, MIX MAJOR PLAYERS
• Venture capital investing has grown from a small investment pool in the 1960s and early 1970s to a mainstream asset • The four major types of players in this market are:
class that is a viable and significant part of the institutional and corporate investment portfolio
» Government Departments: usually in the form of loan guarantee schemes (e.g. SBIC program in the US) and tax
» Venture capitalists invested over $13 billion in about 2500 companies in the United States alone (approx. $5.4M per incentives (e.g. Venture Capital Trust in the UK)
company)
» Venture Capital professionals: Also called ‘fund managers’ or ‘general partners’. Usually manage investment
» Capital under management in the U.S. is around $45.6B by more than 3,000 professional venture capital providers schemes; typically raise “closed end” investment funds from institutional investors such as private and public
pension funds, endowments, corporations, high net worth individuals, and wealthy families. Some venture capital
» New funds raised by venture capitalist rose sharply from $3.1BN (1992) to $18.7BN (1998)
professionals manage ‘open-end’ funds that increase in size as they invest in companies
• Venture capital volume is concentrated in the U.S. market with Europe and Asia growing quickly
» Incubators: provide services aimed to help companies in their professional image projection and provide
» High appetite for risk and an entrepreneurial culture results in a strong need for start up capital in the US orchestrated access to critical business support
» The European and Asian markets are less developed than the U.S., although growing rapidly » Investors: Also called ‘limited partners’; provide capital; typically private sector venture capitalists, private investors,
pension funds, insurance companies and banks
• The main drivers of growth comes from Internet start-ups and technology companies that have sprung up to take
advantage of the paradigm shift in retail and corporate commerce » Venture Capital Associations: Help fund start-ups and encourage venture investment (e.g. British Venture Capital
Association
» Internet specific investment accounted for 39% of new capital raised in 3Q 1999
» Computer software related investments accounted for 15% of capital raised in 3Q 1999
Work Examples – Market Feasibility 3

4. Example Trading Activity Chain
Once the market is sized, FrontLine Partners works to understand the trading environment and
analyze how things work in the industry/market
TRADING/
RISK ORDER RELATIONSHIP
Value Chain OPERATIONS POSITION RESEARCH SALES
MANAGEMENT EXECUTION MANAGEMENT
MANAGEMENT
Key • Confirmation • Exposure limit • Trader position • Principal trade • Data collection • Price quotation • Account
Processes • Transaction setting/ monitoring (risk taking) or and analysis • Order planning
settlement monitoring agency trade • Periodic
• Hedging • Packaging management
• Fees processing (executed on discussions of
• Credit risk limit • Proprietary • Delivery • Advice to clients
exchange or needs
• Feed to books, management trading OTC) on current • Introduction of
records and G/L and monitoring trends research
• Reconciliation
• Regulatory analysts and
• Custody reporting product
• Information specialists as
management needed
Sell Side: GS, ML, JP, MS, SSB
Pure market
maker:
Knight/Trimark
Custodian: State Specialist
Risk Management
Street, Bankers Pure agency research
solution providers:
Trust, Chase broker: ECNs companies:
Reuters, BARRA,
Manhattan Princeton
SunGard
Economics
Sources of
Value to 1 0 0 3 2 1 1
Customer
Sources of Cost 4 1 1 3 2 3 1
to Supplier
4 Greatest source of 0 Least source(s) of Areas under change due
Industry utility
value, cost value, cost to market trends
Work Examples – Market Feasibility 4

5. Market Overview Framework for Valuing Markets
Next we translate the activity chain into pools of value and analyze each one for total market and
percentage of value in the process
EXAMPLE OF ANALYSIS ON PRIMARY POOLS OF VALUE
Fund Portfolio
Custody Execution Distribution
Admin Management
Total Value
Captured (2) 29 bp $34.0 5 bp $6.0 7 bp $8.5 35 bp $41.0 2 bp $2.4 78 bp $91.9
As % of total 37% 7% 9% 44% 3% 100%
• Fund administrators • Custodians • Broker/dealers • Fund managers • Pension Consultants
• Fund managers (i.e., direct
Key
sales)
Intermediaries
• Fees paid by plan • Securities borrowing / • Commissions and spread • Management fees paid • Fees paid by plan sponsors
sponsors on services lending fees (off P/L) earned paid by fund managers (off by plan sponsors based on amount invested
performed (e.g., by custodians P/L), incurred directly by plan
Value Capture
customized report sponsors as lower AUM
Mechanism generation) -- bundled
• Fees on AUM paid by fund
managers (off P/L), incurred
together with
directly by plan sponsors
management fees
Growth Rates
• Increased value • Commoditization of services • Increasing competition for • Greater performance • Increased demand for
attributed to fund leading to margin buy side wallet leading to accountability, enhanced personalization Fastest growing
administration services compression pressure on spreads and premium placed on good
by end customers commissions performance
• Growing power of pension Slowest growing
• Increasingly used as a loss consulting services
Trends • Proliferation of services leader for fund administration • Disintermediation of • Globalization
required (e.g., account services broker/dealers’ electronic
• Proliferation of fund types
aggregation) dealing platforms & crossing
networks
Work Examples – Market Feasibility 5

6. Finding the Underlying Value Points
Then we go one step future and figure out where the underlying value is in the market place
SECONDARY POOLS OF VALUE
Fund Transaction Portfolio Sales &
Custody Execution Risk Research
Admin Processing Management Marketing
55% 4% 19% 19% 12% 9% 13% 50% 50%
Institutional
Fund Mgr 0.5 0.6 2.0
2.0 0.8
0.8 1.1 5.2 1.7 4.3
4.3 17.9
Costs (2)
0.4 bp 0.5 bp 1.7 bp 0.7 bp 0.9 bp 4.4 bp 1.4 bp 3.6 bp 15.2 bp
36% 7% 39% 29% 7% 23% 37% 19% 50%
Retail Fund
Mgr Costs 14.0
14.0 0.3 5.2
5.2 1.1
1.1 3.4 8.4
8.4 2.3
2.3 20.9 59.7
13.7 bp 0.3 bp 5.1 bp 1.1 bp 3.4 bp 8.2 bp 2.2 bp 20.5 bp 58.5 bp
Available to
Service 2.0 2.0 2.0 1.0 3.5 5.0 1.0 16.5
Providers
Growth Rates
• Consolidation of
• STP - need for bundled back office solutions • STP • Regulatory shift • Increasing • Information
Key Trends / wealth mgmt tools
towards more sophistica-tion of overload
• Shift from batch processing to real-time messaging • T+1
Drivers disclosure and portfolio analytics
• Pressure on soft
• More demand for
• Need for customer data aggregation • Globalization new reporting personali-zation
• Increasing dollar
and deregulation requirements
complexity of arrangement • Greater
• Diffusion of manufact-uring performance
market liquidity accountability
% CAGR (Yr 1-Yr 3)
Pressure points: Activity Growth > Average Growth Fastest growing Slowest growing
$ bn Total cost in $bn
bp Costs per AUM
Work Examples – Market Feasibility 6

7. Figuring Out How the Industry Works
Knowing the key value points of an industry is only useful once it is applied to the primary
market interactions – this is where value is determined for a trading system
EXAMPLE TRADING MARKET INTERACTION ANALYSIS
Prime LEGEND
broker
Role Description on facing page
Ex.
ECN Stock Repo
broker OTC
loan Transactional
Type of
Informational
Interaction
Administrative
Info.
prov.
Research
Number of
players in
role
1-2 3-10 11-100 101-1000 >1000
Monthly or less
Frequency
Weekly
of
Daily
Interaction
Hourly
Acct. Admin Mkt. Hedge
fund Flow of One way
information
Two way
One-to-one
Investors Nature of
One-to-many
interaction
Many-to-many
Work Examples – Market Feasibility 7

8. Understand the Key Market Players
We believe the best way to source deal flow is through other internal trading and execution
platforms that is why we spend the time to get to know the market players
SERVICE PROVIDERS BY TYPE
VALUE CHAIN
ACTIVITIES
Research,
Fund Transaction Portfolio Sales &
Custody Execution Content &
Administration Processing Management Marketing
Analytics
Back Office Systems Order Mgmt
eCRM
Risk
Management
PROVIDERS
Prime Brokers
ECNs / Trading Ratings
Communities Portfolio Mgmt, Analytics Groups
Custodians / Fund & Decision Support
Administration
STP Enabler Knowledge Infomediaries/
Portfolio Aggregator Communities
Accounting Middleware / Messaging /
Data Distribution
Market Data &
News Vendors End-customer
Transaction empowering
Cost Analysis direct marketers
Artificial Intelligence
Systems Account
Aggregators
Functionality can overlap e.g., modeling capabilities
Closely related, enable straight through processing
in back office functions Note: Full service provider solutions and internally-developed
solutions can range across the entire activity chain
Work Examples – Market Feasibility 8

9. Know the Trader/Customer
FrontLine Partners knows that traders are creatures of habit and like proven methods, we go
beyond the market and get in the heads of the user
Trader Productivity
Drivers of Trader Productivity
• User-friendly, intelligent deal entry interfaces
Valuating market
System » Contracts with up to 50 fields routinely captured in 30-
information (e.g., price,
Performance 60 seconds; most trades entered within 10-15 minutes
supply/demand)
17%
27%
» Automatic data entry for logistics details
• Single data entry and integrated front and middle
Create reports (e.g.,
P&L, VAR, Curves) office systems to reduce manual reconciliation
Set trading strategy
13% 21%
• Credible system-generated reports on as-needed
basis
Deal workflow
management (e.g.
logistics, • Web exchanges to reduce broker chit-chat and
modification) facilitate digital data flow
12% Execute
deal
10%
Inefficient
Trader Time
Work Examples – Market Feasibility 9

10. Value the Important Functions
Electronic trading platforms need to address the critical market components to enable liquidity
SAMPLE TRADING PLATFORM HEATMAP
Pre-Trade Work Flow Post-Trade Work Flow
Credit Information Risk Middle
Assessment Provision Pricing Trading Logistics Valuation Management Office
Products Instrument
Short Term
Forwards
Long Term
Financial Swaps
Exchange
Futures
OTC
Straddle
Spread
Options
Asian
Put/Call
Metals
Com- Coal
modity
Oil/Gas
Non- Com- Weather/
modity Temperature
Processing
Impact Minimum Maximum
Work Examples – Market Feasibility 10

11. Build the Business Case
Finally, FrontLine Partners takes the industry and trader specific knowledge and builds a
business case to provide our clients with recommendations and direction
SUMMARY BUSINESS ASSESSMENT
Estimate of financial value creation Score along value creation dimensions
Community
Community
Value attribution Potential Financial Feasibility, Sustain- Member- value score
Source of value
methodology value ($m) value immediacy ability ship
Block trade Lower transaction Potential savings to institutional
A facilitator costs; lower search investors in market impact(2) 650 3 4 2 3 3
costs
Research quality Higher confidence Maximum earnings associated with
B aggregator research ratings business of <40 1 4 4 3 3
Institutional Investor Magazine(3)
Institutional sales Better information; Commission part of sell-side
C communities personal relationship revenues associated with trades 15,000 4 4 2 2 3
executed for institutional investors(4)
Middle office / Lower transaction Total sell-side clearance
D back office costs expenditures(5) 1,200 4 4 4 3 4
Execution Lower transaction and Total revenues of ECNs,
E communities search costs exchanges, and IDBs(6) 4,200 4 4 4 3 4
Sector trading Better information; new Total industry revenues in sector
F information trade ideas trading information(7) <100 1 4 4 3 3
Work Examples – Market Feasibility 11

12. Build the Business Case
Finally, FrontLine Partners takes the industry and trader specific knowledge and builds a
business case to provide our clients with recommendations and direction
SCORE
VALUE CATEGORY DESCRIPTION POOR (1) FAIR (2) GOOD (3) EXCELLENT (4)
Financial value The total potential annual revenue < $100 million $100m-$500m $500m - $1 billion > $1 billion
creation associated with the activity
underlying the community
Feasibility & How feasible is the community in Serious obstacles Obstacles can be No current Demonstrable need
Immediacy the near term (e.g. due to mean currently overcome obstacles
regulation, technology, market unfeasible
dynamics
Sustainability The number of years the Trends already Value likely to Supported by Aligned with long
community is likely to retain the undermining value sustain for 2-3 current trends: term industry
majority of its value potential within 1 year years 3-5 years trends: > 5 years
(including momentum)
Membership Number of member organisations - Small: < 50 Medium: 50-1,000 Large: > 1,000 N/a
a broad membership increases
exposure
Value creation score Total of the above scores, <8 8-11 12-14 15-16
expressed on a scale of 1-4
Work Examples – Market Feasibility 12

13. FrontLine Partners Overview
FrontLine Partners (www.frontlinepartners.net) is a management consulting firm that works
with banks, institutional investors, lenders, owners, intermediaries, and service providers in
the commercial real estate and financial services industry to help them accelerate growth of
their business or repositioning of their business model and assets.
FrontLine Partners offers a number of services ranging from strategy formation, corporate
and business development, mergers and acquisitions, capital sourcing, loan work-outs and
corporate restructuring. Refer to our website at www.frontlinepartners.net for additional
information.
For further information on your unique needs, please contact our Managing Partner - Jim
Vincent at 214.369.2085 – for a free initial consultation.
Work Examples – Market Feasibility 13