Last week, interdealer brokerage firm Tullett Prebon announced it had entered into an acquisition agreement for an undisclosed amount with derivatives valuation services provider OTC Valuations (commonly known as OTC Val). Paul Humphrey, CEO of Tullett Prebon’s Electronic Broking and Information division, explains to Reference Data Review that the acquisition is all part of the firm’s drive to service the complex end of the valuations market.
The two firms have been discussing the acquisition for over a year, according to Humphrey, and Tullett’s interest in the space was prompted by what he calls “significant” demand for its data suite from a range of valuations companies over the last two years. “We have seen marked growth in both the quantity and breadth of data that is being consumed by valuation service providers,” he elaborates.
In order to provide more transparency around pricing, all the players in the valuations space have been forced to invest in this data, including both vendors and market participants. Clients are asking for more data and validation to prove that pricing models, for fair value at the complex end of the spectrum especially, are accurate. Dual sourcing and even triple sourcing of data has therefore become commonplace across the industry.
The decision, then, for a data provider and a service provider to team together to boost their overall offering is not unusual. There have been a whole host of partnership agreements signed to this end over the last two years months and these will likely continue to occur for some time to come.
For its part, Tullett Prebon certainly had a plethora of choice in terms of valuation service providers on the market. According to Humphrey, the firm conducted a survey of the providers and noted the trend for these to be either very large (valuations services offered by large players such as Thomson Reuters for example) or fairly small, niche operations. Tullett Prebon offers its data to most of these firms: “All of these companies require quality data. Small niche providers are no exception however they lack the resources to purchase it. They are also faced with the dilemma that when they go to sell their services, often to risk departments, the fact that they are small is a risk in itself. When the risk departments chose a provider they want one that is sustainable and these small companies often fall foul of that judgement because of their size.”
What they lack in resources and scale, however, they often make up for in expertise, notes Humphrey, and this is what attracted the firm to OTC Val. Tullett’s evaluation of the firm indicated its mathematical modelling and software capabilities at the complex end of the instrument spectrum. Moreover, although it has a strong focus on the valuation of illiquid, hard-to-value OTC securities and exotic structured products, the vendor also provides vanilla instrument valuation services.
The vendor contends that the acquisition complements the skill set of Tullett Prebon’s market data business, Tullett Prebon Information, and reflects the increasing demand from its clients and the financial industry as a whole for independent valuation services. On the part of OTC Val, the attraction is simple, according to Humphrey: “Tullett Prebon certainly brings OTC Val global scale. We also have data so that we can enrich their product with the full data suite that we have. We have an existing customer base that we believe will see this as a value add for them. We can therefore add data and we can add clients. The three things needed for a valuations company are clients, high quality data and individuals that are very good at maths! Now we have all three.”
The brokerage and data firm is keen to get into the area of very hard to price exotic portfolios in particular because it feels that it is under-exploited in the valuations arena, he continues. “We think that between 80% and 90% of the valuation services that are required in the market are already well covered by the larger vendors. Where they typically fall down is when the products and portfolios are at the very niche end of the market, which is where we are going to aim this service,” he elaborates.
The firm is hoping to get a foot in the door by offering its complex instrument focused wares and then extend this to other areas, as requested by the client. Humphrey is confident this strategy will be successful: “What tends to happen is that if the hurdles have been overcome with regard to proving the value of your service, the client will say that you have done a good job and seek to extend the coverage to the more vanilla products. This then starts to cascade down. Once you have proved that you can deal with the top 5% of the exotics in their portfolios, often that results in you gaining a larger percentage of the client’s business.”
Humphrey feels Tullett’s strength is its cost effectiveness and the fact it is small enough to be very close to its clients and offer them a bespoke service, rather than the more unwieldy players on the market.
In terms of changes to OTC Val in the short term, the vendor’s management team will join that of Tullett’s Information business. “The management team at OTC Val will complement our data business team and a lot of their respective customers will be shared,” he says. “In terms of logistics, they are based in Vancouver but one of the executives will come across to be based in London and one will go to New York. The operational side will remain in Vancouver.”
This geographical relocation is another benefit of the acquisition, claims Humphrey: “One of the challenges they have faced as a small company based in Vancouver is that many of the clients they are targeting are in London, New York and continental Europe. This deal gives them presence in the locations where they are most likely to sell their products without the cost of expanding into new locations.”
The technology integration between the two firms is also expected to be minimal: “OTC Val has spent the first two years since 2007 in developing their technology internally and that is something that migrates very easily. The only integration that will be required is the integration of our data into their product and we have been supplying them with data for our due diligence. It will not be a heavy lift for us.”
The acquisition fits into Tullett’s wider strategy to expand its reach into the valuations and risk management space. “Across the organisation, on the electronic broking side we are looking at providing risk management services to our clients. We have recently launched something called TP Match, which is a matching algorithm platform where clients are able to upload their FRA portfolios and an algorithm matches them to mitigate their risk. We feel that this fits into that kind of service and that valuations adds into managing and mitigating risk,” he elaborates.
The vendor is therefore hoping to join other specialists in the risk and valuations corner of the market, including players such as Sophis, Reval, RiskVal and Fincad, to name just a few. To this end, Humphrey sees great potential in the valuations market in the short term: “From 2009 to 2012, the valuation industry as a whole is predicted to grow from US$2 billion to US$2.8 billion. We will target the largely untapped exotic market, which is approximately 20% of the valuation industry.”
He does accept that there will be consolidation but contends that it is very hard for any valuations company to be a one stop shop for everything. “We think that some of the larger providers will actually use our service for the areas where we are targeting our solution,” he adds. The next 12 months should indicate whether his hopes are realised.