The exponential growth of the sharing economy has demonstrated the powerful impact of the network effect. Justin Klug, president of Capitolis, believes the network effect will come into play in the future of financial resource optimization.

The fintech was launched in 2017 to help financial firms use their capital more efficiently with minimal friction which results in more liquidity, lower risk and higher returns for the whole industry.

Capitolis enables banks, hedge funds and asset managers to optimize their financial resources by freeing up balance sheet and capital, enabling firms to both efficiently manage and increase capital markets activity through Capitolis’ proprietary technology platform and network. Capitolis allows firms to see where capital is being consumed, identifies what can be optimised across its network and automates this process. For example, financial institutions can eliminate large and unnecessary positions and then find the most suitable party in the network to hold the remaining positions. The platform also helps institutions facilitate new position creation by uniting capital providers with capital users in unique ways.

Capital optimization is currently a painful process for financial institutions as it is often bespoke, infrequent, and usually involves the same set of players, leaving vast parts of a financial institution’s business in sub-optimal states. Capitolis removes friction through its use of technology and diverse network. The firm aims to help the financial industry eventually move towards continuous optimization, so it becomes as ubiquitous as hedging across capital markets.

“If you achieve a system where everybody is optimizing everything with everyone all the time there is more access, liquidity and flexibility,” Klug said. “In order to get that done, you need a network, data and analytics, and low friction. That is what we have built and are continuing to enhance.”

Efficient use of capital is even more topical as SA-CCR, the Basel Committee on Banking Supervision’s standardized approach for measuring counterparty credit risk, is implemented in the US this year.  This changes the industrial logic for many market participants and shines a light on how critical capital optimization can be.

Gil Mandelzis, founder and chief executive of Capitolis, continued that the end goal of financial resource optimization is that the capital implications of all relationships, transactions and instruments will be fully taken into account and optimized to the benefit of all participants, which requires collaboration across a network.

“Through collaborative models, people will be able to optimize in real time, but also partner with the cheapest sources of capital that are out there for every relationship that they have,” added Mandelzis.

For example, institutional FX trading firms are increasingly looking to lighten their balance sheets via capital optimization, as trades can be open for weeks, months, or years. The right technology and network creates an opportunity for a trade position to be offset by a reciprocal position on the books of another market participant.

Mandelzis said the continuous, on-demand, customized optimization market is in its infancy but has tremendous potential. Beyond advancing the technology that enables optimization, the financial industry needs to change its mindset on what is possible to optimize.

“We created a funding business that bridged two markets that couldn’t previously see each other,” noted Klug. “When you create new market connections in ways that work for all sides, then you are creating a step change in the ability to optimize for the benefit of all participants.”

As more bridges are built between different parts of the market this will result in more access, and more liquidity, as participants will have freed up more capital that allows them to transact.

Klug said: “It can also mean lower levels of total risk, more dispersion of that risk and better risk-adjusted returns. Business will be able to grow because risk is distributed more appropriately, and capital is optimized continuously.”

More and better data is also critical for more optimization.

Mandelzis added: “Many participants are currently flying blind, so we are already making the more data accessible and providing analytics.”

Klug compared the potential growth in electronic optimization to the past and still ongoing expansion of electronic trading. The increase in electronic volumes across asset classes, including fixed income, has highlighted the benefits such as increased efficiency, transparency, and lower costs.

“You can certainly imagine a tipping point where the ability to access and execute optimization opportunities becomes so compelling that everyone will do it, all the time with everyone else,” said Klug. “If the industry gets this right, this ‘friendly disruption’ will allow it to operate with lower and more dispersed risk, higher returns and improved capital distribution.”