There’s an old saying: If you love something, set it free. And Wall Street firms, in the midst of their love affair with alternative data, are rushing to liberate some of the datasets and technologies that financial firms have raised in captivity, to take advantage of commercial opportunities for these tools.

In particular, the growth of alt data is prompting a new wave of startup data and analytics providers specializing in specific content niches. However, one of the largest, ready-made sources of alternative datasets is financial firms, which over time have amassed massive proprietary data collections that would fall under this umbrella. Firms now see the value of the data assets they have in-house, and are increasingly seeking to commercialize these for wider use by clients and third parties. But once the commercial proposition is clear, these firms must make a choice: Do they want to get into the business of being a data vendor, with all the responsibilities that entails around sales and marketing, product development and maintenance, and client support—all of which may be a far cry from a firm’s core competencies—or would they rather push their hatchling from the nest and let it learn to fly solo?

In some cases, the decision to spin off a business comes from the realization that the product a firm originally developed in-house to solve an internal challenge has a much broader potential appeal among other firms in the same boat, and could become a money-spinner instead of just an internal cost center. Potential products need their own support structure to achieve profit. For example, Boise, Idaho-based asset manager Clearwater Advisors created a data aggregation, reconciliation and reporting platform to service its own client base, and in 2004, decided to spin it off as a separate company after seeing an influx of business from customers attracted by the platform itself.

In some cases, strategic separation is driven by an understanding that any service that handles other firms’ sensitive data needs to be segregated from its parent company, if that parent might compete in any way with the service’s potential clients. When Trillium Trading spun off the operation behind its Surveyor anti-spoofing trade monitoring platform, it decided to make a clean break even before offering the platform to others. “The primary driver [for creating a separate company] was that we have access to other firms’ trading data, and we needed to safeguard that,” says Michael Friedman, general counsel and chief compliance officer at Trillium Trading. “We correctly anticipated that it would be a concern for our customers. We can document our security procedures and safeguards … and with very few exceptions, that is sufficient.”

Pete Goddard, former founding CEO of options market-maker and hedge fund Walleye Trading and founding partner and CEO of time-series data platform Deephaven Data Labs, which spun off from Walleye at the start of 2017, also notes client concern about a spinoff vendor’s roots, but says this isn’t a deal-breaker. “Prospects very much want to talk through the separation and understand that we have their interests clearly in mind,” he says.

Divide and Conquer

In other cases, the decision is driven by the conclusion that a good product might wither and not evolve further if only fed one source of nutrient—i.e., if its development is based solely on the demands of one firm where it must compete for internal resources.

For example, around 2011, Walleye needed a single platform to support functions including research, algorithm development, and risk management. Finding nothing commercially available that met its needs, the firm built its own tool. 

By around 2015, the rise of Big Data in financial markets and other industries presented opportunities and Walleye realized it had a powerful and unique platform on its hands. 

“Maintaining a cutting-edge product with only internal customers, [i.e., for Walleye’s exclusive use], would be harder than with a group of hungry external customers feeding into its development,” Goddard says. “One of the things we had to convince Walleye of … was that Deephaven represents infrastructure, not alpha.”

And while the potential for broader feedback to improve a product is a key consideration, a close relationship with one firm helps bring products to market sooner, because the vendor side can back-test proposed improvements in-house instead of enlisting external clients for initial beta testing. When it’s time for client testing, the product is already more complete and polished, and time-to-market is shorter overall.

“It’s a plus in some cases. Some of our customers are frustrated by the lack of trading sophistication at vendors, so having a proprietary trading background is seen as an advantage because we can more easily understand their questions and concerns,” Friedman says.

And as importance as independence is, that financial background and association still pays dividends, Goddard says. “We focus our sales efforts and marketing on capital markets customers because we understand those use cases. It’s not just that we can speak to them, but that we’ve lived and breathed those issues ourselves for many years.”

While Deephaven has assembled a cadre of investors—individuals and institutions—including management and those who contributed capital, intellectual property, or elbow grease, and Trillium Labs is owned by the same holding company as its trading sibling, independent funding and private equity both play a role in companies’ ability to go it alone. And in some cases, companies have spun out of their parent organization only to be snapped up by another, and those who have experienced it say there are benefits to both models.

For example, in 2016, a dozen years after deciding to spin out of its parent, Clearwater was acquired by private equity firm Welsh, Carson, Anderson & Stowe. Justin Reed, director of product management at Clearwater Analytics, says the firm is helping the vendor to adopt better operating and management techniques.

“They bring their perspective, so some aspects of how we operate change, but our principles—where we’re going, how we approach research and development, etc.—are the same,” Reed says.

Different Strokes

Chicago-based equities, options and futures trading platform vendor Sterling Trading Tech has seen its fair share of different perspectives. Founded as Sterling Trader in 2000, the company was acquired in 2014 by Professional Trading Solutions, a holding company that also owned broker-dealer Lightspeed Trading. 

“The benefit of common ownership with Lightspeed was that it gave us better economies of scale, the resources to invest in infrastructure, and … broader management expertise with deeper levels of experience,” says Sterling president Jim Nevotti. “And it enabled us to do two other acquisitions in our space, and take platforms that were not profitable under their previous ownership structures and by bringing them under ours, we were able to operate them profitably.”

Then earlier this year, PTS sold the broker-dealer assets of Lightspeed to Lime Brokerage. Nevotti says that just as there were advantages to being part of a larger organization, there are also benefits to not being part of a company that also owns a trading firm. “We still have critical mass and economies of scale … but this gives us more freedom and eliminates brand confusion,” he says.

In addition, the shake-up fostered introspectiveness. “It forces you to reevaluate everything you do, to look at processes, and ask, ‘Are we doing things this way because it’s the best way to do things, or just because that’s the way we’ve always done it?’” Nevotti says. “When you grow, you have to continually improve and reinvent the company to support that growth.”

A key benefit of independence is that it removes conflicts—both internal and external: Internally, companies no longer have to make a choice between whether to invest in product or in their trading business, while potential clients will speak to an independent provider more frankly than they would to a competitor, Goddard says.

Indeed, some credit this independence with Thesys Group winning the deal to build and operate the Securities and Exchange Commission (SEC)-mandated Consolidated Audit Trail over larger competitors, where until the start of this year, it had also operated a high-frequency trading (HFT) business. Founded in 1999 as Tradeworx, the company separated its two lines of business in 2009, and sold the trading business in January. While officials downplay any direct correlation between the two, it seems unlikely that the SEC would have chosen a supplier so closely allied to an HFT firm.    

New York-based Quantitative Brokers, though legally an independent broker-dealer, is more technology provider than broker—and though its models and algorithms are used to support better trade execution, QB itself doesn’t execute trades. CEO Ralf Roth, who joined the firm last year after holding senior roles at IHS Markit, Thomson Reuters and Deutsche Bank, says the firm has seen so much interest in its Simulator pre-trade execution analytics tool that it might consider spinning it out as a standalone product line in future, compared to being reserved only for QB’s existing and prospective clients. 

But if anything, QB’s debate is not so much to spin off its tech arm, but whether the company should ever become a fully fledged broker or futures commission merchant (FCM). 

“There have been points in time when it has come up: Should we be an FCM or an executing broker? But it’s a short discussion: Clients value that we are not those things. We want to be in the business of quantitative research and helping our clients achieve best execution—and the best way we can do that is to be independent, because the minute we become a broker, we would no longer be independent … and we would be competing against the FCMs that we work with today,” Roth says.

Untangling Entaglements

When companies separate, there are logistical, legal and operational issues that must be ironed out—for example, whether a company moves into new offices completely separate from its former parent, or stays close (such as Clearwater, which took space in the same building, or Trillium Labs, which is just a door away from Trillium Trading), and which staff remain with the old company or are assigned to the new one.

“We are separate legal entities, but there is common ownership, and we share some resources,” such as administration, payroll and back-office clerical functions, says Trillium’s Friedman, who uniquely has a role within both companies. “Because of the nature of the software we sell to compliance officers, it benefits both sides that I play a role on both, and that we have someone who plays the same role in-house. It benefits our trading group that I understand firsthand what customers are going through … and that I’m available as a resource to those clients.”

Sterling’s Nevotti says the vendor had a number of resources that it shared with the Lightspeed broker-dealer business, including office space, and “some of the basic functions you need to run your business,” such as HR and accounting staff. “On a deeper technology level, we had been preparing for some time, so we had positioned Sterling Trading Tech to be a pure technology company… and where the broker-dealer needs resources, we now operate under a service-level agreement,” he adds.

Thesys was in the same boat of wanting to be a pure technology company, despite its predecessor Tradeworx leveraging its technology to become a high-frequency trading firm. In fact, in 2009, the company structured itself so that Thesys could function purely as a fintech provider. Therefore, when the company fully sold off its trading arm (now named Blueshift) to a private equity firm in January, the process was “relatively simple,” says Thesys COO Anshul Anand.

A key challenge when separating a technology company is extricating the technology itself. Often, a tool that grew up within a financial firm is not only heavily embedded within the firm’s workflow, but within its IT infrastructure, and separating the two in a way that leaves both functioning properly can seem like brain surgery.

“One of the hardest things was separating the technology dependency,” says Clearwater’s Reed. “We initially created some shared infrastructure, but it took a while to become as separate as we wanted to be. When we first separated, the advisory business was using a lot of Clearwater Analytics’ technology to run its business … so there were some things that took five or six years to fully untangle.”

Establishing an independent, unconflicted code base was an important consideration for Deephaven, too, Goddard says. “From a maintenance point of view, you don’t want a lot of legacy code hanging about in your code base … or any conflict of interest around competing firms using code from Walleye.”

Separation Anxiety

While Clearwater’s separation went smoothly from a legal and operational perspective, “having a better-defined technical separation at the beginning would have been better,” Reed says. “It would have given us a level of autonomy that would have allowed us to solve technical problems early on. If you can do this when you’re still relatively small, the pain of separation is less.”

As in many other cases where the former parent still licenses its offspring’s output, Clearwater Advisors still uses Clearwater Analytics’ technology, though now just as a client. But technical dependency can take a toll on a new vendor-client relationship, where before each party has been used to dealing with colleagues rather than customers.

“At first, it was business as usual. But there came a time—maybe a year or two after we split—where they were used to operating a certain way and making certain assumptions that they could no longer make. Then after that, we got into a good working relationship,” Reed says.

When it comes to that evolution of an internal business into serving external clients, Deephaven’s Goddard says an important lesson learned was the degree of change required to become a customer-facing organization. 

“It’s a product challenge and a cultural challenge. The skillset of facing external clients and providing external product support is different, and not to be taken lightly,” he says. “Hedge funds have investors, but not customers—so spinning out to become a company with customers involves more than just good technology. It needs marketing, sales support, evangelists. … You’re going to be working with a wider range of people than when you’re at a hedge fund or prop shop.”

In addition, vendors must be mindful of how their investors and customers expect them to behave. For example, “someone who is invested in a hedge fund may not want you to spend their money on building a technology business,” says Thesys’ Anand. 

What’s in a Name?

As with any new company, the right branding can be critical to success. But with spinoffs, branding has an additional layer of complexity: the spinoff may want to emphasize or minimize the association with its parent, and may not legally be allowed to keep any of its previous branding.

Like Trillium Labs, Clearwater Analytics kept its parent’s name prominent in its branding, though this decision was a “double-edged sword,” Reed says. “It meant there was immediate recognition, but we had to overcome the perception that we were still tied to the advisory business,” he says, adding that it took between six months and one year for the company to fully establish itself as a separate brand.

Deephaven originally spun out of Walleye as Illumon, calling its data platform Iris, but changed the name around six months ago to avoid any conflict with other similarly named companies or products. “We determined late … that Iris would be a more conflicted name than we envisaged, and that we might get cease-and-desist letters from other companies three years from now once we’ve built up the brand,” Goddard says

Network and cloud services provider CFN Services rebranded as Apcela—a name whose etymology conjures up images of apps, clouds, and even an express train, perhaps in an unconscious nod to its railroad parentage—in 2016 to reflect its new business model and end any legacy association with its former parent, rail freight operator CSX (CFN stood for CSX Fiber Networks). 

Though not a spin-out from a financial firm, Apcela’s evolution follows many of the same paths. CFN was originally created to leverage the opportunity of running fiber networks along CSX’s rail routes. Though surface freight transport had grown steadily through the 1970s to 1990s, much of that went to the trucking industry. So CSX diversified, using its routes to create a network for Sprint with Southern New England Telephone Co., then creating a database of fiber routes to map and optimize networks, dubbed FiberSource. When road freight transport reached saturation in the new millennium and rail freight began to grow again, CSX refocused on its rail business and spun off its infrastructure assets.

In a management buyout, CFN took the IP behind FiberSource, and became a boutique network optimization consultancy. CEO Mark Casey says the new vendor “stumbled into” the capital markets around 2007 when big proprietary trading firms enlisted it to find the fastest path for low-latency data between New York and Chicago. Yet, he says, the vendor would likely not have been able to take advantage of this new opportunity if it had still been owned by CSX. 

“If we hadn’t separated, we would have been a real estate-focused business. When we went beyond that scope, the railroad didn’t really appreciate the risks. The railroad would never have bought into us building a low-latency network between New York and Chicago. … They weren’t interested in becoming a service provider,” he says.

Equally, CSX would have been unlikely to support the vendor’s next transition from low-latency into the broader cloud services field, and from a sub-set of the most latency-sensitive capital markets firms into broader, non-financial enterprise clients, even though “the way you manage [cloud] performance is the same way you manage latency in the capital markets,” thus representing a logical next step.

CSX’s journey well illustrates the challenge facing financial firms with fledgling data and technology assets: Spin them off, and they may surpass their parent faster than a runaway train; keep them in-house, and they are subject to the whims and fluctuations of the core business, and may hit the buffers when firms hit the brakes. But often, it seems, the best way for these assets to respond to the opportunities presented to them is to do so independently—and to become independent early and quickly.