In 1984, former Naval officer Peter Lambertus founded a technology company called Charles River Development (CRD). He’s remained with the vendor ever since as its president and CEO, and the firm has grown to become one of the top providers of front-office technology to the buy side.

Even as the order management system (OMS) space has undergone various periods of significant consolidation over the past 30 years, there were some in the industry who thought that CRD would stay independent because of its steady founder and the fact that it had a bedrock of large institutional clients that weren’t likely to jump ship simply to try a cheaper—perhaps slicker—option.

They were wrong.

Last week, it was announced that custody giant State Street would buy its Boston neighbor for an eye-popping $2.6 billion. In a statement, Lambertus said, “State Street is an ideal partner for us” and that the firm’s management is “excited about the opportunities ahead and what the combination of our two firms can do for the industry overall.”

Still, even if the sale itself wasn’t surprising, the valuation was.

“That is a lot of money that State Street paid. How the hell does Charles River go for that?” says one hedge fund chief information officer, who has used Charles River’s OMS. Others concurred, variously describing the amount that State Street agreed to pay for Charles River as “outlandish,” “unbelievable,” and that Lambertus had made out remarkably on what should have been a much lower valuation.

One bank CTO, for instance, while talking with editors at WatersTechnology two months ago about potential deals in the market, said that Charles River had “probably missed the boat” to sell the company at a premium. So when the news broke, the CTO was not surprised that Charles River was on the market; it was the price that stood out.

“I think [CRD] got a tremendous value for the company—probably double what I thought,” they say. “They were getting too big to stay independent, and they were on the verge of getting irrelevant without making some sort of big move.”

Quite how this price was agreed upon is still unclear, as is the ultimate reason for Charles River deciding to sell now, after weathering similar waves of consolidation in the third-party vendor space as a smaller company. A senior source at a US-based trading venue suggests that Charles River may have made the move as a result of inroads made by BlackRock, the world’s largest asset manager, which also controls a key piece of technology in the form of its Aladdin platform.

“The motivation, as far as I can see, is that BlackRock owns Aladdin and Aladdin has been gaining some traction,” says the executive. “Charles River is the largest OMS vendor for large asset managers, but they’ve been losing some share to Aladdin.”

I will tell you that [the Charles River platform] is very expensive, and it’s the massive banks and asset managers that are using Charles River—it’s so hard to switch out or decommission them, even when the cost makes sense.

CIO at a hedge fund

WatersTechnology spoke to over a dozen industry experts on the buy side, the sell side and in consulting roles to better understand what this merger means for users of Charles River and what the ripple effects might be for the OMS market as a whole. Some asked for anonymity in order to give their true thoughts. Charles River did not make executives available for interview in time for publication.

A Sticky Web

In order to understand the rationale behind the deal—if not its price tag—it’s important to understand the crucial position that CRD occupies in the buy-side technology ecosystem.

The Charles River Investment Management Solution (IMS)—its order and execution management system—is ubiquitous at the largest institutional asset managers and banks, hedge funds and wealth managers. It connects front-to-back, with solutions for the middle office, compliance and regulatory teams, portfolio managers and analytics units. The vendor also offers an investment book of record (IBOR) and a robust data service.

Essentially, it is a hulking, all-encompassing platform that is not easily replaced. It has extreme stickiness and delivers recurring revenue, two factors that have become critically important to any third-party technology supplier in today’s fintech-mad world, where disruption is the new normal.

This, sources say, is by design and not by accident. The former user of Charles River, who has subsequently switched over to Eze Software’s Eze OMS, says they felt that CRD’s model wasn’t necessarily focused on the software as much as it was interested in selling services that would “cater to big, complicated installs—places where software packages get implemented and then run for 20 to 30 years because they’re so difficult to rip out.”

“I will tell you that [the Charles River platform] is very expensive, and it’s the massive banks and asset managers that are using Charles River—it’s so hard to switch out or decommission them, even when the cost makes sense,” they say.

Cost estimates for subscriptions, installations, support, and maintenance are often closely guarded secrets in the world of traditional financial technology. But estimates garnered from users by WatersTechnology place the subscription cost for CRD at a hedge fund requiring compliance and with around a dozen seats, with roughly $10 billion in assets under management, at around $350,000 to $450,000 per year for a term license. Initial installation and integration costs could range between $500,000 and $1 million before a single trade is even processed.

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Such amounts are relative to the entity in question, sources say, but the price is still eye-watering. So why pay for it? Sources say a big reason for Charles Rivers’ success isn’t just its order and execution management capabilities, but also its compliance piece—the vendor first started out as a compliance engine and added the OMS piece later. Its compliance suite of services and consultants is extensive and suits firms with complex compliance needs, particularly buy-side firms that may have thousands of accounts, all with different mandates, investment criteria and compliance considerations to account for.

“[Charles River’s] compliance module is probably the best in the industry,” says the CIO, a point backed up by Stan Moss, CEO of Polen Capital, whose firm took on a Charles River implementation as part of its wider technology transformation.

“One of the large benefits is from a risk management perspective,” Moss told Waters for a profile featuring Polen published in 2017. “In our OMS we have thousands of accounts, and those accounts have a variety of restrictions. Charles River is the leading technology in this area, and that implementation has helped us very efficiently handle our existing restrictions—and even those that we wouldn’t have been able to handle in the past. We can take on an account that has more complicated restrictions, whereas in the past, maybe we could not.”

Yet Charles River implementations often take more customization, whereas a solution like the Eze OMS, for example, is more easily installed right out of the box. Again, this points to CRD’s stickiness, sources say, and its ability to justify its cost.

Despite its dominance in the front office of buy-side firms, however, there have been rumblings that many have not been entirely pleased with the system. Several sources note that CRD has perhaps been slower to innovate than its competitors—yes, it is customizable, but actual rollouts with significant, bespoke enhancements that are easily installed are limited. And if Lambertus had an idea that he was going to sell in the near future, says the bank CTO, then that would have perhaps prevented the vendor from going down riskier innovation roads.

One CEO of a specialist software company, whose solutions connect into OMSs, says that its buy-side clients have found that innovation in the OMS space—and this extends beyond Charles River to the other major players, including Fidessa, Thomson Reuters, and Bloomberg—is “super slow” and “the price is high.”

“These firms roll out new releases two to three times a year, and because of the pain and cost of upgrading, it’s often years—plural—before most of their customers have taken the upgrade. In a world where we’re used to mobile apps and websites getting updated multiple times a month, that’s an absolute snail’s pace,” says the CEO. “Switching costs to another vendor are so high that a lot of people stick with the incumbent no matter what. It makes for a nice cash cow business for the vendor, though.”

It’s important to remember that this isn’t just a bank or a custodian acquiring an OMS; this is a much bigger deal than that.

Rob Hegarty, Hegarty Group

From that perspective, it’s easy to see why CRD would be an attractive addition to a firm with deep pockets, the ability and resources to innovate where necessary, and a need to penetrate the front office of its existing client base, an area that has so far eluded it. That on its own wouldn’t justify the cost, however—hundreds of new client wins would be needed to make back the money on installs and subscriptions in any reasonable timeframe. Instead, it has to be part of a wider vision. The CEO also wonders whether or not State Street is looking to become something of a utility for the buy side.

“So many buy-side firms rely on CRD that it makes sense one would step in,” says the source. “That said, I’m curious as to whether State Street considered a consortium. In general, I think the big buy- and sell-side firms feel like some of these vendors—Bloomberg, most notably, but Ion, Thomson Reuters, and others—have too much power over them and aren’t delivering innovation fast enough. Not that an industry consortium fixes everything, but it feels like a reasonable solution to things that are not alpha-generating—individual algos might be, but OMS and market data, as a whole, isn’t.”

A Bigger State

As for State Street looking at more of a utility model, the hedge fund CIO says this could be a sign of banks looking to get back into this space since their large institutional asset and wealth managers are also clients of Charles River. Indeed, more than a few jokes were being passed around LinkedIn once the announcement of the acquisition went out, pondering whether State Street had looked at a bill from CRD and decided that it would be cheaper just to buy the company.

“The OMSs are sticky businesses and the banks know that,” says the CIO. “From the rest of the services that State Street offers, I can say that they seem to be more interested in offering commoditized services, rather than specialized services. State Street’s technology has always been a step or two behind, quite honestly. But that goes back to their mentality of offering more commoditized services and being more conservative. State Street is big—it’s like the post office.”

Others are a bit more perplexed by State Street’s move, to say the least.

“I have no idea what [State Street’s] motivation is,” says the trading venue CEO. “I do understand that it’s recurring revenue and that’s nice, but I don’t think it makes a blip in the overall State Street performance revenue number. I don’t believe that they will expand the customer base or increase revenues. So, I don’t think there are a lot of synergies. All of Charles River’s clients are already State Street’s clients—they already have the assets in custody. So I have no idea what the strategy is going to be to be able to leverage that—I just don’t get it.”

On a darker note, the trading venue CEO suggests, a bank buying an OMS provider “has never worked out for them” in the past. Lou Maiuri, head of State Street Global Exchange and State Street Global Markets, disagrees with this statement and points to several products that he believes State Street has successfully brought in-house over the years. “We have platforms today [such as] FX Connect, which is the second largest provider of FX liquidity in the world, we have FundConnect, we have Currenex. … We have these trading venues and platforms and EMSs that have been very much a part of our ecosystem and very prominent in the industry,” he says.

Maiuri says this addition will allow State Street to better help customers manage a very challenging trading marketplace by creating a more powerful front-to-back experience for users.

“Whether it’s active to passive shifts, the cost of regulation, their transparency needs, [the fact that] it’s hard to generate alpha and be paid for it—there’s been a lot of pressure,” Maiuri says. “We [have] $11 trillion of assets under servicing. We’re onboarding this year alone an additional $7 trillion—it took us 15 years to get to $11 trillion, and we’re onboarding $7 trillion. That is an indicator to show you that the buy side is really trying to rationalize their costs and simplify their complexity.” 

There are those who say that if you want to remain competitive in today’s tough technology market, beyond innovation—which is important, but can be overrated if it comes at the detriment of the bottom line—scale matters.

Being able to offer expansive services to the buy side is paramount, says Rob Hegarty, managing partner at consultancy Hegarty Group. In addition to being the former global head of US equities at Thomson Reuters, Hegarty, who is also based in Boston, has worked with both State Street and Charles River in various functions in the past.

“It’s important to remember that this isn’t just a bank or a custodian acquiring an OMS; this is a much bigger deal than that because this is a large-scale, full-service asset servicer acquiring an integrated asset management platform,” he says. “To even put CRD in the OMS-only bracket isn’t fair. I think many people know it’s bigger than that but it’s been getting characterized as a bank buying an OMS and this is not that.”

Hegarty says this is a big bet being placed by State Street, wagering that value creation on the buy side is going to occur in the front office over the next five to 10 years. He says that if you look at the traditional custody businesses of State Street, JPMorgan, Citi, Northern Trust, Brown Brothers Harriman and the like, custody has become highly commoditized, ironically thanks to the efficiencies that these very institutions have brought, and it’s tough to create real value. The front office, though, is not commoditized, and won’t be for some time.

“This is State Street placing a big bet and saying that the value creation for their clients, the buy side, is really going to be in the front office,” he says. “And that market has kind of been underserved.”

John Adam, senior director of portfolio management and trading solutions at FactSet, says, “Institutional investors expect their solution providers to support an increasingly complex and nuanced portfolio lifecycle with automation, integration, and transparency across the front, middle, and back office. We believe State Street’s acquisition of Charles River Development carries on this path,” he says.

In his interview with WatersTechnology, Maiuri seemed to agree with these sentiments about being able to offer scale across the bank. 

“We want to go front-to-back in our own infrastructure,” Maiuri says. “Today, there’s a lot of infrastructure and inefficiencies in the market structure because of the way that things grew up. Every bank has this problem; this is not a State Street idiosyncratic thing, it’s an industry thing. But now that we have a full stack of software, a full stack of data—take security master data; there are no standards in the industry—we can tell clients that are using our full platform that if they use our security masters, they’ll go straight through. We can have intraday net asset values (NAVs), we can give them better cash availability, we can give them cleaner data faster, and provide insights around that data. Our goal is to help the buy side transform the way they work. It’s going to transform the way we work at State Street to make us more efficient, and we’re credible today with our platforms and venues and we want to play that same ground game with a much bigger, prominent provider with Charles River.” 

Additional reporting by James Rundle, Josephine Gallagher and Emilia David.

Update 07/27 : This story has been updated to include comment from State Street.