Derivative Function

SAN FRANCISCO (08/31/2000) - You may think the world of derivatives is too esoteric for a regular business. It's not. Say you're the treasurer of a construction equipment distributor. A Russian company wants $5 million worth of dump trucks, but it can pay you only in rubles. You fear the ruble will drop by the time payment goes through, so as insurance, you place a complex bet, called a currency swap. To execute this swap, your bank finds a counterparty who is willing to bet that the value of the ruble will rise. If it does, the counterparty keeps the difference; if not, it covers your loss.

A useful service, but there's another risk. If you are too right and the ruble totally collapses, your counterparty could go belly up, leaving you unprotected. The September 1998 collapse of the ruble left many organizations in such a predicament.

If these organizations had signed on with Cygnifi, they could have anticipated the collapse and taken protective action.

Cygnifi is an application service provider that provides information on pricing and risk for organizations that trade derivatives like the currency swap mentioned above. Its clients, midsize banks and corporations that do a limited derivatives business, pay a monthly fee based on the size and complexity of their portfolio and the frequency of system use. But can Cygnifi become a significant company?

To break down its business model, we must first define it, then apply the four tests from my previous article: Does its industry have economic bargaining power? Does its strategy offer customers a closed-loop solution? Does its management have integrity and adaptability? Does it have a compelling brand family?

THE INDUSTRY

The global derivatives market totals $80 trillion annually, according to the International Swaps and Derivatives Association. The capital at stake makes accurate analysis of derivatives valuable to market participants - endowing derivatives information providers with economic bargaining power.

Cygnifi's chairman and CEO, Jay Helvey, says that only the largest players can afford the millions needed to build derivatives information systems (spent on hardware, software, quant jocks, analytical apps and consulting to integrate the system with trading operations). A reasonable estimate would be that roughly 20,000 midsize banks, hedge funds, asset managers and corporations will rent access to derivatives ASPs. Assuming the average customer pays $10,000 per month, the derivatives ASP market could exceed $2.4 billion.

THE STRATEGY

Cygnifi offers information and analysis to create and manage derivatives portfolios. It "stress tests" the value of derivatives portfolios based on market factors (such as interest rates) and credit factors (like the balance sheet strength of counterparties). Simply put, Cygnifi offers better models than clients could build themselves, at a fraction of the cost.

THE MANAGEMENT

Cygnifi's management team is experienced in the derivatives information market. Jay Helvey was vice chairman of J.P. Morgan's risk committee and global head of derivative counterparty risk. Cygnifi President Vlad Torgovnik headed Morgan's derivatives information technology division. Moreover, J.P. Morgan has provided much of the technology used by Cygnifi and has a large stake in the company. It's betting that its equity in Cygnifi will be worth more than it can generate by keeping its models and technology to itself.

THE BRAND

Cygnifi's brand family is compelling. In addition to Morgan, Sybase, Gamma Investors and NumeriX (a derivatives analytics company), contributed to its $22.3 million first-round funding.

With its economic leverage, compelling value proposition and strong management, Cygnifi is poised to dominate the derivatives information market.

(Peter S. Cohan is a management consultant, an angel investor and the author of e-Profit, published by Amacom. He is not invested in the companies mentioned.)

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