Wednesday, January 10, 2007

Banker's patents: locking down financial innovation

You've heard of patents on inventions and intellectual property.

Now the financial industry is looking to march in step with the trend towards patenting ideas and innovations, as bankers get ready to seize control over newly created financial products and service methods with patent protection.

The Financial Times reports on a possible sea change in the financial and investment industries in "Banks lay traps for copycats".

Bankers have historically been highly aggressive in protecting their turf – and profits – but surprisingly bad at stopping rivals from copying ideas. While patents are a vital tool for, say, pharmaceutical companies, their use has not been widespread in finance.

As a result, whenever a bank produces a startling innovation, it is quickly copied elsewhere.
When ABN Amro, for example, came up with a product called a “constant proportion debt obligation” last summer, other banks replicated the scheme within days.

In recent years, however, attitudes to intellectual property have undergone a subtle shift, as banks and other financial companies have become much more active in filing patents, particularly in the US.

Okay, that's the good news. Here's the downside (there's always a downside, right?):

Banks now view intellectual property as an important operational risk, say lawyers. Investment banks and other financial services companies are actively building portfolios of business process patents.

Some in the financial world view this with dismay. Satyajit Das, a former trader who now works as a consultant, argues that the rise of financial patents could crush innovation.

“Just imagine if something such as Black-Scholes had been patented – it would never have circulated so widely, and [created] the whole options market,” he says. “Patents will just end up enriching the lawyers.”

Lawyers – perhaps unsurprisingly – dispute this. “If you have patents in industry, why shouldn’t you protect intellectual property in finance too?” asks a lawyer at a US bank.

I remember a story in Michael Lewis' Liar's Poker that revolved around the issue of financial innovation in investment banks.

Working at Solomon Brothers in the 1980s, Lewis and a colleague managed to invent an entirely new product for speculating on German bonds (the exact nature of the product eludes me now), an idea that was subsequently stolen by a more highly-placed co-worker.

At that time, the invention of a new financial instrument was enough to give the originating firm a head start in that market and bragging rights over other firms. Over time, competitors would imitate or build on the product, making it more widely available. A very free market kind of ideal.

Now it seems, the rush to patent everything under the sun has hit another industry. While not as egregious as the practice of patenting human genomes, etc., it is another leg in the boat for IP and the industry that has grown up around it.

Is this wise? Maybe someone with a first hand view of this field will provide further insight. In the meantime, see another interesting viewpoint in "Bastiat on patents and monopoly".