Financial Services

Many financial services companies develop proprietary software systems that qualify for the R&D tax credit. Given the rapid pace of technological advances, especially in service-related industries, software is viewed as a competitive advantage for financial services companies. Financial services companies no longer just buy software off-the-shelf. Almost all large financial services companies now employ their own software developers. Many firms including insurance companies, banks, trading companies, hedge funds, mortgage companies, investment companies and many more develop their own proprietary systems that may qualify for the R&D tax credit. In addition to proprietary software, financial services companies are often forced to integrate disparate legacy or third-party systems with new proprietary systems. The integration of these different technologies may also qualify for the credit. Financial services firms may also hire contractors to perform development activities that can also qualify for the R&D tax credit.

Qualified Research Activities for Financial Services Companies

  • Design and development of new software components
  • Design and development of Internal Use Software
  • Development of analysis tools
  • Developing data mining techniques
  • Development of financial or pricing models
  • Design and development of portfolio optimizers
  • Quantitative research tool development
  • Development of risk management systems
  • Researching and developing algorithmic trading systems
  • Developing simulators
  • Design and development of trading platforms
  • Block chain or cryptocurrency technologies
  • Development of monitoring systems
  • Developing gateways with exchanges
  • Developing market feed handlers
  • Reducing system latency
  • Developing market data systems
  • Insurance or agency systems development
  • Developing actuarial systems
  • Developing policy administration systems
  • Developing mortgage loan and administration systems
  • Integration of APIs and other technologies
  • Developing proprietary banking systems and user tools
  • Integrating disparate or legacy systems with new software
  • Real estate systems

R&D Case Study: Financial Services-Hedge Fund

Founded more than 15 years ago, this mid-sized hedge fund has become one of the most respected names in their industry. The company currently manages approximately $5 billion in assets primarily for pensions, endowments, and foundations. The company’s trading strategies span equities, fixed income, commodities, foreign exchange, credit, and convertible bonds globally.  

R&D Qualification

Several years ago, the decision was made to primarily build vs. buy software systems to provide the firm and their investors with a competitive advantage in the market. In order to optimize trading performance and risk management, the firm relies on their various proprietary software platforms. This unique software platform required extensive research, development and testing to ensure that it could function within the constantly evolving and volatile markets. The advanced trading platform and automated risk systems enables them to trade more profitably, at a lower cost.

The research process at this firm was collaborative between traders, risk management and developers. Research into and improvement in the performance, functionality and reliability of these systems was continuous and iterative. Testing and simulations of software prototypes and complex algorithms was ongoing throughout the life of an R&D project. The company’s software developers conducted extensive tests and simulations to verify and validate the software specific to its purpose for gathering and processing data and distributing that data, compiling reports, building a database of information for traders, and enabling real-time trading and risk management.

Larger projects with longer durations represented investments that transform the business while building a non-replicable competitive advantage. Technology enabling business transformation and market-leading product design were often the types of projects undertaken by this company. On average, in the early phases of the project, approximately one-third of the design time goes to initial design and specifications based on requirements, one-third to coding development and unit tests, and one-third to testing and issue resolution. The project team included the CTO, portfolio managers, traders, risk management, software engineers, and QA functions.

The performance-testing environment was especially critical to preparing a software release for production. If the new product was to replace an older version, parallel testing of performance data often was conducted. Verification and validation were iterative experimental protocols to ensure the technology met performance and precision expectations before being released to production and offered to portfolio managers. Even in production and in verification and validation efforts undertaken by traders, any deficiencies were addressed and solutions developed through additional research, rewriting, and retesting.

Risk management systems were also an important part of proprietary software development at the firm. The Risk department was charged with understanding the current positions of the entire firm and their potential impact. The makeup of the various funds led to a highly complex order book, with positions in over 15,000 securities. Advanced models and intellectual property from the risk team was crucial in building out the risk monitoring systems, position reports, and alerts. The advanced models and analytics created by the risk team were generally passed on to developers who automate many of the risk management functions.

Back office systems were also either internally developed or integrated with third party systems to provide for enhanced real-time and efficient reporting that could not be done by off-the-shelf systems. Back office development supported various functions, building out systems and automation, facilitating straight through processing, and other time efficiency initiatives. These teams were responsible for development related projects from non-trading functions. They helped service compliance, tax and operations.  

Results Speak For Themselves

Total combined federal and state tax credits for this hedge fund were $225,000 for the first year. Given the firm’s growth and continued focus on innovation, they now realize an annual credit of about $250,000.