Lehman’s Anniversary Blog: The New Normal for Capital Markets

11 September 2013

The 15 September 2008 is a historic day in finance. As the date nears when Lehman Brothers' declared bankruptcy five years ago, starting the full-blown financial crisis which is still shaping the financial world today, it provides an opportune moment to look back. A raft of regulations emanating from that day are now hitting compliance technology systems, reporting and market infrastructures, capital adequacy rules and all other aspects of the industry. In this fifth anniversary blog from Tim Dodd, head of product management at the SunGard Front Arena technology unit, the impact of Lehman’s collapse on capital markets and the subsequent raft of regulations, from Dodd-Frank to Basel III, are assessed.

It is clear that a ‘new normal’ is developing in the global capital markets since the collapse of Lehman Brothers almost five years ago. As the anniversary since that dark day on 15 September 2008 nears, many global regulatory regimes have now been implemented that are designed to curb risk-taking by banks, increase transparency requirements and provide more stability going forward.

The regulations emanating from the post-crash Pittsburgh G20 meeting in 2009 - such as Basel III, Dodd-Frank, the European Market Infrastructure Regulations (EMIR), the drive towards central repositories, clearing, common legal entity identifiers (LEIs), and so forth - have meant a sea change in business practices, reporting, connectivity and technology requirements. The ‘new normal’ is driving a need for operational efficiency like never before.

The Last Five Years Since Lehman Brothers’ Collapse
The Basel III capital adequacy regime is driving banks to set aside more regulatory capital, pushing banks' balance sheets to contract. With higher Tier One capital requirements, the cost of capital is up, and so a fundamental re-assessment of business line profitability has taken place at many banks.

In parallel, imposition of changes in market practice is being forced on banks by regulators in several asset classes, most notably in over-the-counter (OTC) derivatives. Again, the drive is to de-risk banks' direct market exposures. The new demand to have OTC derivatives centrally cleared, helping to ensure that collateral for any failure is set aside across the market, is completely changing market practice.

In the US, this has created a ‘new normal’ where OTC derivatives are electronically traded directly by end users. Those banks that are offering to service clients have moved from principal to agent in the trading and/or hedging process. We at SunGard expect this new practice to spread to all parts of the globe in the coming years despite the cost associated with it.

Furthermore, with the US Volker rule, and similar pressures across the globe, directly forcing banks to reduce proprietary trading, many of these trading desks are now closing down. Trading talent is leaving the capital markets arena and often moving into hedge fund management. All this is driving banks to focus more on servicing simpler flow business for customers with more automation, straight-processing (STP), auditability and technology support.

Market Changes
From the other end, customers are demanding better electronically connected front-ends providing access to many markets via one portal. Indeed, today, the ‘man on the street’ retail investor can easily access platforms that offer execution-only capability in funds, single stocks, futures, options and, indeed, structured products. Many banks and brokers have offered this to their larger buy-side clients and have already invested in technology - now it is coming to a much wider audience.

Capital markets participants that already have a strong franchise in particular asset classes or offer special regional access may be well-positioned to maintain a competitive edge. There will always be clients that need to do large-value trades in single names that need to be brought together with liquidity. For example, the reason that the projections for electronically traded bond volumes remain below that of equities is because of this need for matching. Historic relationships can help preserve success in these more niche businesses but is not a guarantee. That said, even shifting relative small quantities of US treasuries has become difficult.

This has all driven a very harsh consideration of the costs of IT - much more has been automated - and wherever possible, IT infrastructures have been simplified. Today into tomorrow and for many years to come, automation and consolidation are the name of the game. Indeed investment to engage with the new conditions has often been used to precipitate IT consolidation.

Will this continue for the next five years? Looking into the crystal ball is always difficult but there are three trends that we think will shape the global banking business over the next five years:

• The quantitative easing (QE) economic support programmes will end.
• Low interest rates will need to rise.
• The regulatory avalanche will at last end.

Future-gazing: The Next Five Years
It is obvious that the prevailing financial conditions are going to change in the coming five years and the associated connectivity, technology and market practices will change with them. The quantitative easing (QE) ‘tap’ flooding the global economy with cheap money will be switched off. Low interest rates may also need to rise. These two factors alone will likely create a bumpy ride in the economies that underlie the performance of global financial institutions (FIs).

Indeed, in the extreme, certain pundits are forecasting that some politicians and their populaces will struggle with large deficits and perhaps we might even see an international default or two. This would be significantly tricky to navigate. Although it seems clear there is a while yet before banks will see good economic conditions on a global scale, time will tell if we see an international default.

On the other hand, we are seeing the emergence of a less harsh global regulatory atmosphere. Banks are needed to oil the economy, and financial markets for equities and bonds fund necessary capital to drive the activities of our everyday lives. In some instances, politicians are realising that locking down banking activity in their own regulatory regime may be to the detriment of their country’s growth.

If banks are too harshly regulated, they will see their business going abroad or worse, other industries’ business losing competitiveness and going abroad. We have seen certain concessions such as the threshold for margining OTC derivatives being raised for non-financial institutions, which should for instance help corporates merely looking to hedge.

Conclusions: Trading Technology Impacts
In the next five years, we may see other regulatory changes too, or more specifically amendments as the new post-crash rules bed down. Finally, those producing the technology for trading institutions and collective global access to financial markets will increase the sophistication of the tools available to everyone. Apps to trade almost anything already exist. Today's capital markets participant can benefit from exposure to improving and even ‘cool’ technology such as social media trading or global access - the next five years will continue to see more innovation.

There seems to be a continued desire from banks to extend services to all types of customers in single platforms that can deal with both trading on all electronic venues, and automated risk/limit management of those trades. Indeed automation has become fundamental to staying competitive in the global banking business. While we are now five years out from the collapse of Lehman, the next five years will solidify the ‘new normal’ for the global capital markets.

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