The global financial crisis of 2008 fundamentally changed the operating landscape for capital markets players, creating a challenging environment of volatile markets and new regulatory barriers. From a market perspective, things are beginning to improve and new opportunities are unfolding as banks benefit from stronger economic growth and buoyant financial markets.
However, the post-crisis world has remained tough for some capital markets firms as they struggle to adjust to the new changes and achieve a return on equity that is higher than the cost of capital. Firms have been forced to undertake huge cost-cutting programmes, which to date has exceeded $40bn in savings. Yet the industry has failed to achieve a sustainable growth model and capital markets firms’ ROEs are still in decline. In 2016, they declined from 12% to 8% and investment analysts have highlighted the difficulty that firms will face to beat their cost of equity capital over the next five years.
Market challenges and opportunities
Firms are also struggling with the challenges of adjusting to the new regulatory landscape, where legacy systems and lack of resources are an industry-wide problem. They are also facing a growing pressure from the quick expansion of fintech disruptors who have the agility and flexibility to adapt to the ever-changing landscape. However, most capital markets firms also recognise the opportunities that new technology can bring them, not only as tools to bring down costs, but also as revenue generators.
Technology is a key driver in increasing operational efficiencies for firms and bringing down costs. Last year, Broadridge and Greenwich Associates interviewed senior executives at 69 capital markets firms, who agreed that technology transformation will be an essential component of producing attractive business returns in three ways by:
a) Focusing on simplifying complex, legacy technology, especially for the largest players
b) Increasing use of industry utilities or key industry partners who can mutualise costs and capabilities for non-differentiating functions
c) Accelerating adoption of new technologies to cut costs, simplify operating models and drive innovation
The case for mutualisation
With these priorities in mind, executives identified three technologies in particular that are driving this change: cloud computing, artificial intelligence and distributed ledger technology. Adopting these technologies as scalable solutions will require significant investment. Yet it would be more cost effective than if banks decided to innovate platforms in-house, which would call for large human and financial investment.
This is why mutualization is now playing a much greater role, as industry executives increasingly opt for a shared approach. Providing an on-ramp and shared investment model for non-differentiating functions as opposed to building bespoke solutions is the best approach to functions like settlement clearing, compliance and reference data.
The benefits are clear. If we look at the core post-trade processing industry costs total between $17bn and $24bn annually. Broadridge research shows that around $2-4bn of this could be eliminated by mutualization. This kind of cost-cutting has led institutions to collaborate on a new trade processing utility, although so far without success. Efforts have been hampered for a number of reasons, such as the lack of agreement between big banks on priorities, the absences of an available next generation, multi-tenant technology platform and the high cost to on-boarding institutions onto said platform once created.
A new approach
However, there is a new option given the changing landscape. Institutions are now partnering with technology firms that can provide them with a phased approach, reducing complications, cost and risk. There is also a growing number of global platforms, including Broadridge’s Global Post Trade Management platform, which allows firms to work globally across different asset classes on a single platform. Both factors mean that firms are able to achieve scale and cost savings, while realizing their innovation goals.
Capital markets firms are also increasingly focusing on the development of differentiating technology, like the ones identified by the executives in our survey. To do this, they are leveraging partnership with FinTech firms in areas where they lack expertise or scale to accelerate innovation. For example, DLT experts are in short supply and the technology requires agreement between multiple institutions on approach. Third parties can help in both regards, as seen with Broadridge’s work with leading financial firms in global proxy and other areas.
Establishing a pathway to profit will not be an easy task for banks as they grapple with new regulatory challenges and legacy systems, but as we have seen, working with the right partners will be key to their success in coming years. By mutualising platforms for non-differentiating functions, firms will be able to dedicate the resources and investment needed to focus on driving forward the technologies that will set them apart from the competition.
To read more, access our new white paper, Pathways to Profit