Bold and beautiful
13 October 2015
For investment banks to continue to be the dominant players in this tough, ultra-regulated world, they cannot simply adopt new platforms. They need to be leaders in the digital trading revolution, says Rob Scott of Commerzbank
Image: Shutterstock
For two decades, scale at all costs was the over-arching mantra of the securities servicing industry. More clients, more volume, and more and more capabilities were seen as the way to outpace the competition. Margins may have been narrowing, but with an explosion of activity across almost every asset class, it seemed like revenues could hold up.
Post-crisis—and with volumes falling away sharply—the flaw in that model was quickly apparent. But with other issues such as regulatory overhaul, business conduct and cost-cutting taking priority in boardrooms, few banks have had the resources or focus to address it.
As a result, while technology has transformed other industries at break-neck speed, many of the big banks have been firmly behind the curve, struggling on with proprietary securities platforms that were built, on average, 19 to 25 years ago or more.
But that looks about to change. A tougher capital regime and unprecedented commercial pressures have forced the industry to a tipping point. As a result, some transformative changes are happening—or set to happen—in trading businesses of the major banks. Here are four to watch out for.
From offshoring to outsourcing
Pre- and post-crisis, banks have saved literally hundreds of millions on their core operational costs by migrating people, processes and systems to low-cost centres such as India. By moving various commoditised processes offshore, firms have been able to drive typically 20 to 25 percent efficiency per year. But while offshoring can create dramatic cost reductions in the early years, the fact that the same aged, bloated systems are in operation means long-term efficiency and cost reductions remain limited.
Banks are waking up to the fact that it’s the systems and processes themselves that need a material overhaul. However, re-platforming is a daunting proposition. It is estimated to cost around €100 million to €150 million to re-build and integrate a new global securities platform for a mid-sized bank. With volumes slowing, margin pressure continuing and most available investments going towards servicing regulatory compliance, few banks are in a position where they have that money to spend.
Shareholders would also rather see banks focus on their core areas of proprietary expertise rather than devote scarce resources to IT infrastructure to support processes whereby they don’t differentiate.
The only viable solution is to consider outsourcing all or parts of a bank’s core processing. Historically, banks have tried to address re-platforming needs through joint ventures and open-source initiatives, usually with other banks. But the fact that banks are in competition with one another has largely led to their failure.
So now it’s the global professional services firms that are stepping into the breach. Accenture, IBM, HP and Wipro, among others, have been bringing their vast experience of creating business process outsourcing models across multiple sectors. For banks, they’re beginning to prove the ideal partner: firstly, by not being direct competitors; and secondly, in terms of the global resources and financial strength that put their balance sheets and core profitability ahead of most of the banks that are hiring them.
The past two years have seen major partnerships being forged to, for example, outsource the whole of one bank’s post-trade processing, consolidate multiple trading platforms or deliver a private cloud platform in order to standardise systems and reduce operating costs. Such initiatives are anticipated to deliver up to 40 percent in savings in a service provider’s underlying cost-base, by creating more bandwidth and allowing banks to operate with smaller, highly efficient and nimble teams.
As the first of the top-tier investment banks adopt these leading-edge technologies, other players can’t afford to be left behind.
Centralisation
In the past, individual business units have tended to have their own IT departments, trading systems and preferred service providers, allowing a mismatch of hundreds of platforms, processes and service agreements to proliferate within one organisation.
In many markets, trading is now a very different beast as volumes have declined and an appetite for sophisticated, high-margin products has been replaced by preference for simpler, cheaper and centrally cleared products and solutions. Banks will be looking to create a far more unified solution to accommodate these simpler needs (particularly as more fixed income and currency activity moves towards the prevalent fee-based e-trading model used by equities). Whether this will lead us down the path to the “execution factories” anticipated by consultant McKinsey & Company in 2013 remains to be seen. But the trading organisational structure of most banks is set for a substantial overhaul and consolidation.
Greater focus
Universal banks with securities trading franchises have long considered it their role to be all things to all clients, but that no longer is the case. Franchises are set to become far more selective in whom they serve and what they offer. Top tier banks are now reviewing clients against tough criteria, from the importance of the relationship, to profitability, to the level of balance sheet that a client consumes.
Hard questions are also being asked about the businesses in which banks can afford to be active. We’ve seen big names dramatically reassess their activities, withdrawing from over-the-counter clearing and custody and exiting peripheral markets. This process will continue, allowing banks to set out their stall as leaders in core capabilities but also opening the way for newcomers and challengers to fill the gaps.
Pricing realism
For years the true cost of servicing clients has been obscured. To attract and retain business, particularly in Europe and the US, banks had to be willing to regularly renegotiate costs without adjusting service levels, and absorb the costs of non-standard services and customisation.
Under a more relaxed capital regime, it was possible to manage this state of affairs by cross-subsidising with revenues from other centres. But under the new regulatory and capital rules, every cost centre and/or location has to be able to stand on its own two feet.
Banks are now realistically examining their price structures and preparing to have more open and honest dialogue on costs with clients. While few have publicly bitten the bullet yet, we anticipate more transparency and granularity in costs, with firms starting to charge explicitly for services that were previously offered ‘gratis’, such as bank accounts, intra-day/overnight liquidity, non-standard reporting and collateral mobilisation. At the same time, we should start to see more open and honest dialogue with clients regarding the absolute cost of consumption of services.
From cost-cutting to new thinking
The hard truth is that six years after the credit crisis and a raft of cost-cutting and retrenchment, trading businesses are still generating returns well below their cost of capital—not simply because of falling volumes, but also the swingeing burden of new risk and conduct monitoring, reporting, and other regulatory demands.
Indeed, some commentators have suggested that even if trading levels were at the same boom levels as the pre-crisis years, the current cost of regulation and capital would still see firms struggling.
For investment banks to continue to be the dominant players in this tough, ultra-regulated world, they cannot simply adopt new platforms.They need to be leaders in the digital trading revolution. The mantra now has to be bold new thinking about financial technology that can transform a historically high fixed-cost business into a more variable, consumption-based model.
Post-crisis—and with volumes falling away sharply—the flaw in that model was quickly apparent. But with other issues such as regulatory overhaul, business conduct and cost-cutting taking priority in boardrooms, few banks have had the resources or focus to address it.
As a result, while technology has transformed other industries at break-neck speed, many of the big banks have been firmly behind the curve, struggling on with proprietary securities platforms that were built, on average, 19 to 25 years ago or more.
But that looks about to change. A tougher capital regime and unprecedented commercial pressures have forced the industry to a tipping point. As a result, some transformative changes are happening—or set to happen—in trading businesses of the major banks. Here are four to watch out for.
From offshoring to outsourcing
Pre- and post-crisis, banks have saved literally hundreds of millions on their core operational costs by migrating people, processes and systems to low-cost centres such as India. By moving various commoditised processes offshore, firms have been able to drive typically 20 to 25 percent efficiency per year. But while offshoring can create dramatic cost reductions in the early years, the fact that the same aged, bloated systems are in operation means long-term efficiency and cost reductions remain limited.
Banks are waking up to the fact that it’s the systems and processes themselves that need a material overhaul. However, re-platforming is a daunting proposition. It is estimated to cost around €100 million to €150 million to re-build and integrate a new global securities platform for a mid-sized bank. With volumes slowing, margin pressure continuing and most available investments going towards servicing regulatory compliance, few banks are in a position where they have that money to spend.
Shareholders would also rather see banks focus on their core areas of proprietary expertise rather than devote scarce resources to IT infrastructure to support processes whereby they don’t differentiate.
The only viable solution is to consider outsourcing all or parts of a bank’s core processing. Historically, banks have tried to address re-platforming needs through joint ventures and open-source initiatives, usually with other banks. But the fact that banks are in competition with one another has largely led to their failure.
So now it’s the global professional services firms that are stepping into the breach. Accenture, IBM, HP and Wipro, among others, have been bringing their vast experience of creating business process outsourcing models across multiple sectors. For banks, they’re beginning to prove the ideal partner: firstly, by not being direct competitors; and secondly, in terms of the global resources and financial strength that put their balance sheets and core profitability ahead of most of the banks that are hiring them.
The past two years have seen major partnerships being forged to, for example, outsource the whole of one bank’s post-trade processing, consolidate multiple trading platforms or deliver a private cloud platform in order to standardise systems and reduce operating costs. Such initiatives are anticipated to deliver up to 40 percent in savings in a service provider’s underlying cost-base, by creating more bandwidth and allowing banks to operate with smaller, highly efficient and nimble teams.
As the first of the top-tier investment banks adopt these leading-edge technologies, other players can’t afford to be left behind.
Centralisation
In the past, individual business units have tended to have their own IT departments, trading systems and preferred service providers, allowing a mismatch of hundreds of platforms, processes and service agreements to proliferate within one organisation.
In many markets, trading is now a very different beast as volumes have declined and an appetite for sophisticated, high-margin products has been replaced by preference for simpler, cheaper and centrally cleared products and solutions. Banks will be looking to create a far more unified solution to accommodate these simpler needs (particularly as more fixed income and currency activity moves towards the prevalent fee-based e-trading model used by equities). Whether this will lead us down the path to the “execution factories” anticipated by consultant McKinsey & Company in 2013 remains to be seen. But the trading organisational structure of most banks is set for a substantial overhaul and consolidation.
Greater focus
Universal banks with securities trading franchises have long considered it their role to be all things to all clients, but that no longer is the case. Franchises are set to become far more selective in whom they serve and what they offer. Top tier banks are now reviewing clients against tough criteria, from the importance of the relationship, to profitability, to the level of balance sheet that a client consumes.
Hard questions are also being asked about the businesses in which banks can afford to be active. We’ve seen big names dramatically reassess their activities, withdrawing from over-the-counter clearing and custody and exiting peripheral markets. This process will continue, allowing banks to set out their stall as leaders in core capabilities but also opening the way for newcomers and challengers to fill the gaps.
Pricing realism
For years the true cost of servicing clients has been obscured. To attract and retain business, particularly in Europe and the US, banks had to be willing to regularly renegotiate costs without adjusting service levels, and absorb the costs of non-standard services and customisation.
Under a more relaxed capital regime, it was possible to manage this state of affairs by cross-subsidising with revenues from other centres. But under the new regulatory and capital rules, every cost centre and/or location has to be able to stand on its own two feet.
Banks are now realistically examining their price structures and preparing to have more open and honest dialogue on costs with clients. While few have publicly bitten the bullet yet, we anticipate more transparency and granularity in costs, with firms starting to charge explicitly for services that were previously offered ‘gratis’, such as bank accounts, intra-day/overnight liquidity, non-standard reporting and collateral mobilisation. At the same time, we should start to see more open and honest dialogue with clients regarding the absolute cost of consumption of services.
From cost-cutting to new thinking
The hard truth is that six years after the credit crisis and a raft of cost-cutting and retrenchment, trading businesses are still generating returns well below their cost of capital—not simply because of falling volumes, but also the swingeing burden of new risk and conduct monitoring, reporting, and other regulatory demands.
Indeed, some commentators have suggested that even if trading levels were at the same boom levels as the pre-crisis years, the current cost of regulation and capital would still see firms struggling.
For investment banks to continue to be the dominant players in this tough, ultra-regulated world, they cannot simply adopt new platforms.They need to be leaders in the digital trading revolution. The mantra now has to be bold new thinking about financial technology that can transform a historically high fixed-cost business into a more variable, consumption-based model.
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