The good times of high margins, large revenues and big bonuses during the pre-financial crisis era have not returned for many capital markets products. Profitability for many banks' capital markets businesses peaked in 2007 and despite vigorous cost-cutting and other initiatives, most banks have not reached pre-crisis levels of return on equity.
Capital markets businesses face a number of challenges as they try to regain profitable growth. Complying with regulatory demands -- such as those imposed by Dodd-Frank -- and higher capital requirements mandated by Basel III and other capital related regulations adds cost, decreases leverage and makes considerable demands on management resources.
Client behavior has also changed. Clients are buying fewer structured products and more commoditized or "flow" products within fixed income, equities and foreign exchange. As clients seek higher returns, they put increasing pressure on firms to lower fees and spreads, and this is aided by the proliferation of new electronic trading venues offering pricing transparency and additional sources of liquidity.
As capital markets firms seek to strengthen and simplify their business and operating models, however, they find themselves working with technology platforms that have, in many cases, been custom-built for individual product "siloes," with disproportionate functionality to support complex trading activities. Such custom applications may support the businesses of the past better than those of the present and future. Historical product applications were not necessarily designed to admit cross-product functions such as collateral management. Adding standardized capabilities -- such as reporting -- to custom applications can be frustratingly difficult and costly.
Thus, while front-office costs have been reduced, IT costs -- including the need for specialized resources to maintain and update applications -- remain high. More and more firms see the need to strategically transform their capital markets businesses. Transformation, however, presents its own set of challenges. There is no "one size fits all" model for equities, fixed income, or other capital markets businesses. While some firms will be comfortable selling more or less commoditized flow products, others will seek to exploit market segments abandoned or neglected by competitors -- including complex structured products and other specialized niches.
To enable lasting competitive advantage through transformation, capital markets firms need to address three major elements:
1. Finding The Right Business Model. Capital markets firms' business models often need a more targeted focus on key clients and relationship management. Firms are often fiercely competing for shares of clients' "wallets" across a range of capital markets products. Firms that coordinate best across products and sales channels, while managing the entire, firm-wide relationship with a client, have the best chance of success. With sophisticated clients seeking lower fees, additional customized services, and greater use of a bank's capital, firms need to manage each relationship in a detailed and coordinated manner to maximize profitability.
To compete effectively in less specialized areas, capital markets firms also need to simplify their organizational structures (some of which became complex and unwieldy during the pre-crisis era) and their compensation arrangements (which sometimes provided narrow incentives for actions that, in some cases, hurt the long-term interests of both customers and shareholders).
2. Creating A Stronger Operating Model. Post-crisis, leading firms have adopted operating model improvements such as cross-product shared services and industry utilities. As many firms have discovered, vendors, outsourcing, and industry utility solutions can support better levels of client service while delivering significant cost savings. Margin pressures have also led firms to consolidate functions and to explore new options regarding legal entities and locations -- exiting, in some cases, less desirable areas to concentrate resources on more attractive opportunities elsewhere.
3. Implementing Transformational Technology Solutions. Capital markets firms are implementing innovative technology solutions -- including off-the-shelf products -- to replace entrenched, high-cost, custom systems. The use of such solutions creates an opportunity to reduce high IT costs, in some cases by as much as 50 percent, by re-shaping technology organizations and architecture.
In custom systems, compartmentalized support and myriad "small change" development efforts to meet client requests increase costs. The proliferation and complexity of custom systems increase the dependence on key people and create a culture of costly experts. With a base of non-custom systems, development resources can be shifted to the enhancement of competitive capabilities and away from nurturing the system itself. Lower value-added IT support and development can be easily outsourced, further reducing costs.
Off-the-shelf, vendor-supported solutions offer other advantages. Packaged software may be able to handle changes in volume with the needed functionality and flexibility, and packaged solutions support the rapid introduction of new products or service offerings. It is important, when considering implementations using packaged software, to assess the current in-house ability to respond to industry and/or regulatory changes.
Packaged software, componentized solutions and use of industry utilities can make the transformation of capital markets firms easier and more cost effective. Bundling architectural simplification with organizational simplification can yield additional benefits in lower costs, better utilization of in-house resources, and a sharper focus on competitive differentiation. With the right IT structure in place, firms can address changing client needs, whether for high-volume flow products or for newer, more complex products offering the possibility of higher returns. Under any circumstances, however, transformation is a difficult and lengthy process, and the time to start is now.
About The Author: Jonathan Firester is a Managing Director in Accenture’s Capital Markets Industry Practice. He has more than 25 years of experience in Financial Services, both in industry and consulting. Prior to joining Accenture, Jon was Head of Equities at R. G. Niederhoffer Capital Management, a quantitative hedge fund. Before that, he was the Business Manager of Global Prime Brokerage at JP Morgan. Jon graduated from Harvard with a BA in Abstract Mathematics. He lives in New York City with his wife and three children.