Each new year brings the hope of new business opportunities, accompanied by wariness that unexpected, unpleasant events might arise. Having experienced both in the past year, brokerages and investment banks can look forward to more of the same in 2006 and beyond.
In 2005, broker-dealers continued to market a host of products -- structured notes, hybrid securities, over-the-counter derivatives and other alternatives to traditional investments -- directed at specific investment requirements. At the same time, the growing storm over under-funded corporate pension plans roiled the industry and moved the U.S. Congress to take steps to strengthen the nation's pension system.
Meanwhile, the regulatory march continued. Regulation National Market System (Reg NMS) went into effect, while the Markets in Financial Instruments Directive (MiFID) placed new requirements on firms operating in Europe. These edicts joined the Basel II Accord, the Sarbanes-Oxley Act of 2002 and the USA Patriot Act as evidence that ever-increasing regulation now is a fact of life for the industry.
So what does 2006 hold? No one can be certain, but BearingPoint has identified seven trends that could significantly impact brokerages and their support systems:
The Aging of the Investor Class
The media is making much these days of the aging of the baby boomers -- and with good reason. This large cohort carries enormous economic wealth and power into a new life stage.
The shifting priorities of aging investors are changing their investment decisions. Brokerage clients will seek access to broader portfolio options as their desires for risk mitigation increase interest in hedging strategies and fixed-income investments. Broker-dealers will need to match their investment management offerings to these new client objectives. At the same time, client communication and reporting capabilities will need to be continually enhanced as tech-savvy clients demand new transaction and information delivery methods.
Institutions will need to establish a high-performance culture centered on the customer, with staff incentives linked to customer satisfaction and service levels. Timely, insightful metrics on customer attitudes will become a greater priority.
These changes will intensify the demand for a single view of the client that transcends products, lines of business and geographies, and requires new platforms that support centralizing data among front-, middle- and back-office operations, as well as across product lines. Emerging technologies such as VoIP, mobile communications and video over the Web will provide the foundation for greater personalization of service offerings.
Cross-Market Competition and Consolidation
"Be Big or Be Focused" appears to be an emerging industry credo as polarization among competing business models squeezes middle-market institutions. Large institutions will leverage their credit capacity to acquire scale, and price aggressively in the face of high distribution costs and compliance costs, and decreasing markets.
Specialized firms, meanwhile, will leverage their industry expertise, talent and premium branding to deliver highly sophisticated products to targeted key markets. For these firms, technologies that support advanced analytical capabilities will be of paramount importance.
Whether large or small, firms will continue to focus on cost efficiency. Outsourcing of noncore functions will accelerate as firms strive for performance improvement by streamlining back-office operations. Firms also will need to create enterprisewide risk management systems as management receives timelier, more accurate information on the performance of individual lines of business.
Direct Market Access
Continuing growth in online debt and equity issuance reflects a technology-driven transformation of capital generation. Disintermediation and potential replacement of the investment banking process, at least at certain stages, is an unfolding story.
Just as big brokerage houses overtook the e-brokers as leaders in online retail trading, investment banks and large commercial banks are positioning themselves to become leaders in direct online underwriting. These firms seek to eclipse the market pioneers by combining underwriting functions with necessary advisory services. As issuer acceptance of online underwriting grows, expect increasing pressure on investment banking fees.
These changing roles will require institutions to standardize infrastructures, expand their capacity to deliver Web services, and refine analytical and business intelligence capabilities continually.
A question remains: Will nontraditional players enter into this area of financial services as retailers have expanded into banking and insurance? Well-capitalized Internet content providers also may secure a foothold.
Web-Based Systems and Automation
The emergence of service-oriented architecture (SOA), business process management, grid computing and other technologies is fueling the development of new solutions for firms of all sizes. Firms see Web-based service delivery and process automation as means to achieve an end-to-end view of their businesses, which allows them to improve portfolio management and advisory capabilities.
Effective deployment of SOA solutions will be a key to infrastructure standardization and consolidation as institutions either abandon low-return businesses altogether or seek to improve margins through automation and process improvement. Integration of back-office processing and increasing levels of automated exception resolution will allow management to focus on allocating resources to transactions that require special processing and treatment.
Business cases driving the implementation of SOA will drive greater visibility surrounding the true profitability of individual lines of business, handing more power to ratings agencies and investors to judge an institution's real value. Product performance will be monitored more closely, leading to more-frequent changes in pricing and guarantees.
A transformative development in the past five years, algorithmic trading will continue to grow in use and change the nature of market activity. There will be more program trades of ever-growing blocks. Such trading has developed on both the buy side and sell side of the markets, reducing the demand for traders in a manner similar to the reduction in demand for institutional salespeople over the past five years.
Trading costs as defined by commissions charged and the width of bid-offer spreads will continue to drop. As they grow in volume and decrease in profitability, mature products such as cash equities or vanilla fixed-income trade execution increasingly will be seen as loss leaders. And the continued fragmentation and decentralization of liquidity across trading venues inevitably will lead to a diminishing role for traders.
Commoditization of the Liquidity-Finding Process
Increased liquidity in the electronic marketplace, the acceleration of exchange consolidation, and growth in program and algorithmic trading all are contributing to a dramatic change in how firms find and tap liquidity. This will mean a further reduction in the role of human-driven trading operations.
An array of technologies will support this continuing shift. Event-driven architectures and applications will draw on real-time, integrated market data to identify liquidity sources. Business intelligence software and analytical capabilities will be keys to making the best choices for capital acquisition.
Reg NMS and MiFID
These new regulations clearly will transform trading operations on both sides of the Atlantic. With its new pre- and post-trade transparency requirements for equity markets, MiFID will require European firms to store trading data for years. The market-structure reforms imposed by Reg NMS, meanwhile, could signal the beginning of the end for the auction trading system in the United States as it hastens the demise of floor trading.
In both regions, meeting the new requirements will require firms to improve data storage, data integration and order management capabilities. <<<
Peter A. Horowitz is a managing director at BearingPoint and the leader of the firm's capital markets team. Previously, Horowitz was founder and managing partner for Three Crown Capital Partners. Since joining BearingPoint in 1999, Peter has lead several initiatives including a cost reduction effort directed at broker fees and the development of an enterprisewide wealth management platform.