Einstein famously said that “Insanity is doing the same thing over and over again but expecting different results”. Likewise, the fabric of capital markets has changed so much since the financial crisis that the old ways of doing business just don’t make sense anymore. And so trying harder with the same approaches simply is not going to work. Einstein’s claim, therefore, should demand our attention and compel us to seek new ways to deliver and extract value from the investment cycle.
It is easy to dismiss retreat Deutsche Bank’s retrenchment from equities trading as just the typical knee jerk reaction of a bank to the cyclical nature of equities trading. But, in fact, Deutsche’s move and other tier one layoffs and restructurings point to a higher set of truths. These secular changes will have fundamental implications for all participants especially in how they think about and deploy technology.
Secondary trading of equities was always seen as an essential part of the investment bank business model. How else, the argument went, can you get involved in lucrative IPO, prime or other work without the capability to trade a stock once it has IPO’d?
But the traditional IPO market is under attack from all sides. MiFID II’s unbundling of research has reduced the information available on listed firms. At the same time, the rise of direct listings disintermediates banks from traditional pre-IPO book building. The disastrous flotation of Aston Martin in 2018 which cost £136m and led to a halving in its stock price has also done little to restore faith in the “good old ways”.
And then we have private equity which, fuelled by uber low interest rates, is able to offer an attractive alternative to public markets. So much so that by 2017 there were 8000 private equity owned businesses in the US or roughly twice the number of listed firms.
Finally, the permanent shift to passive investment means that share trading is increasingly focussed on closing auctions which sucks further volatility out of the market.
So is it all doom and gloom for our industry? Actually, far from it - it is just that we are finally seeing a new capital markets paradigm emerge. As Bill Gates prophetically said back in 1997 - “we need banking we just don’t need banks”. What I think he meant was that rather than the traditional, people heavy, slow moving participants of yesteryear, we need something far more nimble.
The good news, though, is that while everyone has been running around trying to catch all the regulatory curve balls being thrown at us, technology has finally evolved.
If you are looking for clues as to how this new technology will impact capital markets then simply look around you at what has happened in your daily retail life or, closer to home, at the revolution underway in retail banking. Put simply, institutional customers expect their banks and brokers to know who they are, what they want and when they want it.
The starting point for all this is data (something that the LSE has recently acknowledged) but data without the ability to create actionable insight is just another overhead.
This has put the traditional siloed based approach of banks under severe pressure. Their systems are typically asset class centric and each layer in these separate stacks is inextricably welded to the layers above and below. What this means is that they are just too cumbersome and costly to be effective. What’s more, these platforms were developed in an age of much higher margins and so were predicated on using expensive human capital to glean information from the data and then communicate this to clients.
Some firms have already seen the writing on the wall. Hg’s Director of research, David Toms, points out that Goldman Sachs has increased its spend on technology by 48% while simultaneously reducing staff expenditure by 13% over the past 5 years.
That is why we are seeing new constellations of technology vendors emerge in areas such as microservice frameworks, desk top interoperability and automated machine learning. What connects them all is the belief that there must be a better way to deploy technology in our industry. But, on top of this, they are collectively proving that they can deliver business applications and productivity enhancements faster and at dramatically lower cost. This is important as speed and agility are essential in today’s world of fragile customer loyalty and vanishingly short attention spans. Only in this way can you monetise your successes and “fail fast” with the less good ideas.
This approach comes with another benefit - the ability to tap into “hidden” markets. These are markets driven by anachronistic supply chains that need the transparency, certainty and customer profiling that technology can bring. Crucially, however, their size (while often significant) has meant that full scale electronification has simply not been economically viable.
But, today, all this has changed as next generation vendors shrink and democratise the cost of automating markets.
Another feature of these firms is that their technology can be implemented in an evolutionary manner. “Rip and replace” simply isn't a viable option for most banks and so newer technologies need to coexist with their older ancestors while delivering value every step of the way. This requires careful systems integration and a deep partnership between vendor and customer. This is essential so that Banks maintain control over final project outcomes and maximise their existing technology resources.
Finally, these next generation firms don’t just deal with change they thrive on it. Banks and brokers need to deliver new experiences that delight their customers. At the same time, these new experiences need to be constantly refined and improved by analysing how users interact with them. Nowhere is this more true than in the seemingly simple process of client on- boarding. We can all set up personal or business bank accounts in minutes on-line and begin transacting business shortly thereafter. So why does it take weeks or even months to on board institutional trading relationships? And, before you mention KYC or AML, these requirements apply just as much to retail as institutional trading. The inconvenient but glaring truth is that tolerance among institutions for not being able to get their business done is fast approaching zero.
Whether we like it or not, capital markets are an essential part of our daily lives. They have yet to finally reach their next Tipping Point but the multitude of factors driving them to deliver agile, granular and more relevant services is inexorable.
Those firms that can select the right combination of technologies will achieve these goals at pace and enjoy a significant cost advantage while they do so.