The Business and Technology Outlook for Capital Markets in 2015 & beyond..(3/3)

(Photo Credit – EconomyDecoded)

This article is the final installment in a three part series that talks about the business issues being faced by firms in the Capital Markets space. This post discusses the state of the market circa mid 2015, the evolving landscape and the strategic imperatives that firms face. We also cover the general business direction in the context of disruptive technology innovation.

Capital Markets are the face of the financial industry to the general public and generate a huge percent of the GDP for the world economy. Despite all the negative press they have garnered since the financial crisis of 2008, Capital Markets perform an important social function in that they contribute heavily to economic growth and are the primary vehicle for household savings. Capital markets allow corporations to raise capital using the underwriting process and it is not just corporations that benefit from such money raising activity – municipal, local and national governments do the same as well. Just that the overall mechanism differs – while business enterprises issue both equity and bonds, governments typically issue bonds.

These securities are then purchased by investors (typically Hedge Funds, Mutual Funds, Corporations, Governments, retail investors and high net worth individuals and Trusts)) as part of their long or short-term planning based on their risk appetites. To give one a sense of their scale and importance, IMF statistics show that as of 2013, the combined size of world-wide capital markets at 282,000 billion US $ – almost three times the size of the world’s gross domestic product (GDP)! (Source – Wikipedia)

As of mid 2015, the world’s capital market participants (be they on the buy or the sell side, custodians etc) find themselves at a critical juncture. On the one side you have a rapid rise in the market indices which shows no signs of abatement with more and more households participating in the market either directly or indirectly; at the same time there is an ever increasing demand in the area of offering new products in this age of the digital (and thus empowered) consumer who has other choices like social lending, virtual currencies.

Regulation and risk management are even more front and center with an incipient sovereign debut crisis in Greece (and likely other countries – Spain anyone?) and the Chinese stock-market crash.  Such economic upheavals only increase pressures on Banks to adhere to stringent Basel III risk ratios in areas like credit, market and liquidity. The result is reduced reliance on leverage and a focus on higher quality collateral. Both of which tend to crimp profits (as compared to the go-go years of the dot-com and the mortgage bubbles) and some would allege turning financial services into a boring utility like business.

IT Background:

Within large bulge bracket firms, Capital Markets groups engineer custom derivative trades that hedge exposure for their clients as well as for their own internal treasury groups. They may also do proprietary trading (on the bank’s behalf) for a profit (though this is the type of trading that the Volcker Rule seeks to eliminate). These groups typically lead the way in being forward looking from a high tech perspective.

Most of the compute intensive problems are generated out of either this group or the enterprise risk group. They typically own system that interface with the exchange facing order management systems, the trade booking systems, the pricing libraries for the products the bank trades as well as the tactical systems that are used to manage their market and credit risks, customer profitability, compliance and collateral systems. As a result, they usually get about a large chunk of a Bank’s total IT budget and see technology as a key competitive advantage. The above business drivers are already being tackled in many areas within the Capital Markets spectrum.

Analysis:

Having set the context in terms of the top strategic issues players in this space find themselves confronting, let’s examine the outlook for the remaining part of 2015 and beyond – 

1. Firms that successfully navigate the business waters will be the ones that can create new business models and offer a superior client relationship based on their data assets. Firms that can better understand and monetize their data assets will be placed in a position of superior returns. It is critical to understand your clients (be they institutional or otherwise) from a 360 degree perspective so you can market to them as one entity across different channels. This is key to optimize profits via cross selling in an increasingly competitive landscape.
2. Firms need to diversify into newer areas (and offer newer services) as profitability from existing lines slowly dries up. To state an example – can a firm that is a broker dealer offer other value added services like collateral management, risk management etc as a service?
3. Like it or not, we are not still past the era of systemic shock – with a geopolitical crises  (Greece) and the risk of a major economic failure cascading down as a contagion – ultimately hurting the general public via unemployment and other kinds of economic retrenchment. Firms need to do the due diligence to comply with regulations like CCAR and maintain transparent communication with the regulatory agencies and the general public. Reputation risk is still too great of a business challenge that can be very hard to overcome.
4. Capital markets is an information intensive business. So it is all about Data and it’s Governance. With BCBS 239 (as we saw in an earlier post), firms need to put on place data aggregation capabilities that help with firm wide risk reporting. We will find more of a focus in changing the Enterprise Risk, Compliance and Finance applications to promote systems and data consolidation.All key risk measurements need to be consistent & accurate across the above internal and external domains across multiple geographies & regulatory jurisdictions. A 360 degree view of every risk type is needed and this shall be consistent without discrepancies. Enhanced ability to process and glean insights from both data at rest and in motion is not an innovative capability anymore but a must-have.
5. Thus, firms that move from experimentation to deployment of elastic computing capabilities (Big Data, Mobility and Cloud) in support of business needs will increasingly dominate the landscape. Capital Markets are an IT & Information intensive business after all. Expect to find the leaders adopt a web-scale approach to building out their information technology architectures in support of business initiatives. Web-scale practices enable the building of business platforms around which ecosystems (and platforms as opposed to standalone applications) can be created and then sustained based on increasing revenue.
6. Compliance with Anti Money Laundering(AML) legislation will continue to be a huge focus with an emphasis on preventing drug proceeds, terrorist financing and other illegal financing from being laundered into the legal system.
7. At the risk of stating the obvious – Cyber-security will be continue to be front and center in the next few years. The media is replete with stories of both internal and external security compromises at major financial firm. Investments in security and increased monitoring of data (both internal and external) to monitor fraud and non-compliance will only increase.  Broadly identifying every potential attack vector, enforcing realtime intelligence & deep learning around these while keeping the overall business context in mind will be one of the key approaches in keeping data & systems secure. We are not far off from the days of mass cyber attacks on the nerve centers of finance as a weapon of warfare by nefarious sources. CIOs & IT Security need to have mitigating strategies for any such eventuality. One significant breach can create outlasting reputational and business damage among clients.
8. Business and IT will thus need to align work closer together to realize positive business outcomes and drive profitability. Management incentives need to be aligned to closer collaboration among peers at different levels to drive better governance and thus lower risk.
9. Digital will be an increasing focus in terms of driving business transformation. To reiterate from an earlier blogpost – Digital in this context is defined as being able to – “adapt high levels of automation while enabling the business to support multiple channels by which products and services can be delivered to customers. Further the culture of digital encourages constant innovation and agility resulting high levels of customer & employee satisfaction.”
10. Data Science and deep learning techniques will find increasing adoption in Capital Markets. Use cases will span the spectrum from Risk management, Compliance (AML & Fraud), Trade Analytics (Pre trade, trade surveillance, transaction cost analysis, bitemporal analytics etc) and client segmentation  as being the four key areas driving adoption. Firms should consider delivering these incremental capabilities via analytic sandboxes to their business users. An interesting business area is for stock exchanges to provide analytic tools as a service to their client base.
11. As Data gets centralized into Lakes or Oceans, enterprise Data Governance and IT Portfolio management will be key in ensuring smooth implementations that can provide incremental business benefits.

The combination of regulatory forces, competition & compliance will compel Capital Markets firms to rethink their IT strategy. Leaders will accelerate their technology & innovation roadmap in a way that promotes long term sustainable growth.