Capital Markets
Megatrends
All industries are being shaped by the global Megatends of Globalisation, changing Demographics, Sustainability and Technology innovation. Shaped by these trends, the pandemic and the declining economy, the sector is being transformed by five major drivers:
Commoditisation
Investment Bank returns have suffered as the markets commoditised, new players have entered and proprietary trading has diminished.
The commoditisation and the move of many products to liquidity exchange trading has squeezed margins, especially as complex, high margin products fell out of favour and proprietary trading diminished.
However. the growing influence of BigTechs has raised the bar for customer service, with the customer experience shifting online. Customers are demanding a wider array of investment options and an improved, seamless service experience.
Players are seeking differentiation to attract customers and find attractive opportunities.
Trust & Compliance
The financial crisis challenged the trust previously placed in banks with regulation focused on capital adequacy and market transparency. As a consequence aggregate costs for major investment banks were 25% higher in 2014 than they were in 2005 [1].
Regulation is intensifying, especially around cybersecurity, operational resilience, customer data & privacy, anti-money laundering (AML), transparency, ESG and digital assets. Fines are growing. The US Securities and Exchange Commission filed 760 enforcement actions in 2022, a 9% increase over the prior year. Enforcement actions totaled $6.4 billion which is the highest in SEC history, up from $3.8 in 2021 [2].
However this has opened up opportunities for regulatory technology (RegTech) and market data & analytical services.
Finanical Services has seen a 35% increase in fraud attempts through digital channels during the crisis [3]. Operation resilience is a key compliance issue.
Innovation
Digitisation has long transformed capital markets from physical to electronic trading. Despite this, true end to end digitisation of the value chain has not happened, leaving considerable friction, cost and a lack of transparency. The move to all digital assets, transparent market data and more efficient end-to-end trading will accelerate.
Capital Markets have been early adopters of technology such as low-latency and algorithmic trading. New technology will be key to differentiation, this includes AI, big data, automation, analytics, quantum computing and blockchain. The challenge is how do the financial market players harness these technologies and how does regulation keep up.
Capital Markets will come under increasing pressure to focus investments on sustainable projects both from a climate and resources perspective (ESG, sustainable or green financing). ESG investments will exceed $53 trillion by 2025, representing a third of the projected assets under management (AUM) [1].
Capital Markets will also need to develop their capabilities in digital assets which to date have been mostly developed by FinTech entrepreneurs.
Efficiency
Capital markets are complex with many steps in the value chain leading to increased costs. Many legacy processes and technologies exist.
In the last ten years, the Asset Management segment's cost base has grown at about 6 to 7% per year, double the organic growth of assets in the sector [1]. Operating margins vary widely across the sector but average 37% [2]. Categories that contributed most to 2021’s cost increase were investment management, technology, operations, and legal and compliance. Nearly 70% of all cost increases over the last decade have been directly related to people costs [3].
While companies have continued to invest in technology and seek greater scalability and efficiency in their operating models, the reality is that with greater business complexity has driven up costs. To deliver greater efficiency firms will need to fundamentaly reengineer their operating models, enabled by technology.
Disruptors will seek to reduce this friction whilst maintaining trust and compliance.
Resilience of financial markets is critical especially during moments of crisis like COVID-19.
Profitability
Global markets hit an inflection point in 2022. A decade of relative calm following the global financial crisis—including two years of supernormal returns after the initial shock of the pandemic—gave way to a new reality of supply-side disruptions, geopolitical tensions, and surging inflationary pressures. The reset button has been hit for nearly every major asset class. This could impact Captial Markets volumes in 2023.
Asset Managers have recalibrated their assumptions about pricing risk across the investable universe. The reset button has been hit for nearly every major asset class. The sectors’s clients—institutional, corporate and consumer alike—are under pressure as they cope with reopened funding gaps and anemic asset class return forecasts, which will impact future revenue growth and potential net outflows of AUM.
Pre the 2008 financial crisis Investment Banks were achieving 20%+ ROEs, but this is nearer 10% today due to capital requirements, regulatory costs, commodisation and new players [1].
The national political focus on financial services is likely to lead to fragmentation as developed economies seek their financial centres (e.g. London vs Europe). Market Infrastructure players are seeking scale and revenue diversification to drive growth. Consolidation is likely to continue, but is likely to become more political too.
However both niche Investment Banks (1.7x) and Financial Exchanges (4.5x) trade at a premium to traditional banks [2].