Unfavorable economic conditions, escalating capital requirements, and stubbornly high costs continue to depress the performance of many investment banks. Their collective 6% ROE in 2015 capped off five years of dismal revenue results.
Yet the same cannot be said for the capital markets industry as a whole—the ecosystem that includes buy-side firms, sell-side firms, information service providers, and exchanges. Indeed, even as regulation forces investment banks to retrench and hinders their ability to compete, other players remain unaffected and will even, in some cases, benefit. Over the next five years, revenues in the capital markets industry will grow by an estimated 12%, increasing to $661 billion from $593 billion in 2015.
Ultimately, investment banks will need to be the right size, develop the right model, and take the right approach to return to consistent profitability. Dealers must learn to compete within the critical sectors of the new capital-markets ecosystem: data and financial technology. How they fit themselves into increasingly electronic, standardized, and transparent markets will be crucial. Investment banks are losing the battle so far, but that does not mean they will lose the war.
Enormous opportunity exists from the collaboration of established capital markets (CM) players such as investment banks with young fintech companies, but the potential is far from being realized. Indeed, fintech is introducing new paradigms that CM players can exploit to their advantage in a landscape that is complex and difficult to navigate. By establishing labs to focus on early-stage, novel technologies that are core to their principal activities, and by systematically pursuing adjacencies that have synergies with their existing portfolios, investment banks can position their businesses for a bright, digital future. Yet time is of the essence. Banks and the entire capital markets ecosystem must take action now in order to gain the considerable benefits that are achievable.
The United Kingdom's decision to leave the European Union will transform Europe’s capital markets. In the short term, the effects may be negative as uncertainty surrounding the final status of the UK's position further depresses investment bank revenues. In the medium term, there may be more bad news as banks face an escalation in costs as they staff and build out additional trading hubs. The long-term effects are less clear, with a variety of possible (mostly negative) outcomes. For some banks, “Brexit” could accelerate their withdrawal from parts of the value chain; others might take advantage of the situation by re-engineering their operating model, aggressively implementing cost-reduction programs and restoring performance.
Digital technology is facilitating the flow of information away from investment banks and into new channels. It is also allowing data to be created and controlled by nonbank entities. Some companies are implementing measures to stay ahead of the curve, yet others are adapting too slowly, if at all.
Ultimately, the technology that has forced other industries to completely overhaul their business models is now being brought to bear on the world of investment banking. The time for digital adoption is now.
Leveraging Digital Advances in Capital Markets
MiFID II will transform the financial markets of Europe. It will do this directly, stipulating new practices by market participants. But its more profound effects will be indirect. By increasing automation and transparency, MiFID II will change the economics of securities trading and, hence, the business models of many market participants. New data management and analytics capabilities will be required, traditional sources of revenue will decline (or disappear), and new players will enter parts of the value chain. The overall implications are profound.