Transforming the Capital Markets Firm Proactive Steps to Profitable Growth
These may not be the worst of times for capital markets firms, but they are far from the best of times. 1
Focusing on the Business Model Profitability for many banks capital markets businesses peaked in 2007, and despite vigorous cost-cutting and other initiatives, most banks have not reached pre-crisis levels of return on equity. While the damage from the financial crisis was severe, a number of other challenges face capital markets businesses as they try to regain profitable growth. Complying with regulatory demands such as those imposed by Dodd- Frank and higher capital requirements mandated by Basel III and other capitalrelated regulations adds cost, decreases leverage, and makes considerable demands on management resources. Client behavior has also changed. Clients are buying fewer structured products and more commoditized flow products within fixed income, equities, and foreign exchange. As clients seek higher returns, they put increasing pressure on firms to lower fees and spreads, aided by the proliferation of new electronic trading venues that offer pricing transparency and additional sources of liquidity. Extracting sufficient profits from such clients requires banks increasingly to manage these relationships holistically, across the full scope of products provided. As capital markets firms seek to strengthen and simplify their business and operating models, however, they find themselves working with technology platforms that have, in many cases, been custom-built for single product silos, with disproportionate functionality to support the more complex trading activities. Such custom applications may better support the businesses of the past, rather than of the present and future. Some firms have built multiple platforms to support products within a single business. Historically, product applications were not designed to support cross-product functions such as collateral management. Adding standardized capabilities such as reporting to multiple, custom applications is difficult and costly. Thus, while front-office costs have been reduced since 2007, IT costs remain high, including the need for specialized resources to maintain and update applications. In the face of these and other challenges, more and more firms see the need to transform their capital markets businesses. Transformation, however, presents its own set of challenges. There is no one size fits all model for fixed income, or other capital markets businesses. While some firms will be comfortable selling more or less commoditized flow products, others will seek to exploit market segments abandoned or neglected by competitors including the sale of complex structured products and other specialized niches. Pressures on Product Economics Regulation Hurdles (Capital) Basel III, SIFI, and other capital increases Uncertainty Costs of compliance Centralized clearing Client Forces (Revenues) Shift to flow products Pressures from electronic trading and venues Investor need for returns and lower fees/spreads Need for safety and control of collateral Complexity (Costs) Traditional product silos and revenue focus History of in-house, custom developed IT Inappropriate architectures for cross-product functions e.g., collateral management 2
Elements of a Successful Transformation In our experience, capital markets firms need to address three major elements to enable an effective transformation, one that positions the firm properly and is conducive to lasting competitive advantage. The three elements are: 1. Business Model Capital markets firms business models often need a more targeted focus on key clients and relationship management. Firms are fiercely competing for shares of clients wallets across a range of capital markets products. Firms that coordinate best across products and sales channels, while managing the entire, firm-wide relationship with each client, have the best chance of success. With sophisticated clients seeking lower fees, additional customized services, and greater access to the bank s capital, firms need to manage each relationship in a detailed and coordinated manner to maximize profitability. To compete effectively in less specialized areas, capital markets firms also need to simplify their organizational structures, (which became unduly complex during the pre-crisis era,) and their compensation arrangements, (which sometimes provided narrow incentives for actions that, in some cases, hurt the long-term interests of both customers and shareholders). Because of the current increased costs of, and constraints on, capital, leading firms will seek to optimize their client and product portfolios to maximize return on capital. They are doing this by measuring and managing capital at finer levels, optimizing their use of global collateral across businesses, improving the granularity of their risk and stress models, and winding down their least efficient products and contracts. 2. Creating a Stronger Operating Model Post-crisis, leading firms have adopted operating model improvements, such as cross-product, shared services and industry utilities. As many firms have discovered, vendors, outsourcing, and industry utility solutions can support better levels of client service while delivering significant cost savings. Margin pressures have also led firms to consolidate functions and to explore new options regarding legal entities and locations exiting, in some cases, less desirable geographies to concentrate resources on more attractive opportunities elsewhere. 3. Implementing Transformational Technology Solutions Capital markets technology is often a complex network of interrelated systems, which makes simple or incremental transformation difficult. For many firms, this makes technology the most challenging part of transformation. First-movers are implementing innovative technology solutions including off-theshelf products to replace entrenched, high-cost, custom systems. The use of such solutions creates an opportunity to reduce high IT costs, in some cases by as much as 50 percent, by re-shaping technology organizations and architecture. 3
In custom systems, compartmentalized support and myriad small change development efforts to meet client requests lead to increased costs. The proliferation and complexity of custom systems increase the dependence on key people and create a culture of costly experts. With a base of non-custom systems, development resources can be shifted to the enhancement of competitive capabilities and away from nurturing the systems themselves. Lower value-added IT support and development can be easily outsourced, further reducing costs. Off-the-shelf, vendor-supported solutions offer other advantages: Packaged software may be able to handle changes in volume without compromising the needed functionality and flexibility. Packaged solutions also support the rapid introduction of new products or service offerings and frequent industry or regulatory changes. Business Model Focus on key clients Leverage relationship platforms Balance primary, secondary, and content Lowest cost, high-volume execution Balance of flow and OTC Simplify organization Capital Optimize client and product portfolio Optimize use of global collateral Improve granularity of risk models Optimize balance sheet, funding, and collateral Wind down least efficient contracts Operating model Implement in-house shared services Leverage industry utilities Consolidate functions Optimize legal entity and location strategy Evaluate vendor, outsourcing, and utility solutions Technology Simplify high-cost, custom systems Reduce cost by right-sizing technology organizations and architecture Refocus development to key, competitive capabilities Replace legacy systems with off-the-shelf Outsource non-core IT 4
Basic Principles for Technology Transformation Every capital markets firm is different, and the paths to stability and profitable growth will be different for each firm, as well. In our work with capital markets firms, however, we have seen that certain basic principles for technology transformation hold true in almost every situation: Given the continuing uncertainty and volatility of financial markets, costs should be moved from a fixed to a variable basis whenever possible. Expensive and specialized custom development should be focused on areas of competitive differentiation, where a firm can build sustainable advantage. Generic, industry-standard, and peripheral needs should be met where appropriate with vendor software or shared utility solutions. Simpler is generally better, but architectural simplification serves little purpose if done in isolation. Architectural simplification should support organizational simplification. Ideally, a simplified architecture with its lower costs can support increased volumes of flow products while providing a strong, flexible foundation for the development of higher-margin offerings. Finally, the need for transformation is often urgent, but the process itself takes many months. The time to start planning and implementing is now, especially as many capital markets firms are well along this road. 5
Improving the Capital Markets Technology Organization Ultimately, people, not software, are at the heart of any IT organization. One of the problems that capital markets firms have encountered in dealing with their IT structures is that, because of customized systems, in-house resources have had to spend too much time on relatively lowvalue added activities. In addition to the benefits derived from non-product specific components purchased from vendors, capital markets firms can reduce their internal infrastructure needs by leveraging productsupported cloud enablement. Through better use of outsourcing and the vendor ecosystem which has grown dramatically in size and sophistication over the last eight to ten years capital markets firms IT organizations can make major advances in the use of in-house resources. By outsourcing non-revenue generating tasks, IT organizations can spend more time supporting revenue-generating activities and developing specialized, cross-product applications, such as collateral management and cross-product reporting. Also, some componentized vendor systems are not specific to particular products, so these application components can support further organizational simplification. 6
Selecting the Right Path to Technology Transformation The challenges facing capital markets firms make transformation necessary, timely, and feasible. Each organization, however, needs to make its own decisions about architectural and organizational simplification. For example, every organization needs to determine how target applications and maintenance will be provided. The right approach, however, will depend upon the chosen business model and the opportunities that the firm plans to pursue. A system that is custom-built to specifications whether in-house or by a vendor will help ensure competitive differentiation, as well as strong control of features. However, it will also be expensive and slow to implement, and will be more costly to support and to enhance. Integration of best-in-class vendor software is another approach to providing target applications and maintenance. This can be both cost-effective and flexible, particularly as the vendor supplies industry enhancements as needed. The downside of a vendor software approach is that there are fewer opportunities for specialization and development of unique products, and less control over features and customization priorities. Firms also have the option, in many cases, to outsource applications and maintenance or to use an industry utility. This is a flexible approach with low unit costs, but it offers fewer opportunities to customize, and the speed and quality of applications may be subject to limitations of the Service Level Agreement. Transitioning to new IT applications poses another set of problems. A greenfield approach, through which new applications are implemented separately and then accounts and transactions are migrated over, is usually fastest, as there are no interim stages and it is easier to make dramatic changes. This approach offers limited savings, however, and there is little value added if the entire project is not completed. It is becoming easier to replace groups of products or functions all at once through the use of components. This allows for partial transformation and delivers savings and functionality in shorter periods of time. In this approach, the overall transformation may be longer and there are additional, interim expenses related to connecting old functions to new components. Finally, an evolutionary approach can modify and/or replace individual applications while they are still in place. This approach has lower upfront costs and does enable changes in strategy and requirements, but it represents the longest path to transformation and may never deliver certain savings. 7
Examples of Transformation Paths Vendor / Outsource Technology Strategy Custom / In-house Product Strategy Complex / structured product set Prevalent regional bank strategy Substantially lower costs Reliance on vendor/s for features and enhancements Example: Leverage vendor software to lower costs Example: Simplify business and technology strategy Current positioning for many top-tier banks Requires high-margin, high-roe products Businesses desire flexibility, innovation, and speed-to-market Example: Transform custom technology platforms Simplified / flow product set High-volume, flow business model Substantially lower costs Custom platforms must be cost-effective Lower-margin ( flow ) products Accenture has been working with a number of investment banking clients to start various transformational initiatives, such as legacy systems replacement and business process outsourcing. Early on in the transformation timeline, these clients have begun to experience benefits that will likely lead to savings of up to 40% over four years. The chart below is a composite of the expected savings from these types of transformational projects from a few U.S. and European client examples. Cost Savings from Technology Transformation Composite of IB Engagements Technology & Operations Cost Base (indexed) 100 80 60 40 20 0 Pre-Transformation Post-Transformation (Year 4) 8
Overcoming Barriers to Transformation While there are many paths to transformation, there are also many obstacles that stand in the way of successful transformation efforts. These can be placed in four main categories: 1. Business and cultural Achieving long-term benefits may take a back seat to short-term goals. The organization needs to be able to work on a long, complex transformation process while delivering quarter-to-quarter results. Many individuals will point out the risks of non-completion and the diminished level of innovation while the transformation process is under way. Proper sponsorship and project governance, along with a clear commitment from business leadership to see the journey through, can help address these concerns. 2. The IT organization itself In many firms, technology organizations have been built up around the custom applications they develop and support, and their culture and organization reflect the ongoing development paths of these applications. They may have little interest or outright hostility to an approach that shifts some control to a vendor, or redeploys developers to new areas. The project team leadership needs to communicate the importance of costeffective, high-performing applications as well as the new opportunities that a simplified architecture and organizational structure will create while addressing any not built here concerns. 3. Financial concerns No matter what path is taken, there will be significant upfront investment, and quarterly pressures for returns will make it hard to present large spend-to-save projects. Short-term optimization often implies adding just one more feature to an existing, complex web of applications but this can never lower costs in a truly transformative manner. The business case should find investment from additional sources, such as a reduction in the CTB budget, and consider the optics of different structures such as a winddown desk. 4. Transformation risks Any major undertaking runs the risk of budget or cost overruns, as well as the possible loss of key personnel. In addition, changes in the firm s situation or in the industry landscape may push the transformation off track. Careful planning, close tracking of financial metrics, clear assignment of responsibilities, and establishment of well-marked rollback points, can mitigate most transformation risks. Barrier Business Cultural IT Cultural Financial Description Need to balance short-term goals and long-term benefits Need appetite to sustain the change journey and not on a quarter-by-quarter basis Innovation is limited in the short term while simplifying the architecture Need to minimize non-completion risk Highly paid technology specialists who support the business lines directly Paid for rapid implementation of technology to enable trading of bespoke products Significant investment required upfront Software amortization needs to be considered in the transformation business case Mitigation Example Correct sponsorship and governance Transformation and integration will allow for more innovation in the future Commitment from business to see the journey through Move towards flow products lessens dependency on specialists Reorganize to create cross-product support Business case needs to be developed to find investment from other outlets (e.g. reduction in CTB budget) Transformation Risks 9 Risk of budget / cost overruns Key personnel attrition Change in company situation or industry landscape during the transformation Financial metrics tracked throughout with accountability Roll-back points established and planned along the transformation journey
Moving Forward Many capital markets firms have a compelling need to simplify or restructure certain businesses, including transforming their IT architecture and operating models, but there is no single path to transformation that is right for all firms. Whatever path is chosen, however, firms should seek to combine business model rationalization, simplification of IT architecture, and appropriate changes in organizational and operating models. With the right IT structure in place, firms can address changing client needs, whether for high-volume flow products or for newer, more complex products offering the possibility of higher returns. Under any circumstances, transformation is a difficult and lengthy process, and the time to start is now. Packaged software, componentized solutions, and use of industry utilities can make the transformation easier and more cost effective. Bundling architectural simplification with organizational simplification can yield additional benefits in lower costs, better utilization of inhouse resources, and a sharper focus on competitive differentiation. 10
Contacts Jonathan Firester Managing Director, Accenture Trading Services NA jonathan.firester@accenture.com Laurie McGraw Managing Director, Accenture Trading Services NA laurie.a.mcgraw@accenture.com About Accenture Accenture is a global management consulting, technology services and outsourcing company, with approximately 275,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the world s most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$28.6 billion for the fiscal year ended Aug. 31, 2013. Its home page is www.accenture.com. Copyright 2013 Accenture All rights reserved. Accenture, its logo, and High Performance Delivered are trademarks of Accenture. 13-4445 / 11-7331