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Capital Markets: Building the Investment Bank of the Future Contents Capital Markets: building the investment bank of the future Contents Executive summary 2 What does the future hold for your investment bank? 3 Reshape the business 5 Grow the business 7 Optimize the business 8 Protect the business 11 Control the business 12 Toward the investment bank of the future 13 Executive summary We believe there is a bright future for the capital markets Grow the business: To regain profitable growth, industry. The long-term market fundamentals are positive, 2 investment banks should clearly define their risk even if the recent financial performance of many global appetite, the clients they want to serve, the products investment banks is disappointing. While aggregate revenues they want to offer and how they want to distribute for the largest investment banks in FY15 were in line with those products, as well as the geographic footprint pre-crisis revenues a decade earlier, some businesses (such of the organization. In addition, they should harness as parts of fixed income, currencies and commodities (FICC)) the power of analytics to better serve the clients they seem to be in terminal decline.1 Moreover, operating costs and already have. capital requirements have significantly increased. This means Optimize the business: New operating models should long-term success will demand that banks fundamentally 3 be developed that take advantage of technology, reshape their business. partnerships and industry utilities to improve service Ever since the global financial crisis, the viability of the and reduce cost. In addition, banks will need to investment banking business model has been under scrutiny optimize their balance sheet in the face of multiple and banks have been struggling to redefine their roles. They’ve market and regulatory constraints. been faced with a litany of challenges: sluggish economic Protect the business: In the wake of the London growth, low interest rates, scandals, fines, legal settlements, 4 Interbank Offered Rate (Libor) and foreign exchange demands for greater tax transparency and new regulations. scandals, banks must rebuild trust. The right Additionally, they have had to contend with the rise of upstart organizational culture will be a key differentiator competitors that are unburdened by large overheads and for leading investment banks. In addition, given the legacy IT systems and can take advantage of regulatory ongoing threat of cybercrime, banks must take steps arbitrage. Banks have retrenched and restructured in what to ensure that their systems are secure, that they use has so far been a mostly unsuccessful effort to recapture technology where possible to maximize the coverage the double-digit returns on equity of a decade ago. The task of internal protections, and that their people are is unfinished. adequately trained and supervised. However, the world still needs a wide array of investment Control the business: Compliance and risk banking services. Even in an age of slow growth, businesses 5 management must be a priority; in addition to continue to need help raising capital, managing risk and using technology and training, management tone, facilitating trade. We believe the winners in this environment transparency and the importance of controls-based will be firms that restructure successfully, develop a sharp reporting should be promoted. focus on the things they do best and embrace innovation. In short, investment banks need to fundamentally rethink the way they are structured and operate. Figure 1 The time has come for banks to focus not on what they don’t Innovate want to do, but on what they want to become. Investment r. e banking leaders should be bold and innovative in developing a tt e b new vision and strategic direction for their organizations. Then s u e the leaders must radically transform their business models to k a align with the new vision. We believe banks should concentrate M Grow Optimize on five goals: Reshape the business: Banks will need to restructure Reshape 1 operations to be more mindful of legal entity structure and transfer pricing. They will need to make K capital allocation decisions and associated footprint e Protect Control e p decisions regarding products, clients, geographies u s s and counterparties that fit into that new structure. a fe But having a robust decision-making framework . and obtaining relevant data to inform strategic decisions will be challenging while markets remain unsettled. Those that seize the initiative and reshape their business will likely do so through disposals, wind-downs, acquisitions and new strategic alliances. 1Revenues earned by the largest 14 investment banks or investment bank divisions of universal banks through FICC trading, equities trading, debt and equity issuance, and M&A advisory services Building the investment bank of the future | 2 What does the future hold for your investment bank? The investment banking industry continues to face an uphill Many banks are pulling back from once-lucrative businesses struggle to deliver sustainable returns to investors. Investment that are now too capital-intensive, such as fixed income banks have been in reactive mode, making incremental and trading, or that have an adverse impact on their funding and tactical changes, often in response to the urgent demands liquidity requirements, such as prime brokerage. Meanwhile, of regulators. The short-term focus of the regulatory agenda competition is intensifying. As regulators have forced major has constrained their ability to make discretionary strategic global investment banks to hold more capital and liquidity and choices, and their long-term vision has been impaired. curb some of their activities, new competitors have emerged Since the crisis, most banks have been through multiple that are either unencumbered by legacy infrastructure or more strategy reviews. They’ve been preoccupied with scaling back able to exploit regulatory arbitrage opportunities. In many their business; withdrawing from geographies, asset classes cases, regional banks and asset managers have picked up the and customer segments; and reducing their workforce. Despite slack (figures 3 and 4). this downsizing, the average return on equity (ROE) for the top The good news is that demand for many investment banking 14 global investment banks was just 6.3% in 2015 (see figure services remains strong (even if the revenue pool for certain 2). And although a handful of these banks managed to post businesses, such as FICC, has shrunk significantly and perhaps ROEs greater than 10%, performance across the industry may permanently). However, the market share of major investment decline further, with regulatory pressures continuing to drive banks in certain businesses is diminishing. Banks are struggling up costs and prudential rules driving up risk-weighted assets to counter this threat, as they remain saddled with legacy (RWAs). In particular, banks are challenged by the fundamental operations, cultures and IT systems. As a result of over- review of the trading book (FRTB), rules around counterparty investment in piecemeal, proprietary IT systems and ambitious credit risk (CCR), credit valuation adjustment (CVA) and capital inorganic growth, disparate systems have not been integrated requirements (especially as a result of total loss-absorbing into single platforms at many investment banks. If global capacity (TLAC) and leverage ratio proposals). As a result, players cannot address these challenges, they will struggle we believe that, without any cost restructuring or capital to win back market share, even if the overall capital markets optimization, industry ROE could fall below 5%. sector recovers as we expect. To meet the complex array of challenges they face, banks must become more strategic and more sharply focused on transforming their businesses. Figure 2: Average return on equity for leading investment banks 18.4% 19.5% 20 17.0% 16.0% 15 10.9% 9.4% 8.6% 10 7.8% 6.3% 4.3% 5 0 -5 -10 -15 (12.6)% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Sources: Company accounts, EY analysis 3 | Building the investment bank of the future Figure 3 Figure 4 Debt and equity issuance (number of issues in thousands) Top 50 M&A deals — value split (US$b) 24.8 25 8 21.1 7.0 20.2 7 6.4 20 5.9 13.8 56% 6 15 5 67% 14.2 12.2 72% 5.0 4.1 65% 4 3.7 10 3 11.0 2 5 44% 0.8 1.1 1.5 33% 6.9 8.0 35% 28%1 1.2 1.1 0.7 0 0 2005 2010 2015 2005 2010 2015 Regional Global Regional Boutique Global Sources: Thomson One, EY analysis Sources: Thomson One, EY analysis Considering this backdrop, what is the best route to businesses; pulled back from unprofitable geographies; recovery for investment banks? Many banks have tried to rationalized their product offerings; sorted out regulatory and make the changes necessary to compete in the future while legal issues; and begun to think about innovation. However, the simultaneously maintaining their existing operations. But that most successful banks will completely reassess what they want approach can be complex, risky and expensive. We believe the to be and how they operate. Traditional organization structures time has come to consider building the investment bank of the and business models are things of the past. future from scratch, or from as close to scratch as possible. Banks now need to return to first principles and ask what their In the future, the global investment banking industry can no purpose is, who they want to serve, what services they want to longer compete while relying on traditional organizational offer and how they want to provide them. How they innovate structures and business models. will be central to their survival. And most important of all will Most global investment banks are at a critical point in be their ability to execute change in a challenged environment.
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