Facing ongoing challenges from disruptive industry trends, investment banks must take action on a number of fronts if they hope to put themselves on a positive trajectory for the future, according to a new report.

The report, Global Capital Markets 2015: Adapting to Digital Advances by The Boston Consulting Group (BCG), a global management consulting firm, is being released today (May 17).

The report, BCG’s fourth annual study of the capital markets and investment banking (CMIB) business, provides a detailed examination of key market developments, placing special emphasis on the evolution of digital technology and the steps that investment banks must take to adapt to a shifting industry landscape.

“Investment banks can no longer ignore the power of the information technology era in which we live,” said Philippe Morel, a co-author of the report and the global leader of BCG’s capital markets segment.

“It has forced other industries to completely overhaul their business models, and is now being brought to bear on the world of capital markets. The time for digital adoption is now.”
Revenues

According to the report, global CMIB industry revenues declined once again in 2014 to $239 billion, down 3 percent from $246 billion in 2013 and down 12 percent from $271 billion in 2010, as cyclical and structural headwinds continued to pressure the top line.

Fixed-income, currencies, and commodities (FICC), which made up 55 percent of all revenues in 2010, saw its share of the total fall to 49 percent ($117 billion in 2014). Unusual volatility and low client flows have been the primary reasons for poor performance, although structural issues have also plagued the market.

Moreover, new regulations that limit proprietary trading, such as the Volcker Rule in the US and ring-fencing in the UK, will undermine the ability of investment banks to act as market makers in the years ahead.

On a more positive note, advisory revenues grew 4 percent to $62 billion in 2014, driven primarily by very strong M&A revenues, which grew 14 percent to $16.5 billion, the strongest growth in five years. BCG expects 2015 to be another good year given the cyclical nature of M&A, which tends to follow five-to-seven-year cycles.

Return on equity and operating profits

Return on equity (ROE) in the CMIB industry continued to fall in 2014, to 7 percent, from 11 percent in 2013 and 12 percent in 2012. BCG expects the downward trend to continue, with industry ROE remaining below 10 percent unless major restructuring occurs.

In addition, industry operating profits were at historical lows in 2014, down 28 percent since 2010 to just $68 billion. Equity capital markets, debt capital markets, and M&A were the only bright spots, buoyed by strong issuance thanks to low interest rates. Rates trading has suffered the largest decline, falling 64 percent to just $8 billion in 2014, down from $22 billion in 2012.

The new digital disruption

According to the report, the information advantage that investment banks have traditionally enjoyed is being eroded at the very moment when information technology is entering a new evolutionary phase.

Digital advances are facilitating the flow of information away from banks and into new channels. These advances are also allowing data to be created and controlled by nonbank entities. Some CMIB firms see the handwriting on the wall and are implementing measures to stay ahead of the curve. Other firms are adapting too slowly, if at all.

BCG says that investment banks must conduct a systematic review of all areas where the business model can be upgraded through digital improvements, including cost reduction and better distribution that lifts revenues. Partnerships will play a key role, and these can occur all along the value chain. There are many opportunities in digital trading, for example.

The CMIB industry also needs to reinvent itself on both the cost and revenue sides by sharing non differentiating operations via utilities, just as retail banks have done for many years in the processing of payments, credit cards, and mortgages.

A shifting industry landscape

The report also says that it is no longer possible for investment banks to be all things to all people. Banks can hold key relationships with some clients and source products as necessary, and they can also maintain a competitive or pole position in other products, but the days of being both a relationship leader and a product leader in multiple products are over.

“Today it is better for investment banks to commit to a few product lines in which they can gain the pole position and succeed in the new scale-driven, electronic, winner-takes-all environment,” said Morel.

“The alternative is to compete in too many areas and achieve only low, loss-leading market shares.” – TradeArabia News Service