The Great Compliance Opportunity
Compliance pressures are costing the investment banking and broader sell side community dearly. An alphabet soup of regulations, along with a tough macroeconomic climate mean value is being diminished for investors, with returns on equity for some falling below the cost of capital in 2016.
Amid this regulatory Balkanization and margin pressure, challenger banks and financial service providers are beginning to carve out market share, unhampered by legal or technological legacy issues.
Industry pain is widely apparent: FIS’s recent survey of 500 sell side executives shows that 76 percent of our respondents expect to be “severely affected” by increased regulations in the next 24 months; 75 percent expect a significant change to their revenue model as a result; 79 percent expect algorithms to take an increased share of trading and transactional activities.
Automatic for the People
Within that last point – the growing role of algorithms - is a kernel of hope for the sell side.
The challenges of dealing with regulatory pressures from Dodd-Frank; Basel III; EBA Governance Guidelines; European Market Infrastructure Regulation; Foreign Account Tax Compliance Act; the FRTB; FSB Principles; MIFID II; MIFID III; et al all have ramped up the cost of compliance in terms of both time and effort. They also spell an opportunity.
While recent industry IT spend has been largely driven by compliance requirements; the investment can also be leveraged to drive better results in areas that are critical to business and customer experience – helping clients respond to demands for trade transparency; with the more repetitive and prescribed jobs of compliance teams increasingly automated.
Digitalization of many more manually handled processes also means that more sophisticated services can be made available to new markets. There are also significant digital opportunities in the deal management area. M&A, IPO, and private placement for example all require heavy analysis, coordination, documentation and communication between multiple internal and external teams that delay the deal management process and security.
Adapt or Die
We see, in short, huge opportunity for banks to change the way they do business. New technologies that make it easier to automate and outsource compliance obligations are enabling the industry to improve the accuracy of asset and liability positions, hedging and performance metrics. They also have significant potential to help manage the market’s rapidly expanding regulatory and administrative burden.
Technology and data can be better used to help dealers more efficiently link potential buyers and sellers, reducing the need for inventory to ‘rest’ on dealer balance sheets and allowing automation of elements of price distribution, construction and risk management.
To make the most of this opportunity, the sell side will have to re-evaluate entire business strategies over the next few years. This will include rethinking the types of products they provide, the technology they operate and their exposure to regulatory risks in a world where their trades and transactions are increasingly transparent to regulators and clients.
Amid diminishing returns on capital from market making, faster structural change is needed. Yet our survey shows that just five percent are increasing investment in compliance and only seven percent boosting their investment in risk. In a world in which companies are under constant speculative attack, this is storing up security trouble for the future.
As established revenue models come under increased scrutiny from regulators and clients, it is likely that old revenue models will start to fail. As a result, large firms in particular must become more nimble at adopting new technologies and business models before their competition.
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