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Investment banking is in the midst of seminal change. The post-financial crisis era has forced a convergence of regulatory, political and cultural change factors that, together, are beyond the vagaries of mere cyclical elements. That was the essential outcome of IFR’s Future of Investment Banking Roundtable.
While the direction of travel of most of the regulatory initiatives is clear, the industry is far from really knowing how all of the initiatives in play –Dodd-Frank, Basel III, European Market Infrastructure Regulation, Alternative Investment Fund Managers Directive, Solvency II, Financial Transactions Tax, ring-fencing in some jurisdictions, to name a few – will knit together and how they will really impact the conduct of business on a day-to-day basis.
What is clear, though, is that running an investment bank just got a lot more complicated – and expensive. The sheer amount of regulation is overwhelming, not just for market participants but for regulators, too. In an environment like this, crafting optimal strategies for success is a daunting challenge.
The high mid-teens and above returns on equity to which the industry and investors had become accustomed are no more. The strategy consultants at the IFR Roundtable talked of a mid single-digit standard for most firms and most products. Investment banking is returning to a utility industry where proprietary trading and complex products that served investment bank salesmen and traders more than customers have given way to customer-driven vanilla flow businesses and simple capital intermediation. Returns will be lower, but investors should perhaps be comforted by the lower volatility profile of those returns.
Investment bank leadership has undergone significant change at the apex of the industry, and the new leaders understand that things are different, and that individual client return metrics and costs of product provision and coverage are fundamentally important. And it’s not just in the front office where things need to change. We’re at the beginning of a fundamental reappraisal of middle and back-office aspects, too, across operations and technology infrastructure.
Senior management is now asking questions it never really asked before. Does it make sense to handle all back-end processing in-house, for example? The answer is categorically no. Are banks yet at the stage of being able to divorce front and back offices? Not yet, but roundtable participants said this was partly owing to the lack of a credible independent third-party that could currently handle the processing flow of a leading institution; surely a hugely lucrative gap in the market.
The era of being all things to all people across all products anywhere in the world is behind us. Bank management is now focusing on areas where they can genuinely add value to their chosen client base. Global top-tier players will number four to five at best. Other houses will need to rethink. This goes beyond deleveraging for capital relief to the heart of the how the business proposition needs to change.
At the end of the Roundtable, panelists were asked to evaluate their thoughts as to how successful they thought investment banks were going to be in the New World using a one to 10 scoring method. The consensus score was a fairly high 7.34. But IFR’s panelists all said that their individual scoring came with a wide standard deviation. Some banks, they said, scored three or four. That’s a sobering thought as banks navigate their way through the fog of change.