Capital markets transformation: evolution not revolution

Technology is once again taking centre stage as capital markets firms strive for better performance. As they realize that the big bang approach of yesteryear cannot deliver the innovation and agility they require, investment banks and asset managers are considering a new evolutionary approach to transformation to overcome challenges and future-proof their organizations.

A new research report from Celent, 'The Great Transformation in Capital Markets – Revolution to Evolution', examines the changes that have taken place in capital markets since the 2008 crisis, the wave of big transformation projects undertaken since 2011-12 (designed to optimize operations and reduce costs), and expected trends in the transformation journey over the next five years. This article summarizes some of the key takeaways.

Transform to innovate

In a fast-moving world with ever-increasing regulatory demands and fast-changing markets, the efforts of the past decade did not yield the results banks expected and delivered only modest improvements to return on equity. Following a round of cost-cutting exercises, capital markets firms are left with fewer resources and a growing demand for a digitalization environment - with new technologies such as big data, Machine Learning (ML), Artificial Intelligence (AI), Distributed Ledger Technology (DLT), and Robotic Process Automation (RPA) shaping the next wave of transformation.

Cloud, once regarded as an impossible fit for capital markets, promises huge cost reductions for this space and the possibility of much-needed flexibility and scalability. Security concerns have been alleviated with the rise of better data security practices and better strategic deployment by cloud providers. The hybrid cloud model now seems the perfect balance of efficiency and security.

Fintech is no longer seen as the enemy. Capital markets organizations are now willing to collaborate more to deliver some much-needed innovation. They look at co-innovation to maximize budgets and decrease risk while leaving in-house resources working on key differentiating projects rather than custom development and on premises capabilities. Gone is the rhetoric of "us vs. them" as investment banks and asset managers take their place in a new ecosystem and reinvent themselves as technology companies.

Dealing with legacy architecture

Over the past 20 years, electronification has gained importance for trading and lifecycle activities, but capital markets firms must consider the changing habits and behaviours of their clients and own personnel. They also must contend with new players benefitting from lower technology costs to develop new solutions and change current practices.

New regulatory requirements and market standards have brought to light the different inefficiencies and bottlenecks generated by fragmented systems and processes. Performance issues have been identified and must be addressed. Strategies must evolve and business models be reinvented if they want to become profitable again. While new regulations such as the Fundamental Review of the Trading Book (FRTB) or the second Markets in Financial Instruments Directive (MiFID II) force them to assess the cost of risk calculations, record keeping, and reporting, firms must rethink and optimize their operational costs. They must also deal with fragmented and complex architectures that are the results of tactical implementations and multiple mergers and acquisitions. Such technological complexity is creating operational problems, increasing costs, and creating more inefficiencies. Looking at the future, investment banks and asset managers must be tech savvy to future proof their new architecture, plan for better control, and increase performance.

The human touch

New technology also needs to be embraced by the organization and its people. From management buy-in at the start of the project to personnel engagement during the execution of the project, there is a constant fight against inertia. Financial institutions are often risk adverse and wary of experimenting. Solutions based on these new technologies may be alluring but equally daunting as they challenge the status quo and force change.

The other challenge that comes with new technology is the need for new talent. DLT, AI, cloud, and big data require new skills that are not always easy to find in the established workforce and are proving difficult to attract. After years of banker bashing, the new millennial generation seems to prefer Silicon Valley to Wall Street and favor innovation from companies such as Google and Amazon rather than what they see as stuffy and old-fashioned investment banks and asset managers.

The way forward

A componentized, piecemeal, and adaptive approach is the best bet for capital markets firms willing to transform and onboard new technologies. Digitalization offers the possibility of better tools and analytics in the front-office with better user experience, personalisation, and behavioral analytics. Operations can be optimised through the rationalisation of systems and the reduction of manual processes to increase automation. Following years of cost-cutting, capital markets firms are choosing to use vendor solutions rather than building in house, and leveraging the cloud to achieve new efficiencies in areas such as risk calculations, regulatory reporting, or collateral management.

There's a recognition that operations and system architectures must be future-proofed and capable of easily integrating new developments such as AI in the short term or DLT in a more distant future. Openness and flexibility can be achieved with Application Programming Interfaces (APIs) and an adaptive architecture that's open to adopt the latest Fintech solutions and connect new tools with existing systems.

Capital markets organisations are opting for smaller, incremental projects that help them build a common layer across silos. While simplifying and rationalising systems and processes, this approach also provides them with more agility and flexibility to deal with changing regulatory or business requirements, decreasing risk as each step of the project focuses on specific targeted components or micro-services.

With legacy modernisation, efficiency improvements, and cost optimisation fuelling the next wave of transformation, the best way forward is a leaner, evolutionary approach.

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