In recent years we have witnessed how digitalisation has triggered sweeping change in the way business is conducted across all industries. Key developments such as social media, mobile, analytics, big data and cloud computing have been the drivers, which in corporate and institutional banking as a whole has meant the development of client portals, electronic trading venues and connectivity standards such as FIX.
The capital markets have not seen the same degree of automation witnessed in other market sectors. This is about to change – but what will it look like?
Change in the capital markets, however, has been slower, with take-up of such technologies varying greatly between different market participants. The onward march of technology in a marketplace increasingly shaped by the waves of regulation since the financial crisis means further structural change in the capital markets is inevitable. Data is already king — but it is the way we use it to optimise working practices that will be critical for the future shape of the industry.
As I look back over my 35 years in the capital markets I realise that many processes remain manual: there has been gradual progression, but limited fundamental change. Driven partly by regulation, but also by the needs of different client bases across multiple asset classes, this hitherto slow pace of change is now gathering speed; it is only by embracing it that banks will be able to serve clients better and in a more focused regulatory environment. With technology, having a clear and open mindset — and a long-term view — is critical to the effectiveness, transparency and fluidity of the global marketplace. While we have seen marked improvements in many activities in the last few years, there is still much work to be done in order to overhaul and automate many day-to-day processes, using both in-house and external technology. Doing so successfully will be crucial for the longevity of the financial markets industry.
Another 48 hoursIn the late 1990s progress in primary bond issuance processes saw many institutions start developing internal bookbuilding systems to support deal execution, giving borrowers their first taste of the order collation process. By 2003, efforts to link such systems began to greatly reduce the time and effort needed to agree the final investor order book and allocation of new bond issues — marking a major milestone in the evolution of primary markets automation. (Deal execution had previously often extended to a 48-hour period, leaving all parties exposed to market volatility — and therefore vulnerable to increased risk.)
Today's marketplace allows borrowers to issue multi-billion, multi-currency transactions intraday. AB InBev's $46bn and €13.25bn M&A-linked debt financing at the beginning of 2016 serves as a classic example of the improved market efficiency we now expect.
But the industry continues to push ahead: systems are providing investors with direct access to order books, supporting and enhancing the existing framework of voice execution that will remain an integral component of engagement. This should allow for an even swifter bookbuilding process, leading to even shorter timeframes for execution.
To understand the future direction of the capital markets, it is perhaps worth taking a cue from the automation witnessed in other businesses. Between 2012 and 2015, the proportion of FX spot transactions executed electronically rose from 60% to 70%, according to a BIS study citing Greenwich Associates and McKinsey data (see chart). If this figure exceeded 85% by 2020 we should not be too surprised. Electronic execution in the same period (2012 to 2015) for US Treasuries rose from 55% to 70%, while for investment-grade cash trading it rose from 15% to 40%.
Government bond investors now regularly trade on prices produced by automated systems, using a variety of protocols ranging from dealer-to-client request-for-quote (D2C RFQ) and central limit order books (CLOB) to dark pools. The ability to share axes with investors electronically has proven to be a key tool in the new light-balance-sheet model strategy adopted by many institutions.
Client co-creationMany see technology only as a cost, preferring to stick with an old-fashioned set-up of spreadsheets and lots of manual labour — but the point of technology is of course that it can bring many benefits. Those that adopt a fintech approach see the deployment of technology as a way not only to build a more robust, long-term business, but also to improve the client journey and explore new ways of working, for instance by engaging in "co-creation" methods with those clients.
It is through this process that market participants are best able to draw upon their creative resources to have a clearer picture of the challenges faced by the industry — and to find enduring solutions to those challenges. This cannot be achieved without investing heavily in IT and employing state-of-the-art quantitative analytics. Unsurprisingly, those that are actively seeking technological solutions in partnership with clients are the ones setting the pace in shaping the future direction of capital markets. Those that underinvest will fall behind and lose market share.
Two priorities: funding the economy and dataData is key: the ability to track client activity and interpret signals from markets will provide insights and intelligence that should not only support the existing industry framework, but maximise its capacity to provide issuers and investors an even greater diversification of funding and investment tools. In the primary markets, the capacity to exchange general market information about current trading flows and general investor appetite with issuers should enhance the price discovery process ahead of a new issue syndicated deal. Historical reference points for new issue pricing — secondary comparable trading levels and credit default swaps — will be bolstered by additional intelligence gained from systems driven by improved technology. However, it is critical that the data sourced be reliable and useable.
Fundamentally, it's all about the economy. Policymakers have long focused their energies on making capital market processes — and hence access to funding — better and more efficient. Take the distribution of private placements (including Euro private placements) and medium-term notes (MTNs): with much of the post-crisis public discourse focused on liquidity and bank lending — especially for small and medium enterprises (SMEs) — this is one area where deploying artificial intelligence and deep learning know-how to monitor market movements could reap significant dividends in mapping investor enquiries to issuer funding levels. And this could happen sooner than we may expect.
New platforms that aim to simplify the issuance process in the MTN private placement market are already in place, acting as a central information hub of insights on funding needs and investor appetite for both issuers and underwriters. There are also initiatives under way in the Euro private placement market that aim to create a dedicated infrastructure underpinning the management of private information in transactions. This should build a strong foundation that will support the issuance process and give market actors confidence on their regulatory obligations (thereby reducing operational risk).
In strengthening the efficiency and accessibility of the market — especially for smaller borrowers such as SMEs — these fintech-driven platforms will play a key role in diversifying the funding toolbox, in turn supporting European policymakers in their quest for market efficiency, transparency and regulatory compliance.
Embracing digital transformationWe are at a crossroads. Investor access, diversification of funding tools, data consistency and regulatory compliance all sit at the confluence of today's complex assortment of market challenges. Embracing fintech solutions will allow us not only to meet those challenges; by easing the operational demands of market participants, technology will also help embed the culture of better conduct in the industry that has taken root — and propel the market into the future.
At the start of this article I made reference to the impact of regulation on the shape of the financial markets. It is clear the likes of MAR, MiFID II and others are fundamentally changing processes in different market places. MiFID II, for example, requires record-keeping of all material steps during the life of a transaction, with all relevant information available to hand in a short timeframe. We must be able to justify final allocations made to each investor and the issuer must formally validate the allocation. This is but one example of the many decision-making processes that are radically transforming how banks interact with clients and with each other. Pre- and post-trade transparency, better record keeping and trade justification must be automated — or we will take a big step backward.
In summary, our financial industry is preparing for dramatic change and we must evolve and adapt. A new generation — the millennials and "digital natives" — has grown up using technology in every aspect of their day-to-day lives and want to extend that experience to the workplace as well. They are the future of our industry and we must embrace their worldview if our industry is to continue to thrive and attract the best talent. Technology will continue to allow markets to evolve dramatically in the years ahead and we must see it as a way of complementing and enhancing existing voice communication, for it is the human connection that will always count. We must move forward — but it will require the participation of all stakeholders in partnership to arrive at the best possible outcome.
This article also appears in Global Capital's special supplement: "30 Years of Covering Global Capital Markets"