Digital threat to investment banks

Regulatory changes and old IT systems add to sector’s woes
The way we lived then: many banks have computer systems that date from the 1970s

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Yet another threat to investment banks’ business models looms on the horizon. While having to cope with a host of stricter rules, a tougher capital regime and a sharp drop in revenues, trading firms also face an uphill struggle to transform themselves into technology companies.

The digital challenge has hit investment banks in several ways. More and more trading is moving into the electronic realm, inefficient back office IT systems need urgent reform, and multiple trading platforms have to be unified. At the same time, competition from IT-focused niche players is increasing.

Executives, distracted by all the other serious problems in their industry, have had little scope to come up with a proactive IT agenda.

Bob Gach, global managing director of Accenture’s capital markets practice, says: “The industry has been slow and inconsistent in adopting digital technologies, particularly because the larger investment banks have been focused on other huge issues, such as regulatory changes, conduct, litigation and cost-cutting. Such issues are eating up all the IT budget, so there is little room left for disruptive technologies.”

Yet there is a sense of urgency among executive boards, as they realise that trading houses will in future primarily be technology firms. The top executive of a large European bank says: “We should have revolutionised the way we approach our clients. But instead, we have not moved anything like as rapidly as other industries. Banks have fallen behind.”

One of the most pressing issues is to tackle the bloated technology infrastructure built up in the boom years. Regulatory demands on conduct monitoring and risk management is inflating IT costs at a time when return on equity languishes at an average 11 per cent, says the Boston Consulting Group.

Market leaders, such as JPMorgan and Deutsche Bank, spend billions of dollars on technology each year and most of them have moved some IT centres to low-cost countries and slashed staff numbers. But this has not been enough to contain costs. Global bank IT spending grew more than 4 per cent to $188bn this year alone, according to Celent, a research firm.

Consultants say the sector needs a radical approach to rid itself of a legacy where each business unit has its own IT department, trading platforms and back office infrastructure. Advisors say investment banks need to move on from such a “mushroom strategy” to create centralised IT departments.

Ultimately, this will mean going from a cobweb of dozens or more trading platforms to a unified solution. Consultants at McKinsey said in a report last year: “The end-game may see firms merging [fixed income, currencies and commodities] and equities franchises to create execution factories.”

Investment banks outside the top five have already outsourced crucial parts of their trading infrastructure. UBS this year struck two deals to replace its patchwork of multiple trading platforms with standardised solutions from Murex and Ion Trading, while France’s Société Générale last year outsourced its post-trade processing to a partnership between Accenture and Broadridge.

Nonetheless, larger banks retain technologies they have developed in-house, while initiatives to share costs between rivals through joint ventures, partnerships and open-source projects have mostly failed.

Senior bankers say top tier banks need to become technology leaders rather than merely cutting costs. One area where this is clearly visible is in the trading of fixed income and currencies, which is rapidly becoming more like equities trading, where transactions are executed electronically for a fee instead of banks acting as market makers and charging a spread for the risks they take.

“If the bid/offer spread is zero, you have to find other ways to make money,” says Colin Fan, co-head of Deutsche Bank’s investment bank. “So you have to be more tech-focused than ever before. Where trading is dominated by technology, the heads of businesses better also be tech guys.”

In foreign exchange trading, a cocktail of regulatory investigations into alleged market rigging, mixed with a decline in revenues, has this year prompted a shakeout among once-powerful foreign exchange voice traders – who work over the phone and execute deals personally – while electronic trading heads become a dominant force.

“The head of etrading used to be a token position, but now is a force to be reckoned with,” says Sassan Danesh, managing partner at Etrading Software, a consultancy group.

Trading automation is also a competitive threat for investment banks. “The electronification of trading will make it easier for technology firms to step into the business,” Mr Fan warns.

The digital revolution means that longstanding barriers to entry have crumbled. The need for a large balance sheet has waned; the advent of the agency model brings more price transparency; and online trading platforms have opened more sales channels.

So far, investment banks have held their own. “There are lots of upstarts and disruptive technology firms in various areas of investment banking,” Accenture’s Mr Gach says. “But they are mostly very small and on the fringes. What we haven’t seen yet is the Walmart of investment banking that completely changes the model.”

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