BCG Global Capital Markets Report 2017
Mastering the Value Migration
The capital markets ecosystem turned in a decent performance in 2016 compared with the previous five years. Although investment banking revenues continued to decline, they did so at a lower rate, while other types of players—such as exchanges and venues, information providers, and buy-side institutions—realized revenue gains. The net result was year-over-year growth of 5% in total industry revenues.
We refer to the shift of global revenue pools from banks to nonbanks as the value migration. This migration has continued along the following paths:
1) From smaller investment banks to large universal banks
2) From players without a specific niche to those with a concentrated focus, such as boutiques specializing in M&A
3) From regulated to unregulated entities
4) From firms with weaker digital capabilities to data- and tech-savvy firms
5) From players without a distinct informational advantage to those with proprietary data and insights
Although a lessening of the effects of quantitative easing, along with impending deregulation, may dampen the impact of the value migration, institutions must still find ways to master it and make it work to their advantage. Several key forces will continue to shape the evolution of the market.
One such force is evolving regulatory dynamics. While some regulatory easing is expected in the US, it is not clear how deep or broad the changes might be. At this stage, the only certainty is continued uncertainty, which may make it increasingly difficult for banks to carry out strategic planning. Moreover, while banks may benefit from regulatory relief, the US financial regulatory framework will, overall, continue to provide advantages to nonbank competitors.
In Europe, regulatory trends are likely to follow suit. Initiatives such as the updated Markets in Financial Instruments Directive (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) will open the door to greater transparency, shift trading to more centralized marketplaces, and develop more explicit pricing for trading and investing.
Another driver of the industry’s transformation is the increasingly tight link between value creation and data and technology. To investigate this point further, BCG looked at total shareholder return for a sample of publicly traded firms in the industry. Our analysis determined that exchanges and venues, along with information providers, have led value creation in the post-crisis era, a finding consistent with the value migration trend. Moreover, we saw that top-performing firms come from every part of the ecosystem—pure-play investment banks, buy-side institutions, exchanges and venues, and information providers—and share a number of common traits. Crucial among these is a commitment to leveraging technology for more digitally innovative ways of doing business.
The implications of this trend vary by player type. For an investment bank, for example, a key challenge is to move beyond traditional ways of leveraging data to drive value. Greater emphasis should be placed on using cutting-edge technologies to provide a more holistic view of the client and facilitate a more customer-centric approach to client service. Similarly, banks must move beyond providing research and advisory services on the basis of a so-called soft-dollar commission model and toward developing platforms that can be monetized either directly or indirectly.
One recent manifestation of technology-driven value migration and regulatory arbitrage is the rise of principal trading firms across electronically traded asset classes. These players are capturing significant share from traditional market participants in trading activities. They are also seeking to expand into new asset classes and to diversify beyond pure market making into areas such as customer business (with the support of prime brokers), risk management analytics, and liquidity outsourcing to other intermediaries, all of which puts further pressure on the traditional “supermarket” model of banking.
Given rapid market evolution, ecosystem players — especially banks — must also continue to push for digital transformation of their businesses. Successful digital innovation requires a comprehensive reevaluation of people and incentives, organizational structure, processes, and operations. The road can be rocky, but if navigated skillfully, it can result in a leaner and more adaptive organization that is better able to seize the opportunities provided by continued market change.
Fintech in Capital Markets – A Land of Opportunity
The fintech phenomenon has grown dramatically over the past decade, resulting in enormous opportunities for collaboration between established capital markets (CM) players such as investment banks and young fintech companies, but the potential is far from being realized.
Indeed, fintech is introducing new paradigms that CM players can exploit to their advantage in a landscape that is complex and difficult to navigate.
Yet time is of the essence. Banks and the entire capital markets ecosystem must take action now in order to gain the considerable benefits available. Without aggressively establishing industry consensus and standards or simplifying IT architecture, incumbents may find themselves left behind by the changing market structure brought about by these new entrants.
BCG Global Capital Markets Report 2016
The Value Migration
Unfavorable economic conditions, escalating capital requirements, and stubbornly high costs continue to depress the performance of many investment banks. Their collective 6% ROE in 2015 capped off five years of dismal revenue results.
Yet the same cannot be said for the capital markets industry as a whole—the ecosystem that includes buy-side firms, sell-side firms, information service providers, and exchanges. Indeed, even as regulation forces investment banks to retrench and hinders their ability to compete, other players remain unaffected and will even, in some cases, benefit. Over the next five years, revenues in the capital markets industry will grow by an estimated 12%, increasing to $661 billion from $593 billion in 2015.
The asset base of buy-side entities is expected to reach around $100 trillion by 2020, up from an estimated $74 trillion in assets under management (AuM) in 2014. If this transpires, the buy side will generate nearly $300 billion in fees by 2020, constituting 45% of the overall capital markets revenue pool (assuming favorable market conditions and current fee structures). However, investment banks, on the sell side, are expected to generate just over $205 billion by 2020, a decrease to 31% of the total revenue pool from 53% in 2006.
Information service providers and exchanges are poised to benefit. They will profit from increased demand for technology solutions and greater access to market information and analytics. Growth in electronic exchange trading and the use of central clearing will mean that their share of the capital markets revenue pool will grow to 19%, representing an estimated $125 billion, by 2020—an impressive rise from 8% in 2006.
Yet even as competition intensifies, opportunities for investment banks will continue to arise. Some larger or niche players will be able to absorb market share from those that are retrenching. Others will require a change in mindset and approach to explore alternative revenue opportunities beyond their traditional roles as capital raisers and market makers. Such players might consider leveraging internal data and technology systems to diversify revenues and enhance their market positions. They should build on their already mature sourcing strategies to push to the next level of operational and process efficiencies.
Moreover, the role of capital itself is changing. Escalating capital costs, occurring simultaneously with the growth of buy-side assets and revenues, indicate that the industry is moving toward leveraging benchmarks and other index products aimed at passive investors. Both the ability to discover liquidity and the demand for risk transformation services are becoming less dependent on capital. If investment banks are to compete, they must recognize their ability to generate revenues as information companies.
Ultimately, investment banks will need to be the right size, develop the right model, and take the right approach to return to consistent profitability. Dealers must learn to compete within the critical sectors of the new capital-markets ecosystem—data and financial technology. How they fit themselves into increasingly electronic, standardized, and transparent markets will be crucial. They are losing the battle so far, but that does not mean they will lose the war.
This report, BCG’s fifth annual study of the global investment banking business, emphasizes the challenges that investment banks face and examines the consequences of new and diverse players in the overall capital markets ecosystem invading their territory. Traditional revenue streams are migrating to these entities, and it is still unknown whether—or when—this trend will reverse. Either way, the investment banking industry has entered a highly dynamic, largely unpredictable era. It is time for players of all stripes to assess their current strengths and weaknesses and to plan for the future.
BCG Global Capital Markets Report 2015
Adapting to Digital Advances
As predicted in two previous reports by The Boston Consulting Group, return on equity (ROE) in the capital markets and investment banking (CMIB) industry continued to fall in 2014 from already-low levels. Revenues declined, although costs did not—and leverage constraints increased. Regulation and regionalization made markets even bumpier and more brittle, with quantitative easing exacerbating market dislocations, as observed in the U.S. Treasury market in October 2014.
Long periods of low volatility have been interrupted by extreme spikes, with issuers flooding the primary market and dealers pulling out of capital-intensive businesses such as fixed income, currencies, and commodities (FICC) when the cost of warehousing assets became prohibitive. Negative interest rates in some European countries means that banks will struggle to maintain a positive overall net interest margin. This development, combined with other punitive capital requirements, has made it very difficult for banks to be in the risk capital business. Indeed, many are turning away.
For the institutions that remain, of course, reduced capacity should provide an opportunity to boost market share—but the challenging environment in 2014 prevented most from making any significant gains. Indeed, a bigger buy side (although itself under increased pressure from regulators) demands margin reduction in a world increasingly characterized by electronic trading, while higher capital costs and the need for more technology investment are impairing profitability. Banks have seemingly reached an impasse of sorts, with the industry’s cost-to-income ratio (CIR) stubbornly remaining above 70 percent, albeit with wide variation depending on the specific business model. The industry gloom that we have been forecasting for some time is now well and truly upon us.
This year’s report, our fourth annual study of the global CMIB business, emphasizes the digital domain. Our aim is to provide food for thought for senior management teams as they look to transform their organizations into lean, digitally fit, client-centric institutions.
BCG Global Capital Markets Report 2014
The Quest for Revenue Growth
The capital markets and investment banking (CMIB) industry continues to try to navigate its way through a transformational period that requires tough strategic choices. Declining revenues, an extremely challenging regulatory climate, clients that demand higher service levels and more innovative products, a shifting workforce culture, and the need to forge meaningful business partnerships are common items on the agendas of senior management teams globally.
Although the industry-wide revenue decline in 2013 was not dramatic, at about 2 percent, the largest revenue pool—fixed income, currencies, and commodities (FICC)—suffered a steep drop of 16 percent. This decline was offset to some degree by substantial rises in equity and investment banking division (IBD) revenues. But after-tax return on equity (ROE) remains under pressure, falling slightly in 2013 to 11 percent, with further declines probable in 2014.
Overall, we believe that the industry’s focus on regulatory compliance and cost reduction, necessary as those activities may be, has worked somewhat against placing sufficient emphasis on improving core business capabilities and increasing revenues. As for regulation, the framework for the future has largely been set. It is the implementation of this structure that still has a long way to go—and that continues to generate uncertainty regarding both revenue models and costs.
With the outlook for revenue growth so dim, the industry winners will be those institutions that are able to increase market share. Several factors will be key to this battle. First, client centricity continues to be critical as a way to make relationships more comprehensive, more durable, and more fruitful both for the client and the bank. Second, CMIB institutions need to define what the investment banker of the future looks like—and to make sure they can attract the best and brightest. Such individuals will need a broad set of skills, an entrepreneurial and innovative spirit, and the ability to embrace a deep cultural sense of compliance and collaboration. Third, CMIB players need to investigate commercial partnerships in order to mitigate the revenue effects of retrenchment in certain regions and products.
In our 2013 report, Survival of the Fittest, we asked whether the CMIB industry could survive in the long term. Our answer then, as it is today, is yes, but tall challenges remain. In this, our third annual report on the global CMIB business, we take a deeper look at those challenges, particularly regarding the core dynamics—revenues, regulations, clients, people, and partnerships—that influence the six business models that we feel are most viable. Our aim is to provide food for thought for senior management teams as they refine their strategies.
BCG Global Capital Markets Report 2013
Survival of the Fittest
The capital markets and investment banking (CMIB) industry is in the midst of a multiyear transformation that necessitates tough strategic choices. In the fixed-income, commodities, and currencies (FICC) arena, for example, some players are pulling out of capital-intensive businesses and radically scaling back large parts of their fixed-income units. Other institutions are leaving the commodities space, providing opportunities for competitors—either existing or new—to gain share. In cash equity brokerage, some European players are either restructuring or exiting altogether. And the industry has still not recovered to its peak precrisis performance levels.
Indeed, after-tax ROE levels of 15 to 20 percent appear to be a thing of the past for most players. The industry average was in the 10 to 13 percent range at the end of 2012, and we estimate that a further 3 percentage points of negative impact from regulation has yet to be absorbed, which will push current ROE levels down to the 7 to 10 percent range.
This situation poses a fundamental question, one that is currently being debated in the market: with other financial-services sectors yielding higher ROE, is the CMIB industry likely to find enough support from impatient investors and boards of directors to survive in the long term? The answer is yes, but with caveats.
Overall, we believe that the central role of CMIB institutions in the global economy remains intact. Corporations and governments still need to raise capital for investments, investors still need to find adequate returns, and risk still needs to be assessed, intermediated, and transformed.
Yet numerous pressures exist. Some issuers and investors, for example, are attempting to create a marketplace without intermediation. Certain less-regulated entities such as hedge funds and physical-commodity traders are venturing into the traditional CMIB space. On the resource side, the industry is experiencing cost pressures as well as capital constraints. As a result of these and other dynamics, although the market for CMIB services will remain vital, the value that banks capture will continue to shrink. Some players may be forced to exit the industry entirely, and many more will leave certain asset classes or gradually reduce their exposure and investments in unprofitable areas. In brief, only the fittest will survive.
In this, our second annual report on the global CMIB industry, we explore key market developments and their impact on CMIB players, address the different choices that banks face today as seen through both a “client” and a “product” lens, and propose six business models that we perceive as the most advantageous. In their purest form, these models have the potential to generate ROE well above the 12 percent level that many players will struggle to achieve. But we emphasize that significantly higher ROE levels, those that are closer to the performance of other sectors of the financial services industry, will be attainable only by relatively few institutions within each of the six business models.