An air of cautious optimism prevails in the capital markets as we head into 2017, which should have positive implications for both banks and technology.

Global Backdrop Offers Promising 2017 Environment for Banks and Technology Trends

(Convergence, Collaboration and Cloud set to be Key Initiatives)

Summary

An air of cautious optimism prevails in the capital markets as we head into 2017, which should have positive implications for both banks and technology trends.

However, given the observations in Michael Lewis’s new book “The Undoing Project” which looks at uncertainty behind the “certainty” of so many predictions, perhaps I should tread warily. Lewis, as always, produces tremendous insight into his chosen subject. This time it revolves around understanding how hard it is to know anything for sure.

He describes one of the key characters, Daryl Morey, suggesting a new definition of an analyst: “a person who knows his own mind well enough to mistrust it.” So on that basis, I will persevere carefully with my observations about the likely influences on our industry this year and how those could manifest new developments in banking and IT.  

The prospect of sustainable economic growth and higher interest rates has already lifted equity markets to new highs (even bank shares) and seen bond rates edge up towards more normal levels. It could still be just a sigh of relief that the surprises (shocks?) of 2016 have not yet been the harbingers of disaster that many had predicted.

Nevertheless, the prospect of a more benign environment than originally anticipated under the new scenarios unfolding in the US and Europe could see many banks finally bite the bullet of IT transformation that will be imperative for their future success.

Of course, all scenarios remain fragile and susceptible to derailment. But as Goldman Sachs contemplated recently: 2017 could be a year of “High growth, higher risk and slightly higher returns.” It believes new President Trump’s focus on growth will lead to a domestic US fiscal stimulus, also noting, "We think the popular media narrative on the downside risk of a trade war is overstated."

A potential win-win. Although JP Morgan cautions that the “elevated political expectations are the single biggest risk” facing the markets.

But for many, the biggest potential upset to the applecart is in the European Union, where the impact of Brexit and important elections will have to be digested in 2017. According to a Morgan Stanley survey of investment customers, “The disintegration of the EU is the No 1 geo-political risk for 2017,” cited as the biggest concern by 32% of its respondents.

But, given the overall backdrop, it should be a much better (and long overdue) year for banks (particularly US), which recent share price recoveries are already anticipating. In turn, this should enable them to translate IT transformation rhetoric into more tangible action.

Of course many banks are still focused on cost containment, capital rebuilding and balance sheet strengthening. But, within those activities, there is going to be considerably more scope to actually adopt more strategic technology renovations that will lay longer-term foundations for agility, efficiency, competitiveness and even profitability growth.

There are even small signs that the regulatory tsunami that has threatened to overwhelm the banking industry might have peaked. Certainly many of the new US administration’s comments appear to favour a lighter-touch regulatory regime, offering some hope to those lobbying to halt planned regulations or row back recent regulatory initiatives. We don’t expect any repeal of areas like Dodd-Frank, but look for looser interpretations.

None of this will change the over-riding market dynamics that will see power continue to shift to the buy-side through greater disintermediation, as the sell-side is forced to regroup, refocus and re-discover core strengths and capabilities. In fact, it would not be a surprise to see the biggest growth in capital markets IT spending in 2017 to come from asset managers.

As for the sell side, the next 12-24 months will see an acceleration of the trend away from universal service provision and global footprints as the cost of regulatory capital makes activity in many asset classes and geographies unprofitable.

So let’s take a look at a few specific areas that should get both a bigger share of the spotlight and IT budget priority in the year ahead.

Technology Trends for Capital Markets

The first thing to say is that there are unlikely to be any significant surprises as we move through 2017, but rather momentum building behind some already evident, but nascent, trends. (A possible caveat being that blockchain does have capacity to produce significant disruption if banks, Fintechs and regulators can reach the mutual levels of collaboration required to deliver industry-wide benefits. But for now there are too many fragmented initiatives driven more by perceived individual gains. So let’s call this unlikely for now.)

From a high level these are therefore likely to fall into three broad categories:

1. Convergence: Putting data at the centre of everything. The use of more analytics and data analysts to drive big data strategies that bring front, middle and back offices closer and significantly enhance decision-making
2. Collaboration: The more widespread adoption of strategic IT transformation initiatives in partnerships with Fintechs, other IT vendors (and even other banks!) that automate and fortify business capabilities and reduce costs
3. Cloud: The embracement of cloud as regulators take a more positive and pro-active stance to services that drive down costs, deliver future flexibility and pave the way for Platform as a Service and similar initiatives

All these have been talked about for some time but, while there have been examples of progress, they have tended to be isolated. But there are now stronger signals that this will be the year when lip service translates into actual commitments. Most banks recognise that tackling legacy IT complexity has been pushed into the long grass for too long. Here are therefore a few specific areas that will see more emphasis this year.

1. AI/Robotics/Machine Learning
   • Banks will develop more widespread adoption of AI technologies to improve productivity, accelerate fraud detection, minimise risk & control costs. This will be particularly relevant as demands for scalability and real-time data management grow.
2. FRTB/IFRS9 & RegTech leverage
   • Banks will start to more widely leverage previously proscribed and ring-fenced IT investment for the delivery of regulatory initiatives for wider business advantages. These will include better pre-trade decision-making and more effective and efficient capital allocation and collateral optimisation
3. STP & Data Integration
   • Back office transformation will receive more traction as banks seek to both drive down costs and develop cross-asset class visibility. This will be as a prelude to eventually migrating these functions to cloud-based structures and, eventually, to shared utilities and/or outsourced service providers.
4. PaaS and APIs
   • The industry will belatedly acknowledge the importance of platform-based IT infrastructures, open architectures and the evolution of API’s for basic functionality. Once adoption begins it will probably snowball. Historic resistance to pan-industry collaboration will also crumble as economic, regulatory & customer-centric benefits prevail.

It will be surprising how much capital and cash flow will be freed up by small improvements to margins from rising rates, and the benefits of previous restructurings are finally able to flow through to the bottom line. I therefore expect many senior bankers will this time not waste the opportunity to re-invest and tackle the age-old problem of legacy and complexity.

Another space will be the development of applications (API’s) for specific functions, which will obviously begin to get support both from practitioners and regulators. One such capability which is in beta test is around collateral management and, if this can produce the security and prove to be robust enough and scalable, it might get some traction.

But again, I would err on the side of caution in expecting significant breakthroughs in capital markets from Fintech investment. The industry is showing a greater appetite to collaborate with (rather than just buy out) new financial technology initiatives. And there are signs that collaboration on a wider scale could eventually lead to new business models across the capital markets universe.

In a wide-ranging recent interview with Financial News, JP Morgan CEO Jamie Dimon again summed it up neatly: 

“Corporate customers are still going to need equity, M&A and debt. They’re still going to need FX and derivatives to manage their exposures. Far more of the delivery will be mobile, online, the costs will come down and a lot of trades will be automated. There will be more people who are technologists than they are a trader or a salesman.”

But he left open the door for the unexpected:

“As long as you’re giving the client what they want and using technology to do it, they’ll still be there. There may be some things that are completely different. It is possible there’ll be something the client still needs and we’re not doing it at all yet? It’s possible.”

The key will be to watch those that embrace change and not just talk about it. But by the end of 2017 we should begin to see those banks which will lead the next wave of growth and those which will get left behind.