Can investment banking successfully embrace digitalization?

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Through Cary Springfieldinternational banker

This article originally appeared in the Winter/February 2021 issue of International Banker

With a heady mix of intense competition from the fintech (financial technology) sector, a onerous regulatory burden, and the coronavirus pandemic lately steering consumers more decisively towards their smartphones and laptops, the story of the transition from retail banking towards digitization has become a well publicized and highly visible topic. But it’s not just in the retail sector that banks face such challenges. At the other end of the scale, the same is true for investment banking.

Over the past few years, the investment banking space has undergone significant change with respect to evolving client expectations, industry trends promoting greater financial inclusion and democratization, and ever-changing regulatory requirements. more stringent. For equity capital markets (ECM), for example, higher regulatory and reporting costs have eroded the commission revenue generated from IPOs (IPOs), prompting companies to stay private. Indeed, there has been a drastic reduction in the number of companies going public compared to 20 years ago. Additionally, there are now many alternative fundraising models, which alienate some of the biggest unicorns from the traditional model offered by investment banks and thus further diminish their earning power.

Investment banking also faces significant competition from fintech firms that can now capture a growing share of business and customers from the traditional space. Price and transaction data, for example, has always been in the hands of the sell side, such as investment banks, and has remained somewhat opaque to clients. This has helped banks control their prices and has therefore been a major source of revenue through higher transaction fees and wider price spreads. But today, digital startups can aggregate that transaction data with relative ease, meaning they can erode the monopoly pricing power previously held by investment banks. As Deloitte recently acknowledged, “the trend toward greater price and transaction data transparency will continue,” reducing or even eliminating the need for an intermediary in many cases.

“These companies are proliferating and providing middle-of-the-road solutions that traditional investment banks do not offer or offer in a limited way,” observed Accenture in 2017. “Crowdfunding and peer-to-peer lending (P2P) also eliminated the need for brokers. or investment banking services. As these alternative service providers grow in popularity, revenue from traditional investment banks’ security, lending, payment and investment banking services has stagnated.

Indeed, there is already a growing trend towards the complete elimination of the investment banker when executing and closing deals. In 2016, for example, Comcast Corporation acquired DreamWorks Animation for approximately $3.8 billion and handled all deal discussions without involving an outside investment banking entity. And Spotify managed to list publicly and determine its opening price based on the volume of orders it received, eliminating the need for investment bankers to be involved in the process. “Companies are building in-house deal strategy and advisory teams as a self-service model for executing deals directly,” according to financial services research firm Acuity Knowledge Partners. “It allows them to be flexible and act quickly when needed. Above all, it also saves them from paying high fees wherever they can. Companies are hiring former senior bankers from major investment banks as strategists to act fast and close deals quickly.

Additionally, the coronavirus pandemic has only further accelerated the need for banks to implement sweeping changes to their investment banking business models, the fees generated by traditional units such as ECMs, mergers and acquisitions (M&A) and debt capital markets (DCM) having plummeted in 2020. As such, there is an increasing urgency for investment banking business strategies to evolve, primarily to help customers to counter economic shocks, but also to adapt and identify new sources of income in this difficult market environment characterized by higher capital requirements, an increase in bad debts. and the squeeze on interest margins that weighed so heavily on earnings.

Digitization is at the heart of such a transformation. The coronavirus outbreak and the resulting social distancing measures put in place around the world have meant that digital tools have simply become a way of life for businesses to ensure they can continue to operate. uninterrupted and that their employees can work remotely. “For many investment banking and capital markets institutions, this challenge only relies on the fierce competition for deal flow and compressing fees and margins they face, while responding to the heightened client expectations,” Deloitte recently observed.

To embrace digitalization, many thought leaders see either transforming their core banking systems or creating separate competing entities as viable ways for investment banks to modernize. “If the creation of a brand new bank is attractive, since it allows CIBs [corporate and investment banks] to take advantage of the latest technology and avoid legacy issues, building a new bank is an extremely complex undertaking that can take years to scale,” Boston Consulting Group (BCG) noted in March 2020. management consulting also acknowledged that these institutions are well aware that it will likely take several years to complete a traditional IT (information technology) transformation and that the results could still end up falling short of customer and user expectations. .

That said, investment banks don’t necessarily have to undertake a full internal transformation if such a task requires significant time and cost. With banks facing growing competition from digital start-ups which tend to be more profitable and flexible with leaner digital infrastructure, existing banking giants are unlikely to be able to outsmart them simply by implementing their own programs. internal restructuring. Instead, some may choose to create “partner ecosystems” that can fill critical service gaps in their portfolios and lower their overall cost structures. BCG has identified three examples of such partnerships:

  • outsource all or part of a bank’s IT and operations to ecosystem players, such as security service companies, to channel resources into higher value-added activities,
  • create a shared services model with other regional banks to pool IT and human resources,
  • forging strategic partnerships with proprietary or principal trading companies to retain market share in high-frequency trading activities.

Additionally, relative to historical infrastructure, Acuity Knowledge Partners sees digital platforms impacting investment banks by leveraging knowledge of historical transactions, providing interactive scenarios that are used in discussions with customers, providing data visualization and developing new analytics. “Overall, this boosts efficiency, provides deeper insights and analytics, automates standard tasks, and allows bankers to focus their bandwidth on closing more deals,” Acuity said recently.

Deloitte has identified four key factors that are essential for investment banks to succeed in their digital transformation:

  1. Disciplined program management: Governance tactics to increase efficiency, including identifying a primary product owner, creating an advisory board, creating a design authority board of technical subject matter experts, and creating an innovation detection and rapid prototyping workflow;
  2. Clear business definition: A human-centered approach to planning that builds on a deep user knowledge base, clearly articulates user needs, and defines future experience that addresses broader opportunities;
  3. Efficient delivery of technology: Challenges to anticipate include managing visibility and access to transaction and record access rights, determining the right set of integration tools for the organization, providing comprehensive visualizations of all available data and managing the wealth of contact and relationship data;
  4. Preparation for ownership: This may involve conducting periodic risk assessments to identify gaps in awareness, using an idea collaboration platform to find features and gauge audience sentiment, and understand business results. appreciated by management.

Going forward, it would appear that the investment bank will continue to have enough barriers to entry in place to retain market share over the long term, e.g. high capital requirements, costly regulatory burdens, skills of investment bankers themselves and long-term investments. long-term relationships that have been forged with customers and that, in many cases, have lasted for generations. That said, Deloitte points out that those looking to capitalize on the future amid changing market dynamics should consider forgoing costly in-house infrastructure and moving to a connected flow model through which external vendors offer services for critical and non-critical functions. “In this new environment, the investment bank’s ability to create and leverage differential insights from data becomes its new competitive advantage.”

Ultimately, some degree of reinvention of age-old business models will be required for the space to survive and, indeed, thrive in the long run. This will involve the adoption of technologies such as artificial intelligence (AI), machine learning (ML) and natural language processing (NLP) to develop digital platforms that can ultimately impact the workflow of bankers, customer coverage and data analytics. And while restructuring internal ecosystems to incorporate digital technologies is likely to be a resource-intensive process, there is growing evidence that it is of paramount importance for the investment bank to maintain its competitiveness. in the long term, to maximize the customer experience and make the best use of data for optimal decision-making. -manufacturing.

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