Most traders working on the buy-side have seen the writing on the wall for some time now. But 2014 is likely to herald a new phase in the post-crisis reconstruction of the financial markets and investment management businesses.
From a day-to-day, operational perspective, this new phase will throw into sharper relief questions about how to access liquidity, manage exposures and drive returns to clients (or at least protect them) when implementing investment decisions. At its most fundamental, the question will be: do I still have the tools to do my job effectively? More specifically, which brokers can supply services to me? Are those services what I really need? And can I afford to pay for them?
As 2014 unfolds, the answers to these questions might become a little less certain than they appear today. Plenty of people have already anticipated the next step in the development of the buy-side dealing desk. In the Q4 2013 issue of The TRADE, global director of trading strategy Bill Stephenson outlined Franklin Templeton’s response to a growing need for traders to support PMs through in-house resources, while other articles in the issue reflect how technology is providing a lot of the decision support and market intelligence for which the sales trader was once the only conduit.
To an extent, this is just evolution. Trading desks have been making significant progress in rationalising their workflows, their broker lists and their use of sell-side resources for much of the past five years. Changes in the way the financial markets have been regulated (perhaps others more than cash equities) and the fall-off in volumes (perhaps cash equities more than others) have given asset management firms little choice. But could the pace of change accelerate in 2014, leaving the laggards even further behind?
On the supply side, banks may well be driven to make even tougher decisions about which businesses they are in and the resources they can commit to those businesses. Over the next 12 months, pressure on costs and revenues will intensify for many. Basel will bite deeper, and the way banks fund themselves will continue to evolve in line with the demands of the liquidity coverage ratio and the net stable funding ratio, but in Europe the mechanisms of the new banking union will also create another set of capital requirements for banks. In preparation for its role as the eurozone’s new banking regulator, the European Central Bank (ECB) will demand banks undergo tougher stress tests than they have so far been obliged to undertake. Firms that fail the ECB’s tests will have to further restructure and / or refinance before they are wrapped in the safety blanket of the single supervisory mechanism.
Already, banks large and small have opted out of whole business lines or reduced staffing levels to cope with the lower revenue environment. Inevitably remuneration costs have had to fall to offset dismal recent return on equity performance. But this process is far from over. Some estimates put the potential shrinkage in global investment banking headcount in 2014 at 20,000. This is perhaps an inevitable response to a fall in investment banking revenues estimated at 10% per annum since 2009 by McKinsey, which also claims that average returns on equity at leading investment banks slumped to 8% last year. Even if the economic gloom is beginning to clear, it is reasonable to argue that providers in once over-supplied markets will need to undertake some pretty radical rethinks to satisfy customer demand in 2014 and beyond.
On the demand side, regulatory pressure – specifically from the UK’s Financial Conduct Authority – will make payments from asset managers for brokerage services more transparent. This has to be a good thing but it has the potential to cause dislocation at a time of smaller commission wallets. Moreover, shifts in the cost/revenue balance are now evident on the buy-side as well as the sell-side. The ever growing pressure to win mandates at a time of scarce alpha is well established, but this primary challenge must be considered alongside other factors, such as the convergence of traditional and alternative asset management models, the impact of UCITS IV on asset managers’ operating models, the growing power of fund distributors and, inevitably, increased regulatory scrutiny, notably in the derivatives space.
This might seem like a slightly depressing assessment of the year ahead. But these trends and challenges to the status quo can be seen in positive light over the long term. In some respects, what we are seeing is firms on the buy- and the sell-side rolling down the hill to sustainability. There are sure to be some bumps on the journey, but the end result should be a sustainable framework for doing business in which the interests of the investor are paramount.