Unbundling tops banking reform recommendations

Scardovi: investment banks need to revitalise from within

Global investment banks need to stop focusing on easy opportunities and start innovating, according to a new report by US business consultancy AlixPartners – even if that means unbundling services and embracing smaller financial institutions as allies.

The document, From Steroids to Fair Play: Global Investment Banking’s Long Road to Industrialisation, suggests that the global investment banking industry is still suffering from overcapacity and a 31% decline in revenues since 2009. In response, it sets out ten steps that should enable banks to adapt to changing circumstances.

Chief among these is unbundling of services. By working out the cost and contribution of each single unit directly to the profitability of the business, banks could become more internally accountable and transparent, according to the report; that would make it easier to take difficult decisions about human resources and outsourcing.

Financial institutions should also draw on products and services across business units, reducing costs by using services such as the derivatives desk for multiple tasks such as investment banking and private banking. In addition, allying with small financial institutions and other commercial bank partners could allow banks to exploit their customer bases and branch networks to reach millions more SME and affluent clients with more customised products, according to AlixPartners.

In September last year, Adam Toms, newly appointed chief executive at broker Instinet Europe, told Banking Technology about the key role unbundling would play in improving the efficiency of his business. Meanwhile late last year, Norwegian broker Christiania outsourced its execution – an area that has traditionally been seen as core – to execution specialist Neonet. The idea behind that deal was to allow the broker to focus on its core business – providing advisory services and research – while saving the cost of maintaining expensive exchange memberships, and costly in-house resources such as IT and R&D staff dedicated to execution technology.

While it doesn’t mentioned that deal specifically, the AlixPartners document does cite the willingness to share, pool or even fully outsource IT, back-office and other services as a key ingredient for improved profitability for global investment banks.

Other recommendations include mid-market extension through focusing on small- to mid-sized clients, proactive restructuring, investigating new revenue opportunities by exploiting the connections between emerging markets and developed nations, and reforming compensation systems for staff to ensure that employees are paid appropriately in line with their contribution to the business, compared with employees in other industries. But these ideas will only work, suggests the report, if banks are willing to provide stronger advice to clients and better incentives for ethical behaviour from employees.

“Merely focusing on sweet spots, low-hanging fruit and new arbitrage opportunities won’t suffice,” said Claudio Scardovi, managing director in AlixPartners’ financial services practice. “A new, holistic management of the overall value chain is needed, with a dynamic approach focused directly on its truly value-added components, allowing some unbundling of the business model through open platforms.”

Many sell-side firms have faced mounting financial pressure from rising levels of cost and diminish incomes in recent years. Commission revenues have fallen significantly since the financial crisis, with a 29% fall in 2012 alone, according to TABB Group. At the same time, equity trading volumes have collapsed and show little sign of emerging from a prolonged slump. European equity trading volumes have fallen from €1.253 trillion in October 2008 to €651.636 billion four years later and just €603.699 billion by November 2012, according to figures provided by Thomson Reuters.

These pressures have been exacerbated and in some cases caused by regulation. New legislation such as Dodd-Frank and the Volcker Rule in the US, EMIR and MiFID II in Europe, and Basel III globally – all of which broadly aim at reducing systemic risk and improving transparency – have hit banks hard, especially the mid-tier institutions.

“Productivity is depressingly low, and the return on capital won’t be healthy any time soon, especially as more layers of red tape and regulation are implemented,” added the report. “Global investment banks face an uncertain future. Chief executives will need to resist the temptation to look for quick fixes, and try instead to build their future performance on a more sustainable basis.”