Many investment banks, especially in Europe, will fail to achieve their cost of capital over the next two years according to Morgan Stanley and consultancy Oliver Wyman and require metrics and mechanisms to allocate capacity and resources to the accounts that really matter.

In a report this month, ‘How Business Models Will Adapt to Less Liquidity’, Morgan Stanley and Oliver Wyman said quantitative easing, financial regulation and changes in market structure have caused a profound shift in liquidity risk from banks to investors. Asset managers will have to adjust processes and product strategies to cope with less plentiful and more expensive liquidity, and far more intrusive conduct regulation. The sellside will have to change the operating model of securities trading and tough strategic pruning will be crucial.

“Regulation and technology – plus the buy-side response – are accelerating the push towards electronic and agency trading in many fixed income markets,” said the report.

Matthew Hodgson, the former global head of rates & credit e-commerce platforms at Deutsche Bank, launched analytics platform Mosaic Smart Data to address these issues. He told Markets Media: “We are currently in advanced discussions with banks, ECNs and buy-side clients in regards to on boarding our platform. The buy-side actually mirror the sellside as they both need to access post-trade information which can intelligently inform their pre-trade decisions.”

Hodgson added that Mosaic’s MSX platform delivers actionable intelligence enabling users to establish views of market share, P&L on individual trades and flow analytics around client behavior and performance. “With this, the world of predictive analytics and machine learning are the next logical steps on the march towards artificial intelligence,” he said.

Morgan Stanley and Oliver Wyman said wholesale banking balance sheets supporting traded markets have contracted by 50% in risk-weighted assets on a Basel III adjusted basis since 2010, implying 25-30% in terms of total balance sheets. The report said: “Many banks are not achieving their hurdle rates, we expect another ~10% shrinkage in balance sheets in the next two years.”

Last year returns were an average of 9% across the major banks, broadly flat on 2014. One-third of industry capital, equivalent to between $100bn and $150bn of equity, is deployed in business lines that produce returns below the 12% yardstick.

As so many banks are performing below hurdle rates, Morgan Stanley and Oliver Wyman  expect more restructuring as banks cut back to the activities and client groups where they can build an edge. They  see most scope to reform operating models in fixed income. Larger players will remain committed across the board to take advantage of their scale but smaller firms will have to carve out profitable niches and exit or outsource other activities.

“This implies a shifting role for sales to leverage data better and further skew towards electronic distribution as banks look to take out cost,” said the report. “Harnessing data will be vital to enable banks to better tier and ration service levels across clients.”

The study continued that there is real scope to boost productivity and drive down coverage costs as banks develop smarter approaches to using data.

“Automated data feeds will allow for increased loading of the salesforce, smarter allocation of resources and targeted trade ideas,” added the report. “Against a backdrop of increasingly automated execution through electronic platforms, this should lead to fundamental changes in sales strategy and costs.”

Firms will also need more reliable information flows to assess client economics in order to allocate resources more effectively. Banks have traditionally focused on serving the largest accounts, and trimming the tail, but the challenge now is to cover the middle 300 to 500 clients that make up between 40% and 50% of the revenue base.

“We think they need to start by defining a target set of clients and building a coherent portfolio of products that are synergistic for those clients,” said the report. “Executing against this will require metrics and mechanisms that allow much a much sharper skew of capacity and resources to the accounts that really matter – in particular, to ensure that any sub-scale activities that are maintained are really focused on those accounts only and do not once again grow into independent product silos attempting to build scale in their own right.”

Hodgson said: “There is tremendous opportunity and a clear demand for us to provide a cross-FICC data analytics solution which is integrated into a bank’s existing technology infrastructure and allows these institutions to aggregate, standardise and analyse transaction data in real-time.”

New regulations such as MiFID II, covering financial markets in the European Union from January 2018, will also increase costs for financial services firms.

Hodgson said: “Banks’ IT departments are continuing to face regulation projects and with this pressure are increasingly looking to outsource strategic projects to third-party vendors that deliver modular, easily implemented tools to help them keep pace with the speed of technology change and save time and costs.”

Featured image by Bloomua/Dollar Photo Club