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Future of Investment Banking in a Changing Regulatory Landscape

Jul 22, 2020| Article

Regulations adjust with times. They may evolve with the progress in technology or may shift in response to the changing market conditions, or their relevance may differ by geographies. But they are always set to encourage prudent management practices and lessen risks.

Back in 1933, the activities of large universal banks were separated into investment banking and commercial banking with the Glass-Steagall Act that got repealed at the turn of the century, only to be brought back post-2008 crisis as the New Glass-Steagall known by Volcker Rule. Rachet forward to today, big American banks just missed the rollback of a few Volcker Rule restrictions by a thin margin.

The economic efficiency of regulations arises when markets don’t develop in a good way (say the prevalence of insider trading) or are transforming at an unprecedented pace. How will then the currents shift against darkening economic clouds, ballooning central banks’ balance sheets, and more importantly, the emerging issues of data privacy, cloud, and new technology steer financial regulation and the future of investment banking? A lowdown.

Adjusting to regulation: From recent past

Although global investment banking revenues improved between Q2 2019 and Q2 2020, there has been a constant noticeable surge in the share of M&A activities over equity issuance, with an exception of 2020 as sellers and intermediaries paused to evaluate the uncharted territory of pandemic’s impact on business.

Advised global volumes reached USD 3.5 trillion in 2018, after the record-breaking highs of 2015 (Dealogic), followed by their fourth strongest year in 2019 when total value touched USD 3.9 trillion (Refinitiv). Among the main reasons for rising M&A were stringent regulations governing capital and liquidity requirements after the 2008 crisis that made capital-intensive activities more expensive for investment banks. Many prominent names such as Deutsche Bank, Credit Suisse, and Barclays declared restructuring their sales and trading by decreasing capital allocation to underwriting and shifting the focus to advisory.

In more adverse market conditions, our liquid and capital-light model outperforms in terms of returns, tells Piero Novelli, the Co-President of UBS Investment Bank.

When regulations evolve, a series of respond and adapt cycles follow suit. A re-scoping creates breathing room for change and innovation while preserving systemic stability.

A few key themes that will shape the future of investment banking and rise to regulatory prominence following the current crisis are ESG, business model reform, data and technology, and cybersecurity. Those who act first will gain a competitive advantage and indirectly expand their threshold for liquidity, credit, and market risk. Let’s take a look.

Big, Bold Banking of The Future

A gamut of industry reports focusses on raising the baseline for technological innovation and service delivery as the customers look for more personalized service with the growing array of fintech solutions.

We suggest new strategies for future investment banking must be fashioned across four areas.

1. Environmental, social, and governance

Sustainability, climate change, and ESG will become defining elements of the future and poignant factors on how investors choose their banks. The regulators and policy makers are also being vocal about integrating climate risks into financial stability monitoring, even as they fathom the potential consequences of this shift. According to KPMG, in the new world that follows COVID-19 sustainability credentials will be central to economic equation for banks and businesses.

One-third of the world’s biggest banks have signed the Principles for Responsible Banking with UNEP, thereby joining a unique framework that ensures that the future actions of signatory banks are compatible with SDGs and the Paris Climate Agreement.

2. Bigger may not always be better

Another future trend is toward fragmentation. The returns from a complete range of services in investment banking are dwindling. As a result, banks are restructuring, specializing, and adapting their offerings. When stricter regulations make some areas of investment banking more expensive than others, haircuts are witnessed in those divisions. Deloitte, one of the big four accounting firms forecast fission.

Investment banking will transition from a full-scale service model into two archetypes: client-capturers (capital-light & specializing in front-office functions) and flow-players (capital-heavy & focusing on middle-office functions).

3. Data and technology

Forward-looking investment banks are blending their operations and cost curves with technology and data. Integrating new tech like AI, cloud, APIs, and data analytics will become differentiators. Those who stick with legacy systems are likely to be in a weak spot. Many large banks are acquiring or partnering with fintech firms to supplement or supplant their traditional operations. Investment banks are using the data sets, AI, ML, and NLP to model client behavior, predict risk appetite, develop risk models, boost customer experience, improve workflow, and even manage liquidity. Governments, central banks, and regulators are also growing comfortable with new tech with much of the regulatory focus on data localization and privacy.

4. Cybersecurity and Operational Resilience

As the IT budget fattens, the spending on cybersecurity continues to rise in the US and the world. The threats around data breaches and cybercrime in investment banking are among the top 4 concerns for the industry (Financial Institutional Survey). Banking institutions are beefing up their operational resilience by concentrating cybersecurity governance on three focus areas: building enterprise-wide cyber resilience, compliance with privacy and data security regulations, and handling risks arising from outsourcing and remote working arrangements.

Make the transition to the future smooth for investment banks with a clear knowledge of the latest industry trends and new tools in your back pocket. As a Chartered Investment Banking Professional (CIBPTM) help industry leaders zoom out to visualize the future, and zoom in to untangle their legacy systems and acquire new technologies to not only survive the regulatory roller coaster but also enjoy the ride!