The financial services industry is unquestionably in the midst of a high-change, one that has the potential to radically re-shape the industry in the coming years. The current changes feel disruptive because they are coming in a range of forms all at once. J.R. Lowry, Head of State Street Global Exchange in EMEA, was guest speaker at Quantifi’s summer breakfast briefing. J.R. shared his perspective on how big data, regulation and technology advances are driving industry change. He also provided insight into what we might expect the buy-side to look like in coming years, and what this means for technology professionals.
New Big Data
There has been an increase in investment going into firms that are aiming to aggregate data and use overlays, like machine learning, to help interpret data. With these developments there is going to have to be a range of new analytical tools because it’s impossible for humans to digest all of this new data themselves. This balance of man and machine will continue to tilt more towards machine, although not fully.. Part of what is making this possible is that storage is continuing to get cheaper and cloud computing is more accessible than ever.
The investment management space is in the early days of big data relative to other areas of financial services and other industries. There are also a lot of companies in the industry struggling to manage the data they have. Firms are now processing and generating data for analytics, regulatory reporting, client reporting and research purposes.
Regulation is having an incredible impact on the industry. The most significant for this industry is probably the changes made to capital requirements. Whilst capital requirements effect the banks more directly than the buy-side, it’s hard to be isolated from their impact. These requirements, including Basel III and stress testing, are ultimately forcing banks to rethink how they see their balance sheet. Banks are getting out of businesses that are not practical from a return on capital standpoint. Clients who are not bringing them enough volume or are too capital intensive to serve are being let go.
The industry has also seen a shift in business models in the sell-side, particularly around derivatives trading. A huge amount of money is traded on derivatives, predominantly through interest rate swaps and this now has to move via central clearing, which has to be compliant with Dodd Frank, EMIR etc. This is reducing the margin requirements and potentially shifting the “too big to fail” problem on to the clearing houses. Margin requirements are going up, which means that everyone is limited in terms of what they can do from a trading perspective, and trading strategies have to change to align with that.
Regulators are also asking for more data, whether that is coming from MiFID II, Priips, Solvency or EMIR. This is forcing managers to be more transparent about fees, in response to the Retail Distribution Review or similar legislation. Now they have to be more open about their fees, the inherent risks in the product and they have to demonstrate the product is appropriate for the consumer. Ultimately all of these regulations are about de-risking the industry and this is not going to scale down in years to come.
Advancements in Technology
Finally, this man/machine balance will continue to change, whether it’s in the form of algorithms or longer term machine learning based algorithms, predictive analytics, artificial intelligence (AI) or robotics being applied to manual processes. Think about how much of the industry still operates by paper, fax, email and how much reconciliation is done in the industry. This is where the industry will change significantly over the coming 5 to 10 years because firms cannot afford to have their own or build/develop their own technology. Firms need to follow the new trends and keep up-to date with the latest technology. For example, building little pieces of functionality – the microservices connected via APIs – and the flexibility to string them together to do different things. It looks like this model is going to be a big trend over the next few years.
So who is likely to benefit? Firstly, the industry need to be more technology centric, whether it be in your trading activity, the way you run your analytics, or the way you do distribution. In turn this implies that platform based businesses will be at an advantage, as they are essentially creating technology driven utility functions for the industry. Whether that’s a platform for portfolio management, distribution or automating trading activity, these platform businesses and the shift into the retail space are going to create a battle for the desktop.
From an asset management perspective there is going to be a bifurcation in the industry where you will see either big and cost effective or small and boutique. The risk will be being caught in the middle which could be between $50 – 100bn in assets. Lowry refers to a telling conversation at a client meeting in the US where the client said “we don’t think $500bn is big enough anymore”. They were looking to use greater forms of utilities so they could get to a trillion dollar of assets to be up to scale. So you have this bifurcation that is fuelled by the technology investment required to operate effectively.
We are at one of these pivotal points in the industry that has been fuelled by technology and regulation. It is about how all this is coming together at once that is driving the disruption that happening in the industry.
This post is a summary of J.R.’s presentation.