Following the 2008 financial crisis, the US and European approaches to reforming the financial sector were markedly different, with European rules resulting in far more onerous capital and trade reporting requirements. Over a decade later the impact of a greater regulatory burden, including the scale and cost of post-trade services as a result of MiFID II, coupled with less favourable economic conditions in Europe, can now be clearly observed. According to recent analysis in The Times, the result has been that American banks now devour about 53% of global investment banking revenues, up from 44% in 2008, and now even hold a 39% share of European revenues as well.
In a bid to boost profitability and reduce operational costs across European banks, a key area of focus for institutions has been how to reduce their post-trade total cost of ownership (TCO) by finding a leaner, cheaper operating model. Yet although a variety of approaches have already been attempted to date, not all of these post-trade transformation projects can claim to have succeeded. In this report, Nicola Tavendale and Mike O’Hara of The Realization Group speak to Matthieu Prieuret of Eurogroup Consulting UK, TP ICAP’s Dominic Cashman, Andrew Morrish of Technolink, James Maxfield and Ali Rutherford of Ascendant Strategy and Atomic Wire’s Colin Parry about the key ingredients needed to create an efficient and more cost-effective post-trade business.
For the last ten years, the profitability of European investment banks has been lagging far behind their US counterparts but recently that gap has increased quite dramatically, says Matthieu Prieuret, Managing Partner at Eurogroup Consulting UK. In terms of tangible return on equities, US banks have been roughly above the ten or eleven percent threshold while most European institutions have been far below that. “They’re not doing their job properly for their shareholders,” Prieuret explains. “There are multiple reasons for that, but one of the main issues is that the US imposed less regulations on banks compared to the EU.” For the EU banks, this has resulted in higher capital costs, greater balance sheet constraints and less budget available for ‘change-the-bank’ activities.
“European investment banks have probably lost the battle against their US counterparts, but maybe not the war,” Prieuret says. So what can they do now to begin to redress the balance? According to Prieuret, most banks have already spent the past five or six years trying to implement traditional cost cutting measures such as laying off large numbers of staff. However, such measures have had little impact on reducing their operational costs and fail to ultimately address the root cause of the problem. Instead, Prieuret recommends that banks begin by tackling the problem head-on with a detailed programme of business and balance sheet restructuring. “Across the industry, there are many, many functions in investment banks which are non-differentiating – mainly around post-trade,” he explains. “So banks need to look at why they are funding all the legacy systems, IT and people needed to process these transactions if it does not provide any competitive advantage.”
“Banks need to look at why they are funding all the legacy systems, IT and people needed to process these transactions if it does not provide any competitive advantage”
Matthieu Prieuret, Eurogroup Consulting UK
Andrew Morrish, Technology Sector Lead at Technolink, agrees, adding that in theory the area of post-trade ought to be extremely standardised and offer far more consistency than is currently the case. Instead, he’s surprised that the structure of wholesale and institutional banking has allowed the whole area of post-trade to become almost its own ‘cottage industry’, despite other areas of banking having overtaken it in terms of more agile technology and a more innovative approach. Morrish adds: “Much has been done to reinvent the middle- and back-office in terms of automation in areas such as settlements and matching, because these are the easy ones to make changes in. But what they’ve haven’t done is to really look at the root causes of the issues, which are primarily driven by how front-office trades aren’t necessarily perfectly booked and executed.” This in turn, he explains, is what drives processing failures, which then end up in human hands, often in individual small units with their own technology, departments, managing directors etc.
“These small units however, don’t command the level of investment from the bank that are needed to get those real back-office automation efficiencies properly spread across disciplines,” says Morrish. “In the area of post-trade especially, it can be difficult to measure the TCO impact and benefits and is an area where software vendors have struggled.” Yet even if vendors manage to get above the business unit level to deal with the CIO or the COO of the organisation in question, there is still the problem of political stakeholder engagement with the areas that will be impacted by that business case. “It’s not the benefits story that’s difficult, it’s the stakeholder challenge,” Morrish argues.
“In the area of post-trade especially, it can be difficult to measure the TCO impact and benefits and is an area where software vendors have struggled”
Andrew Morrish, Technolink
Using the data better
The potential development of new utilities to help streamline post-trade functions is also increasingly being discussed, says Colin Parry, Co-Founder and CEO at Atomic Wire. However, he warns that the desire for the development of such utilities is only there up to a point and quickly diminishes when it comes to actually building them. He explains: “Over the last decade we’ve had six or seven exploratory talks, some at a very, very detailed level, about the concept of a utility. But while people like the model, nobody wants to give up the business they have already built.” The utilities that have been built also have limitations, he adds, as they only result in the bank giving its fixed costs to the utility to manage, rather than significantly reducing costs in any real sense.
Instead, he believes it is time for the industry to view the problem from a different angle by asking: “What’s out there already which can unlock the cost paradigm for the banks?” Parry argues that the answer could be in the technology that underpins many of the leading ‘big tech’ giants such as Amazon and Facebook and applying those principals to banking technology. “Even so, you can’t say to a bank that we will rewrite everything and build them a new greenfield site,” he adds. “Essentially, what we’ve proposed for our clients is a methodology by which you slowly move flow over from the historic stack and onto a strategic modern platform.” According to Parry, rather than processing on the platform from day one, the first steps are to begin pulling all the transaction details from the legacy systems, including Swift, the custodians and the front office. “This will reveal a few things, especially if you also include unstructured data such as email and chat data,” he says. “What you tend to find is that a huge swathe of what people do in operations is read and respond to emails, or manipulate data in Excel. This use of ‘humans as APIs’ is very inefficient and takes up a huge amount of time.”
“By having all the data in the right place, you can then identify where you have ‘humans acting as APIs’ in the process and begin to create a better system on a super cheap, ‘big tech’ platform”
Colin Parry, Atomic Wire
In addition, Parry noticed that operations teams only use core apps around 10% to 15% of the time, even though such apps can be expensive yet offer greater efficiencies. “Actually, what do we need the functionality in core apps for then becomes a data-led question,” he explains. “Often they are for functions which are quite generic and could be utilised – and you can actually buy all those interfaces quite easily.” But the move to processing on a platform is more of a journey than a silver bullet, Parry adds. “Yet by having all the data in the right place, you can then identify where you have ‘humans acting as APIs’ in the process and begin to create a better system on a super cheap, ‘big tech’ platform,” he says. “It is also cloud-native so there is no need to keep updating databases etc. Eventually this platform can run the whole of the bank’s post-trade infrastructure, so you can begin eliminating the legacy architecture over a period of time.”
Harder to find efficiencies
However, while reducing cost is a pressing challenge for banks, they also need to be realistic about the savings that can be made from streamlining their post-trade services compared to their overall cost base, warns Dominic Cashman, Head of Integration and Transformation Programme at TP ICAP, previously European CAO at Nomura and speaking here in a personal capacity. Cashman adds that they should also take time to evaluate how much of a priority transforming post-trade operations should be. “I don’t think there are many areas of investment banking which are actually ripe for bringing overall costs down significantly,” he explains. “For example, in some banks their total Operations costs are 8% of their revenues. So then even if they achieved a 20% reduction in that, which would be very challenging, that would still only give them a 1.5% increase in their returns.”
According to Cashman, most of the larger financial institutions have already spent a lot of time in the past twenty years improving technology and efficiency in their post-trade environment. He sees this as having been achieved in two waves: firstly, the push to straight-through processing and then secondly, a move to using lower cost locations. “Now those have been achieved, most of the low hanging fruit is gone,” Cashman says. “So it’s now more, I believe, about finding the marginal gains instead.” There have also been a number of recent joint ventures between consulting firms, technology providers and anchor clients in the area of utilities, but Cashman observes that these haven’t been particularly successful in expanding beyond the original participants. “I’m sure there are people whose view is that utilitisation and some of these big, structural organisational changes are the way forward,” he explains. “I’m just not convinced – and I think history is on my side, but that doesn’t mean that the next one won’t work.”
A more effective approach, especially for smaller and mid-sized firms, would be to acknowledge there are limited benefits from being a ‘first mover’ in the utilities space and instead aim to be a ‘fast follower’ once success is proven, Cashman claims. He explains: “Many of these post-trade and data utilities depend on critical mass for success, but just haven’t achieved that. So the correct strategy should be to watch the space closely and, if a project is proving successful, only then to start to consider being a part of it.” In the interim, he suggests that banks can instead focus on finding any areas of marginal gains, such as filling in the white spaces of straight-through processing and looking at workflow technologies to improve communications and internal hand-off between different processing teams.
A more flexible architecture
In addition, institutions should be considering the potential deployment of robotic process automisation (RPA) technologies to any areas where they have specific gaps and needs, says Cashman. “But again, although some consultants may claim RPA can deliver 20 to 30% efficiency gains, these numbers need to be regarded with a healthy degree of scepticism,” he adds. “RPA as an efficiency tool, and a tool for taking human mistakes out of the process and therefore improving accuracy and control, is a good thing to do, but even if you managed a large-scale RPA deployment across an entire back office chain, I think it is unlikely you would achieve the claimed levels of efficiency gains.”
“The scale of cost pressures are beginning to force a re-think and making banks be more realistic about mutualisation, only at a more granular level”
Ali Rutherford, Ascendant Strategy
According to Ali Rutherford, Managing Director at Ascendant Strategy, although some of the external solutions that banks can leverage such as utilities and technology are now well understood, once those options have been explored, do banks really know what else can be done to streamline post-trade processes? Many of these decisions are more challenging, he explains, and carry more risk. “The obvious one is mutualisation, which historically has been quite challenging, for various reasons, but mainly because banks simply don’t trust each other and do not want to cross over in how they run some of these functions,” explains Rutherford. “But we are now seeing that the scale of cost pressures are beginning to force a re-think and making banks be more realistic about mutualisation, only at a more granular level rather than a saying, ‘Here, take all my back office.’”
However, this is all very dependent upon the ability of the bank’s technology architecture being able to support such changes. What infrastructure firms are now offering is really decision making, such as whether you store data in the cloud or locally, based on a set of parameters, Rutherford adds. In the same way, he says that institutions need to make decisions about their functionality and to have IT infrastructure that can support the adoption and termination of variably sourced functionality and services. “To be able to effectively leverage what’s available, you need flexible technology infrastructure,” Rutherford argues. “Then as market infrastructure evolves, it will also hopefully simplify further, enabling firms to offer solutions which require a smaller slice of your back-office processing than a wholesale move to an APTP (Accenture Post-Trade Processing)-style model.”
Time for change
So why now? What has actually changed to make post-trade transformation a more viable option for banks? According to Prieuret, on a global level the peak level of regulatory scrutiny now appears to have passed. He believes this creates an opportunity for banks to begin thinking a little differently about their strategy, rather than the last six of seven years in which their spending focus was all on finding ways to address the regulatory agenda. “In addition, most European banks have now realised that their aging legacy infrastructure and workforce must be replenished,” adds Prieuret. “Some equities derivatives processing platforms are dying, or require hundreds of millions in investments, while the people supporting these platforms are now retired or close to retiring.” But he also warns that many of the people running these legacy systems and processes are also unlikely to want to disrupt what is essentially their job function, so much of this change needs to be driven from the top. “That’s the condition of success,” he argues. “Following the industrialisation model seen in other sectors, our industry can also collaborate on creating a commercial entity, potentially a non-bank commercial entity, where the valuation multiples could be far bigger than that of any single bank. If you have a commercial mindset and you sit at the top of these banks, you would realise that could be quite a substantial business to invest in.”
Typical integration technologies can also be useful, adds Morrish, but developers don’t always see the benefits and strategic goals that are needed for firms to integrate new technologies such as artificial intelligence and cloud infrastructure across the organisation. “There also need to be more conversations about what the drivers of volume are in our value chain, so that we can develop code which ensures that the number of high volume activities that need to move to the cloud are as low as possible,” he adds. “It’s not just a business call or a technology call, it requires both to work together. And that’s tricky to achieve, because quite often they don’t speak the same language.”
Morrish cites a well-known European bank as interesting real-world example of what this approach can achieve. “They realised they didn’t have a fully scaleable platform, which meant that as the front-office was needing to deal with greater volumes, they also had to grow their back-office to keep up. That’s not a sustainable method in the 21st century,” Morrish explains. “Instead they began testing where and how robotics could be used alongside people to optimise their processes, then to move to a more fully automated system hosted in a cloud environment. This solution was low cost and far more sustainable in the face of the continued higher volumes that they were forecasting.”
Finding a new approach
According to Cashman, “To succeed, you have to set yourself an ambitious target at the beginning and recognise that there’s going to be an upfront investment cost. You have to be very disciplined about running very structured programmes and being sure to monitor each step to not lose track of the cost benefits achieved.”
“You have to be very disciplined about running very structured programmes and being sure to monitor each step to not lose track of the cost benefits achieved.”
Dominic Cashman, TP ICAP
Although there’s been a very simplistic view of post-trade costs historically, people are now waking-up to the need for more impactful moves to streamline these processes, adds James Maxfield, Managing Director at Ascendant Strategy. “It’s not about focusing on individual gains, doing things more cheaply, trying to find silver bullets or being able to replace the full technology stack, which fundamentally doesn’t work,” he warns. “Instead it is more effective to have access and visibility of your operational data and to have the transparency and the accountability in place to enable informed decisions. These are the key differentiators between the best, and worst, in class.”
“It’s not impossible to be successful, and there are organisations that have done it, but they have done it by thinking differently and taking a different approach”
James Maxfield, Ascendant Strategy
According to Maxfield, there also continue to be a number of macro considerations that people typically hide behind, with costs and regulations too often being used by some organisations as an excuse to take no action. If the profitability of European banks continues to fall significantly behind those in the US, while US banks are beginning to compete on European soil as well, then many of these banks are actually risking the continuation of their investment banking business as a whole. “They really need to think about the value of bringing in people who have had credible track records, vendors who have been credible in this space and people who have good success stories in order to learn from them,” he concludes. “It’s not impossible to be successful, and there are organisations that have done it, but they have done it by thinking differently and taking a different approach.”