How much more regulation can the industry take?

As regulators are about to unleash even more regulation on the financial services industry in the wake of the financial crisis, guest blogger, Gareth Lodge of TowerGroup,  says they should stop and think carefully about whether more regulation is going to have the desired effect?

I’ve just been enjoying the Big Issues debate on transaction banking, chaired by TowerGroup CEO Karen Cone. I may be somewhat biased when I say how interesting it was!

What continues to strike me is how transaction banking has emerged successfully from the financial crisis. There are some good reasons for that success. Bankers and other observers sometimes forget that global transaction banking isn’t one “thing” but actually comprises multiple businesses. As a whole, however, transaction banking emerged as one of the few areas of the bank to have grown in the last year. Transaction banking is all about helping the banks’ customers manage risk. The help may be as straightforward as a letter of credit designed to take the risk out of international trade or as highly sophisticated as the systems and processes that flawlessly move billions of transactions and trillions in currency value. The recent market uncertainty has therefore been good for the transaction banking business in many ways.

At least in some parts of the bank such as global transaction banking, banks have managed risk extremely well, I think. The policies and processes put in place meant that no payment system failed, which is why many are surprised about the threat of increased regulation. This concern stems from the open question as to whether existing regulations — and regulators — are effective. Many banks, particularly in Europe, have come to see regulation as unavoidable and in effect simply an increasingly large cost of doing business. What has always been a concern, and is becoming of even greater one, is the perceived lack of benefit and value in the regulations. The proportional cost of IT spend related in some way to regulation is already large and is rising. 

The cost is starting to have a material impact on some banks, with results contrary to what the regulator wished. In essence, much of the regulation addressing competition and risk levels the playing field. One consequence seems to be that some banks suffering from the burden of spending on regulatory compliance are outsourcing to larger banks, with the converse and unintended consequence of reducing competition and concentrating risk. 

Of course, not all will agree with this view, each “group” having a different opinion as to the view’s truth and merits. Although there is no easy solution, it would seem beneficial to all to provide greater clarity and governance of regulation before embarking on yet more. Defining and agreeing what is required and how success should be measured surely should be the basis on which any project should be undertaken.

The Prime Brokerage Business: One Year Out, Where Are We?

Dushyant Shahrawat, senior research director, securities and investments, TowerGroup, examines the fall out for the prime brokerage business one year after the collapse of Lehman Brothers.

It has been one year since the collapse of Lehman Brothers, the fall of Bear Stearns and the hectic sale of Merrill Lynch to Bank of America.  One can argue that the biggest impact of this string of events within the financial industry has been on the prime brokerage business. What has changed? The prime brokerage business has been impacted and has changed in the following ways:

1) The demise of two major prime brokers (in Lehman Brothers and Bear Stearns) has shaken hedge funds’ confidence in their prime brokerage providers

2) The events of just a few months have dramatically changed the relationship between hedge funds and their prime brokers for a long time to come. Cosy relationships have been questioned, and both hedge firms and prime brokers are re-evaluating their mutual association.

3) The competitive dynamic of this business has changed, with Goldman Sachs and Morgan Stanley dropping in market share from an estimated 52% of the global prime brokerage business in 2007 to under 35% in 2009. New players such as Fidelity Investments are entering, and several other firms are waiting on the sidelines.

4) Large Wall Street brokers have been deprived of a major and steady stream of revenue from the prime brokerage business. The estimated $12.5 billion that US brokerage firms make from the prime brokerage business may well see a 20% cut in the next few years.

5) Client perceptions and attitudes about their prime brokers have changed drastically during the crisis. Hedge funds have become more sensitive to the stability of their prime brokers and are demanding their prime brokers segregate client assets so that they are not overly exposed to the prime broker. 

6) Finally, a major trend that has emerged is the shift to a "multiprime broker" model. That is, hedge funds that used to rely overwhelmingly on one or two prime brokers are now hiring multiple prime brokers to spread the risk of doing too much with particular firms. Is the trend towards multiprime brokers a flash in the pan, or is it here to stay? We think this is a longer-term trend and will not reverse itself anytime in the future.

The need to innovate

Guest blogger, Gareth Lodge of TowerGroup, says the financial industry appears to be turning a corner and that innovation or the art of doing things differently will be key to recovery.

 

It's true, SIBOS is here — two parties already and a looming happy hour are testament to that! But as I sit waiting for the opening plenary session to begin, I reflect on the year that has passed. I suspect many in the industry wondered at least once in the last year whether they or even the industry would survive. It has certainly changed the focus of the banks since that point.

When I first saw the agenda for Sibos, I was slightly surprised to see the Innotribe track. I should say, that having previously worked at an innovations consultancy, that I believe in both innovation and its benefits. But innovation has certainly suffered in the last year, as budgets are frozen or cut across the bank, making its inclusion on the agenda a bold move. 

There is a general feeling over the past few months and certainly heard in the conversations I've had today, that we're turning a corner. Banks are planning for 2010, for at least a form of business as usual. That's why innovation is important. Innovation is synonymous with cutting-edge technology. 

In reality, innovation can be considered to be the art of doing something differently. Technology may play a part but isn't the answer. Technology without an application is just technology. Why do I raise this point? Because the world has changed. Don't banks therefore need to change as a result? If clients' demands have changed, banks need to respond. Now more than ever is the time that banks need to innovate. What is needed is a much a cultural change as any other kind of change. 

Innovation begins in the thinking and approach of an individual, not in a piece of technology. The key objective has to become how to deliver value to the customer. Innovation for innovations sake is a luxury. Retaining customers is essential for survival of the firm or institution. I encourage you all to attend the Innotribe stream today. To respond to the world tomorrow, you need to start today.