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Transforming Capital Markets: Winners and Losers

In the ever-changing environment of capital markets, it isn’t always clear who the winners and losers are. Clearing houses or central counterparties (CCPs) are of course already considered big winners, with the additional revenues that they will be able to earn from underpinning a larger share of the swaps markets. Now that the rules are becoming clear for the new swaps markets in the U.S., winners will start to appear that may establish global leadership.

By contrast, broker-dealers and buy-side firms will continue to bear most of the costs of change and of working in the new market environment. The buy side has to find and manage the additional collateral required and needs to adjust its business processes to cater for marking to market and frequent margin calls. In many cases, firms will be posting margin for the first time. The sell side, meanwhile, will of course be even more heavily affected, by the transition of its primary business role from principal to agency, and by the requirement to provide access to new trading and clearing venues. First movers can find an advantage, but not an unassailable one.

Not everything is negative, of course: the new environment may create demand for new services, most obviously in the field of collateral management and optimization. Potential annual revenues are estimated at $5-$8 billion by Morgan Stanley/Oliver Wyman, although the large global custody houses will probably take most of this prize. Overall, the same analysts expect a hit to overall sales and trading revenues of 3-5 percent by 2015. Other estimates have been higher.

Of course, the massive changes outlined above confront all broker-dealer firms with complex decisions on future business strategy. Even the largest will have to fight to defend market territory and win ground in the new game: the principal-to-agency switch and the new transparency requirements mean that broker-dealers will no longer be the exclusive gatekeepers to liquidity and will lose part of the information advantage that they had enjoyed in the past. The winners are likely to be those who waste no time in working around this, but immediately start looking for ways to win in the new environment and asking themselves some key questions, which we discuss in the sections that follow.

There will probably be a need for only a few global ‘flow monsters.’ Most of these are likely to be U.S. headquartered, or will have large businesses there, as the increasing complexity of doing business across borders in Europe and Asia will add to the existing scale advantage of the U.S. Other market participants will need to look hard at the relative attractiveness of different options, and consider how (and where) they can best leverage their strengths.

Smaller regional firms should continue serving more specialized requirements, where specific connectivity and/or expertise can add to the edge that they have as a result of their local knowledge. There is unlikely to be much space for ‘vanilla’ brokers and pure execution services will be hard to differentiate. Sustainable pricing power is more likely to result from well-judged combinations of services across research, clearing and collateral management.

Firms are already beginning to make some hard decisions in the new world of capital markets. Examples include the several European and Asian banks that no longer trade swaps with U.S. firms (due to the burdensome dealer registration process) and others quitting the fixed income business.

New service opportunities in collateral management are bound to receive a lot of attention.

Buy-side clients will need help in several areas: warehousing and valuation, asset transformations to meet different clearers’ criteria, and access to the markets (repo being a key example) in several areas to enable transformation of processes: there will be balance sheet pressure for everyone as a consequence of the new and additional collateralization requirements, and sell-side firms that are able to leverage financial strength to assist clients in funding margin calls will have a useful advantage.

Regulatory compliance is another interesting area for potential new service development: some firms will make a virtue out of necessity by demonstrating leadership in developing their own relevant business processes, and then assisting their clients in the same areas.

Another strategy is to seek ways of making clients more profitable by increasing levels of self-service—technology has a key role to play here.

There is much to think about at the business strategy level. Estimating attractiveness of the various options isn’t easy, given that pricing and profitability in the new business segments are impossible to predict with confidence. Flexibility, and the process and technical agility to allow rapid change in the future, will be important attributes for firms to maintain a competitive advantage in the transforming world of capital markets.

For more on the changing landscape of capital markets, read SunGard’s report, “Transforming Capital Markets – Competiveness and Profitability in the Brave New World of Trading.”

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of SunGard.


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