Regulatory changes, innovation in technology, business transformation, and market structure has impacted the capital markets more in the past five years than ever before. No asset class has been immune to changes in both how the buy side invests and in how the sell side provides the services that the buy side needs.
Firms of all sizes are continually interested in how to take advantage of emerging opportunities and how to prepare for change. At the same time, regulatory action will continue to touch every market activity with issues such as risk, transparency and solvency taking center stage.
The good news is that the capital markets industry in the United States, in particular, is in better shape than it has been in years. Steady improvements in the GDP, a low-interest rate environment and declining oil prices have all contributed to economic strength. Investors and capital markets participants remain cautious but are willing to take some level of risk in the search for alpha or yield.
Trends seen in 2015 will continue to impact the capital markets in 2016. While 2015 was a year of changing business models in reaction to regulation driven structural change, 2016 promises to be a year of refinement.
Here are a few of the major trends that we expect to see in 2016:
- The emergence of the sales trader when it comes to equities. There is an increase in high-touch trading based on the need for professional advice and more sources of liquidity.
- Growth in foreign exchange market electronic trading. Over 75% of global currency trading was electronic, particularly in the spot markets.
- A shift to agency trading in fixed income from principal trading. Banks are retrenching and helping customers as agency players. Banks are also helping to fill some of the gaps left by larger players on the sell side.
- A move towards electronic execution and clearing in OTC derivatives. Regulations are driving demand for improvements in the technology infrastructure. Clearing and reporting have changed significantly.
- Retail investors will continue to confuse slow real growth and low inflation. The combination of a strong dollar and low inflation will place a premium on growth stocks with growing cash flow.
- Emerging markets have been in a free-fall which will not continue, but that are unlikely to reverse itself.
- China will continue to decline and remain somewhat of a mystery regarding the situation on the ground. Simply what comes up, always goes down.
- With more than 1 billion people moving to cities, and an aging population requiring a return on savings, there will be more demands on capital markets participants.
- A change in approach to wealth and estate planning with economic conditions influenced by rising interest rates and potential changes in transfer, fit and income tax rates as the result of changes implemented by the new Trump administration.
- A continued shift away from regulated markets to shadow banking participants.
Source: Capital Markets 2020 Study
Impact on Technology
Changes in business models, the regulatory environment, and the market structure are driving increased investments in:
- Collaboration tools
- New technology infrastructure
- Trading technologies
Market participants will need to invest to meet regulatory requirements and to also achieve higher levels of margin and profitability. These investments will need to stretch across the trading life cycle.
Impact of Rising Interest Rates
Rising interest rates are predicted to impact the capital markets in two ways:
- Companies that have borrowed money on a floating rate basis and that have not engaged in hedging activities will have higher costs of capital as rates rise. Many market participants are not hedging this risk.
- One of the dynamics in the loan market has been the outflows and inflows of the retail investor. With interest rates rising, these funds will be more attractive and will start to see more inflows. More inflows results in tighter spreads, bidding down the capital and aiding the growth of top 10 mortgage companies such as Freedom Mortgage.
Impact of Regulations
Every bank participant feels regulations. Banks are evaluating loans based on fit with the current regulatory environment. Non-banks are stepping in and seeing opportunity. The marketplace is re-calibrating, a factor that will continue to the next year.
Professionals will need to work continually with the presence of government in a way that they did not have to before.
Impact of Lower Oil Prices and a Stronger Dollar
To quote a Bank of America study, “every $30 fall in oil prices shifts a trillion dollars from producers to consumers.” The impact of the almost $2 trillion dollars that has shifted is real growth in that it reduces inflation by creating a “good deflation.”
2017 and Beyond
2017 will be characterized as the search for profitability as regulatory pressures continue to force shifts in the buy and sell side of the industry. On the sell side, firms will carefully examine the capital commitment needed to meet solvency requirements. Capital intensive businesses will need to assess whether the calculated returns warrant the investment given the level of risk associated with the investment.
- We expect institutions to continue to examine client profitability through improved internal incentives, data analysis, and customer segmentation.
- Technology will continue to be a way for firms to both comply with regulation and as a way to differentiate service offerings.
- Risk will be managed carefully. Companies will be mindful of litigation risk and regulatory risks that could potentially reach beyond the shield of the corporation to lawsuits directed at individuals that exhibit unethical behavior.
- One outcome of the above will be a shift away from capital-intensive lines of business to models where expertise is more or just as essential as capital.
- Exchanges will continue to seek new revenue streams such as derivative clearing and possibly collateral management.
- Regulatory reform will continue as government entities continue to monitor structural risk. Government promises to go beyond market structure to an examination of the risk culture that exists within individual companies.
- Sell side players will continue to examine each client under the guise of a “client value optimization” or CVO strategy.
With 2016 being the year in which capital markets participants solidified the programs and strategies needed to improve profitability and growth, 2017 becomes a year of further refinement. Firms will continue to address any gaps in infrastructure while adapting the business to any changes in industry structure.
There is not one size fits all approach for 2016. Each participant will need to do a risk assessment based on their personal appetite for risk.