The aftermath of the financial crisis will be the defining industry driver in the year ahead, according to Rob Hegarty, a market structure specialist at the global clearing, settlement and information group, DTCC. Speaking at a gathering of industry heads in London, Hegarty identified ten factors that would define the way the financial community regrouped following what he described as a “year few would forget, although most would like to.”
The single biggest driver for the financial markets is the aftermath of the financial crisis. All other industry drivers pale in comparison. This aftermath is bringing issues such as more robust regulatory structures, risk management, differentiation in a risk-averse era and employee morale, acquisition and retention, to the forefront.
Across the industry we’re seeing pressure on revenues and a renewed drive for corporate profitability, among many forced consolidations. While there has been a lull inconsolidations in recent months, we expect to see this activity pick up as firms jockey for position as we emerge from this crisis.
There will also be a rapid global electronic trading evolution, a re-evaluation of the role of derivatives and how they are traded, cleared and settled, and a fresh look for hedge funds as they adapt to this new environment.
Strategic responses…and resultant technology initiatives
The predominant “strategic” response from the industry has, in fact, been very tactical: to analyse positions and dispose of toxic or dubious positions as quickly aspossible. Simultaneously, firms have been developing strategies that focus on either survival or – for the smart, brave or lucky – capitalising on the financial crisis to grow their business. Thankfully, this is not an industry that likes to look in the rear view mirror for too long.
Improving risk management controls and reporting capabilities are seen as essential, but not particularly as a technology problem. The risk issues related to the financial crisis are primarily policy and procedural issues. Once these are in place, firms can move forward with technology solutions, although at the moment we’re still seeing firms curtailing IT spending.
Looking forward, these firms are looking to develop new markets and sell products in new asset classes, as well as to invest in the trading infrastructure to manage crossborder trading.
On the technology side, firms are looking at IT governance strategies to rationalise expenditure and to integrate different systems on the back of mergers or acquisitions. A lot of resources are being channeled into this area. We’re also seeing the development of models to measure risk across every aspect of the business, and to build a more client-centric data management system.
Risk and regulation – front and centre
Whether it’s a strategic or technology response to the crisis, overwhelmingly the common denominators are the importance of risk and regulation. This stems back to September 2008 as the world reeled following the collapse of Lehman Brothers and the acquisition of Merrill Lynch by Bank of America.
This was the point at which we knew that the industry had to be redefined and we knew that risk and regulation would be front and centre. Everyone was talking about risk, but the point we were making was that risk can be defined in many ways, with very different meanings. If you want to manage risk, you have to understand the kind of risk you’re dealing with.
At TowerGroup, they developed a 10-point summary of risk ranging from the most obvious – operational risk – to reputational risk. Firms were starting to understand that every risk, if not properly managed, leads to reputational risk. And in the climate we were dealing with, a firm’s reputation is paramount.
Turning to the impact of regulators, the most complex aspect is the sheer number and jurisdictions of the regulators: US-based, Europe-based and Asia-based. It’s been widely reported that Citi – with its diverse business lines and global footprint – has a reporting structure into 140 different regulatory bodies globally. This certainly can create roadblocks and hurdles if not managed properly. So the question is: can the vast number of regulators balance the needs of their global constituents?
Comments from the G7 meeting in October 2008 gave a strong indication that global leaders were addressing this point. The number one takeaway at this meeting was a commitment to ‘take decisive action and to use all available tools to support systemically important financial institutions and to prevent their failure’. If there was any doubt that regulators would be taking a more active stance, that statement eliminated it.
At TowerGroup we digested these comments and developed what we saw as the ‘four constants of regulation’. These were that regulators would regulate around entities – for example being regulated on the basis of the type of firm you are (e.g. exchange, broker, etc); around activities – such as short-selling; around products such as swaps – and balancing the need for product innovation with the need to monitor; and around asset classes like equities or commodities.
The major headache for the regulators will be how to do all this in concert across the globe. The risk is that rather than reducing the number of regulatory bodies, we may even see an expansion. The Federal Reserve will likely take a leadership role in this initiative, and there is even talk of an international regulatory body – although I suspect we are many years from this – if ever.
Look ahead
Looking ahead, two issues will continue to dominate. Firstly, a complete reset of regulation has been pushed to the forefront by the crisis, and is now one of the most significant drivers in the industry. It will happen one region at a time, rather than being a grand global effort. Only once each region – the US, Europe, Asia – has got its house in order are we likely to see any coordination between these areas.
Secondly, risk management is being redefined. It’s now more about policy and procedure, than technology, although we do expect to see spending on risk management technologies picking up in the second half of the year.
Rob Hegarty was speaking at an FPLorganised event in London on 15 July, hosted by Nomura.
Assessing The Aftermath – Risk And Regulation Top The Agenda In A Search For Solutions
