THE NEXT STAGE.
Marcus Hooper and Jannah Patchay, Agora Global Consultants look at the fate of equities
If we tried to place the maturity of the equities markets on a human life span, where would we put it? Teenager or young adult? Not likely. With the challenges and compression in equities right now it’s far more likely we’d say that, at the very least, equities markets are going through a mid-life crisis, and at the most extreme end, looking frail and progressing towards the stages of old age. There’s no suggestion that equities are somehow going to die, but it is increasingly looking like this asset class has long since reached its zenith, and is likely declining to a very different future equilibrium state.
The youthful explosion of growth has long since disappeared. Primary issues are in decline and many of the most visible ones to emerge recently have been fraught with difficulty. Facebook may well have deterred an entire generation of fledgling equity investors. Younger investors who had no particular interest in equities but did have a significant interest in this technological aspect of their lives are all too aware of what happened when this company came to market. The market should have taken advantage of this flotation to inspire confidence in these aspirant investors, but instead the outcome was disastrous, and it will take a great deal to rebuild the reputation of equities in the future. In Europe, Megafon’s recent issue was hit with its own difficulties and is no flag bearer for equity markets either.
When we look further down the food chain to the small and mid-cap stocks, sadly there is no better inspiration. Primary issuance in smaller companies is laggardly and if anything getting more burdensome. ICAP realised that, in order to make its acquisition of PLUS Stock Exchange more commercially viable, listing requirements had to be strengthened. A clear consequence is that this makes it even harder for smaller companies to launch and sustain on this market in future, but that really isn’t ICAP’s problem and nor should it be. Commercial viability has to be the first consideration.
Pleas that small companies should be encouraged and supported in order to drive the growth of the greater economy as a whole seem worthy, but are utterly hollow without concrete action backed by government and regulators. The extraordinary growth of equity market regulation can only act to stifle market access for smaller businesses. There are significant questions around whether or not equities markets are indeed fit for purpose, when it comes to enabling businesses to raise funds from investors, but these unfortunately are outside the scope of this piece.
We hardly need to mention the declining state of secondary markets trading and increased regulations are taking their toll already, even though many are not even close to coming into force. The shock wave is already ahead of the explosion.
So for those businesses trying to survive in the provision of financial services around equities, what to do? If you are an exchange, then fundamental change is the only viable way forward. Revenues from the old business models simply aren’t going to sustain; we are well down the road on the race to the lowest fee for trading. Vertical integration across trading, clearing and other services is only a temporarily sustainable model – this movement away from fungibility and standardization runs contrary to the general market zeitgeist. Whoever delivers the now-mythical consolidated tape will also have to smash the present Exchange charging model for market data fees; otherwise it won’t represent a low cost solution as demanded by European governance. That being said, even when the consolidated tape eventually becomes available, how much do besieged traders really want to identify that they need to set up new trading venues, with all of the costs that this will entail? The consolidated tape may indeed solve one problem, but it shall certainly be a stepping-stone to identifying the next problem and no doubt will open the doors to further regulatory scrutiny of the trading process.
Exchanges will evolve, decline or consolidate, and very likely trading firms will do much the same for the foreseeable future. It is, however, often less onerous for a trading firm, to diversify into more exciting asset classes, than it is for an exchange, which typically lacks the agility to react swiftly to changing market conditions. Those firms that are today weathering the storm best are generally those who are capable of combining introspection and forward thinking. They also tend to look at their businesses in terms of life spans and the maturity of the market and their activities. This type of business review, maturity modelling, is common practice in general industry and now increasingly used in financial services too. In general industry it is common for a product or service to follow the path of a defined life span, and in the case of equities we can now see this trend replicated.
Maturity modelling enables firms to identify positive opportunities rather than simply focusing on the negative impacts and challenges of a tough market environment. Even in hard times there are always commercial opportunities and you can’t spot them unless you set aside time to look at where you are, and where you want to be. The tough conditions aren’t unique to your own firm either, and the grass isn’t greener on the other side of the fence.
The current compression in listed markets, that makes it so hard for smaller companies to raise funds, actually lends itself to the emergence of opportunistic new businesses and new commercial opportunities. Crowd funding and crowd lending will certainly be beneficiaries of the equities market’s inability to service smaller companies, no matter how immature such models appear right now. After all, when you first saw the Facebook application, did you really think it would become so pervasive?
The pendulum is still hanging over the territory of cost reduction and survival. Even if we agree with the cliché that “this is the new normal”, the environment isn’t going to stay like this forever.
Market change is inevitable and inexorable. The companies that succeed are those who do not merely react passively to new environments, but who proactively help create those new environments through their forward thinking and innovative approaches
Marcus Hooper and Jannah Patchay provide financial markets consulting services through Agora Global Consultants.
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