For tier 1 global institutions, Celent expects Dodd-Frank and EMIR derivatives reforms, as well as Basel III, to individually cost between $150 million and $350 million per firm at least. This is larger than any of the “big” pre-financial crisis change programmes that we have seen for compliance initiatives in the last decade, such as for SOX, AML, IFRS, MiFID I, and Basel II.
The ongoing impact of regulatory dynamics, in conjunction with the effects of economic deterioration, reputational issues that still plague the financial industry, and “scarcity of capital” effect from regulation specifically related to liquidity, funding, and capital—these are continuing to cause a reduction in risk-taking in the regulated banking sector, where 50% indicate selective reduction in risk appetite, and 33% have indicated “across the board” risk appetite reductions.
The different dynamics are also expected to have a direct impact on P&L and trading economics, with firms citing capital constraints and increased regulatory capital charges as having a direct impact on most capital markets businesses, in particular credit and rates.
Celent observes a number of top themes in how firms are responding to mitigate the impact: To reduce and optimize Basel regulatory capital / RWA in existing business lines; to systematically optimize the use and placement of collateral at a firmwide level—across different business lines (securities lending, exchange-traded markets, and cleared OTC as well as in non-cleared OTC arrangements); to prepare processes and systems to move trade to a central clearing environment; and lastly, a general thrust to improve operational efficiency in order to mitigate against the erosion in margins and profitability. In order to underpin and execute these initiatives effectively, firms would require a significant upgrade and/or, in certain cases, a revamp of their trading, risk, and capital management infrastructures.
For different institutions, the level of ambition for business and infrastructure capabilities may vary, but one area where we see a consistent theme—and where Celent believes future battles are won and lost—is in the manner to which performance and risk measures are deployed and utilized, especially in the front office. Here, 60% of firms believe that bringing performance and risk measures in tandem to the front line can be used to shape and facilitate the right risk-taking culture, behavior, and incentives within a firm’s trading operations, therefore facilitating better trading decisions, stronger controls, and a more accurate picture of profitability.
The gaps and/or barriers between ambition and reality remain formidable. In speaking with firms, the technology and data issues are usually around areas such as: fragmentation of systems and trading risk data sources resulting in technology and operational complexities (70%); achieving an aggregated view across counterparty, desks, products, and geographies (60%); and the need for stronger front office risk tools and controls (42%). Here, Celent believes that, if “legacy baggage” within financial institution is not properly addressed, new capabilities will be increasingly difficult to develop given the growing pace, complexity, and demands of regulations on the horizon.
Responses also indicate that the majority of firms (60%) have significant manual processes and checks, often with a lack of straight-through and data integration between front office pricing and decision points with middle/back office market, credit and capital management systems, which are required to produce the required performance and risk measures accurately and in a timely manner for the front office.
In the longer term, whatever the term “real time” means in the context of trading desks at present, the emerging consensus seems to be for firms to have at least an aggregated, near-real time view of positions and exposures; and a timely predeal delivery of risk and capital metrics such that the front line can be sufficiently effective in making risk-adjusted pricing and trading decisions before entering into a deal.
In the near term, the priorities for risk technology and operations are: For the front office, firms are looking for risk-aligned decision-making tools, analytics, and metrics achieved in an automated manner (>40%). On the other hand, at an enterprise level, firms are looking to achieve tighter alignment with front office processes (80%) and golden sources of data (40%) to ensure greater timeliness and accuracy.
In the longer run, Celent believes that winners will be characterized by the following principles:
- Exploitation of next-generation technologies.
- Coherent risk IT strategy underpinned by strategic principles and sound IT
- An ecosystem change approach across end-to-end trading and risk workflows.
- Tight orchestration and improved operational efficiencies.
- Initiatives catalyzed by regulation, but led by innovation and value.
While the industry anticipates changes and structural shifts in the coming years, individual firms will face a high degree of risk and unpredictability in how the various markets, participants, and end clients will react and respond. Although no one has an absolute insight into how the end game will look, firms would do well to prepare and equip themselves—to perceive and discern risk more clearly in a rapidly changing environment ahead (without a fragmented lens), and to develop sustainable mechanisms that provide the firm with a collective perspective to make decisions on. Firms need to make investments now for new realities emerging on the horizon.