Capital markets told to wean off ‘lucrative inefficiencies’

It shows how the capital markets industry can wring out historical inefficiencies in its business model — inefficiencies that were acceptable in order to grow rapidly and capture market share — as it now faces digital disruption and struggles to overcome fragmented cost structures and create shareholder value.
 The report, titled “Capital Markets Vision 2022,” is based on Accenture’s proprietary financial analysis of the capital markets industry and on interviews with executives at leading industry firms.
Accenture is a global professional services company, providing a broad range of services and solutions in strategy, consulting, digital, technology and operations.
 For the report, Accenture analysed value pools bottom up — based on individual players’ results — creating a view on specific sector and subsector profitability, using fiscal year 2017 data as a baseline. The company used economic profit as a yardstick, deducting credit losses, full operating costs, taxes and the cost of equity. The researchers took special interest in the underlying profit dynamics for key sectors including investment banking, corporate and investment banking, asset management, wealth management and market infrastructure. The researchers then discussed the implications of this baseline and the likely development of these value pools with executives at leading capital markets firms and, during these conversations, identified key management challenges against this backdrop.
Among the key findings: Wealth and asset managers generate 90 per cent of overall industry economic profits (profit after taxes and cost of equity) but are ineffective at achieving scale efficiencies and should prepare for down-market scenarios, with shrinking margins. Investment banks, meanwhile, show a diverse picture: Only some institutions — both large and small — are earning 10 or more cents on the dollar in economic profit, while many others are not earning their cost of equity. And traditional market-infrastructure players’ revenues are now rivaled by those of emerging cryptocurrency exchanges.
 Capital markets firms collectively earn about US$1 trillion in annual net revenue, which translates to more than US$100 billion in economic profit, according to Accenture analysis. But as shareholders, regulators and customers continue to exert pressure on them to deliver higher value at lower cost and as quantitative easing tapers off, fee pressures will place an ever-greater burden on the industry to resolve its once-lucrative inefficiencies, the report shows.
“Some expect the capital markets sector to normalise again and resemble itself before the financial crisis, but our outlook for the years ahead is very different,” said Nontawat Poomchusri, Country Managing Director and Financial Services Lead, Accenture in Thailand. 
“This industry still leans heavily on historically ‘lucrative inefficiencies,’ when there was little incentive to change the status quo because the industry was generating such strong profits. But unlike in other sectors, the core business of capital markets accounts for a very small fraction of its cost bases — and in an era of rapid digital innovation, that leaves the industry ripe for disruption.”
The report, based on Accenture’s proprietary financial analysis of the capital markets industry and on interviews with executives at leading industry firms, focuses on the three main sectors: investment banking, asset and wealth management, and market infrastructure. Among the key findings for each: Market infrastructure players. According to the report, revenue from cryptocurrency exchanges now matches that from traditional exchanges. The interdealer brokerage business—the most traditional arm of the market infrastructure subsector—is narrowly profitable on a pre-tax basis; and most interdealer brokerages are actually shrinking shareholder value. The most profitable part of the subsector are regulated exchanges, which often generate pre-tax margins greater than 50 percent. However, their growth prospects seem to be modest. Most are exploring opportunities in asset servicing, data services and traditional and cryptocurrency trading.
“Adapting a trillion-dollar industry for the digital age while it’s entering an era of profound disruption is a complex and shape-shifting goal,” said Nontawat. “But it is also an era that provides significant opportunities for those who act fast as value pools are being redistributed. Nimble firms will be able to capture new profit opportunities in a ‘race for relevance’—while also benefiting the industry’s customers.”