Future assets

Though the macro environment remains stalled by tough regulation and low interest rates, investment banks are on the cusp of some fundamental technological breakthroughs

Over the past few years, a series of political shocks has substantially blurred the global economic outlook, while any sort of anticipated global recovery has been frustratingly slow to play out. Indeed, according to PwC’s June 2017 Global Economy Watch report, levels of economic uncertainty recently hit their highest point in decades, even exceeding those at the time of the 2008 financial crisis (see Fig 1).

The report draws on the Global Economic Policy Uncertainty Index, which, among other things, is influenced by the extent to which forecasters disagree over their predictions. Faced with such high levels of uncertainty, the investment banking sector is now being forced to adapt its strategies to a new kind of global climate.

A combination of consistently low interest rates and strenuous regulation has gradually taken its toll on the sector’s profitability. In particular, the fixed income, currency and commodities (FICC) sector has seen severely reduced revenues. According to a report by McKinsey, FICC made up just 46 percent of revenues for the biggest 10 banks in 2015, a huge drop since 2010, when it accounted for 61 percent. Looking ahead, the implications of Brexit and the regulatory changes proposed by Donald Trump in the US are yet to play out, with potential for further disruption looming ahead.

A year in numbers Data from Dealogic revealed that revenues from the global investment banking sector slumped by two percent in 2016, compared with the previous year. The decline was particularly pronounced in Europe, which witnessed a concerning 13 percent drop in revenues over the same timeframe (see Fig 2, overleaf). This is largely due to the continent’s careful regulatory requirements and a turbulent external environment, clouded further by concerns over China and dwindling commodity prices.

While Europe’s investment sector has struggled to reach sustainable profitability levels since the introduction of far-reaching post-crisis regulations, the US has fared relatively well. Despite being faced with the same external environment, the US experienced a mere one percent drop in revenue over the same period. Asia, on the other hand, has seen even steeper declines than Europe, with revenues down by a staggering 24 percent. On a global level, equity capital markets suffered the most, with profits down 25 percent worldwide. Meanwhile, revenues from mergers and acquisitions, debt capital markets and syndicated lending actually increased, albeit by a small amount.

But this is just one side of the coin; as ever, the investment banking industry is constantly reacting to new challenges and finding ways to reinvent itself. In particular, technological forces are rewiring the sector and bringing about huge opportunities for growth and increased efficiency. Furthermore, a gradual improvement in economic conditions looks set to continue, though it is unlikely that even increased interest rates will do much to spark an immediate upturn in fortunes.

Indeed, though sustained growth is not immediately on the cards, the sector has fared relatively well so far in 2017. By August, revenues were up year-on-year by four percent in Europe, 16 percent in the US, and nine percent globally.

Puff to profits With revenues squeezed, only those investment banks that are able to embrace the fast pace of technological change will be able to keep ahead of the competition. Indeed, a McKinsey study calculated that digitalisation and related cost efficiencies could lead to a two to three percent increase in return on investment over the course of three years.

Furthermore, when it comes to developments such as artificial intelligence (AI) and blockchain, the potential for savings is even greater. While it is easy to become lost in hype and hyperbole, these transformative technologies are starting to translate into genuine practical applications, and their future role in the investment landscape is beginning to take shape.

The coming year will certainly see advancements in the industry’s understanding of blockchain technology, which is currently teetering on the edge of practical implementation. Blockchain, also known as ‘distributed ledger technology’, is able to cut through a multitude of back-office inefficiencies, and thus has the potential to dramatically reduce costs, as well as ensure more reliable and efficient transactions. Increasingly, banks are forging large-scale collaborations in order to identify and explore the best ways to harness the technology. Banks are also fuelling the uptake of the technology through partnerships with blockchain start-ups and the creation of incubators and innovation labs, with a number of prototypes and potential-use cases being explored across the industry.

Does compute Another exciting trend in the sector is the rise of the robo-advisors. Automated investment advice is becoming increasingly viable as a result of rapid improvements in programming technology, and it is even being enhanced in some cases with AI. As a result, a series of new online robo-advising platforms have begun to emerge, challenging the established sector, but also giving traditional investment houses a path to a future that could otherwise leave them in the dust.

This is not to say that the sector will find itself being run entirely on algorithms any time soon, particularly as digital investment advisors so far occupy just a small portion of the market. Furthermore, many argue that a hybrid robo-human approach will more likely define the investment management industry of the future.

This said, a study by Business Insider’s research unit recently projected that robo-advisors will manage $8trn in global assets by 2020, which would amount to 10 percent of the world’s assets under management. In either scenario, one thing is for sure – the banking industry is transforming before our very eyes, and the investment branch of the market is soon to become more efficient and accessible than ever before.