Finding the right balance

After facing difficulties in 2017, things are looking up for the investment banking sector. But financial institutions won’t be getting carried away, as uncertainty still lies ahead

By and large, 2017 was a good year for the global economy: the US saw growth of 2.3 percent (see Fig 1), a marked improvement when compared with the previous year; the eurozone experienced its fastest rate of expansion in a decade; and global stock markets soared.

However, it was not such a good year for investment banking. Sustained low volatility hit revenues hard, even among the industry’s biggest players, while many banks continued to struggle with internal restructuring and strategic indecision. Revenues for the world’s 12 largest investment banks fell by four percent compared with the previous year, reaching the lowest levels since 2008.

Income from equity trading and fixed income, currencies and commodities was particularly disappointing, with the latter falling by 11 percent during 2017. With profitability proving hard to achieve, banks will have to hope that the investment landscape becomes more favourable, or else find new ways to cut costs. Fortunately, 2018 has already provided grounds for optimism.

Volatility is returning, and a number of expected unicorn IPOs should stimulate increased investment banking activity. With 2018’s positive outlook underpinned by continued global growth, there are certainly plenty of reasons for banks to be bullish. However, with the investment landscape prone to sudden change, they shouldn’t get too carried away.

Reasons to be positive Although for the most part investment banks struggled during 2017, there was one bright spot: equity capital markets (ECM) activity totalled $872.6bn across the year, according to data published by Dealogic; a 20 percent increase compared with 2016. Follow-on offerings were up 13 percent year-on-year, global IPO activity had its strongest 12-month period since 2014, and ECM fees increased by 42 percent.

The ECM boom was largely propelled by robust global growth and record-breaking stock market performances. In the US, the Dow Jones Industrial Average experienced 70 record closes throughout 2017, a feat that hadn’t been achieved in 22 years. In addition, strong performances in Europe, Japan and emerging markets all contributed to a favourable investment landscape. The sustained period of low inflation seen across developed economies has made growth stocks particularly attractive and created a stable corporate environment. With interest rates also low, the temptation to bolster investment portfolios is high. Although loose monetary policy may entice investors to make riskier choices than they otherwise would, for investment banks it is a real boon.

There is evidence that last year’s positive trends will endure in 2018: stock markets are continuing their upward momentum, and consumer confidence remains high. Investment analysts expect these favourable conditions to encourage larger flotations, and – in the US market, at least – investment banks will surely be encouraged by the tax reforms passed by President Donald Trump at the tail end of 2017.

The cautious approach If the strong performance of equity capital markets gave investment banks something to cheer about in 2017, then the year’s disappointing mergers and acquisition figures will have curtailed celebrations somewhat. The global value of mergers and acquisitions fell 5.2 percent to $4.74trn compared with 2016 (see Fig 2). Uncertainty over US economic policy, protracted Brexit negotiations and anxieties over North Korea all helped to reduce the number of deals taking place.

While it is true that mergers and acquisitions did pick up in Q4 of last year – major tie-ups were announced for Cisco-BroadSoft and Apple-Shazam, among others – this has since been tempered by Trump’s increasingly protectionist economic policies. The president’s decision to block the proposed takeover of Qualcomm by Singapore-based rival Broadcom on the grounds of national security concerns back in March will have alarmed many in the investment banking community. Seven banks were supporting Broadcom’s bid, but now they and many others will surely hold a more sceptical outlook concerning international investments.

In addition, the market volatility that returned at the start of 2018 has given financial institutions something to think carefully about. A degree of volatility is certainly welcomed by investment banks as it encourages clients to trade. Too much volatility, however, can have the opposite effect, scaring off investors. When US stocks experienced their biggest single-day fall in more than six years back in February, many investment banks were bullish. This is unlikely to remain the case if this kind of market volatility is sustained over a prolonged period of time.

There are other uncertainties clouding 2018’s investment outlook. In the US, economic question marks surround Jerome Powell, the new chairman at the helm of the Federal Reserve, while November’s midterm elections could scupper Trump’s future policy proposals. What’s more, the lingering threat of a global trade war will have investors – and the banks that support them – concerned, regardless of where they are based.

Investing in innovation If investment banks are to minimise risk while capitalising on favourable economic conditions, then the adoption of new technologies must continue to be prioritised. Investment banks may be more complicated institutions than their high street counterparts, but they remain fully aware of the threat posed by fintech start-ups.

Given that many of the highest profile investment institutions have a long and well-established history, legacy architecture can prove difficult to shift. Nevertheless, recent IT advances are making their presence felt in many banks across the world. JPMorgan Chase, for example, has committed to spending an additional $1.4bn on technology throughout 2018 as it moves to a ‘digital everything’ model. New mobile applications, big data and blockchain solutions are among the main targets for investment.

Other innovations are also being pursued. Robotic process automation (RPA), where software is used to automate repetitive tasks like data entry, is proving increasingly popular in the financial services industry. Estimates indicate that RPA can improve processing speed and efficiency by as much as 80 percent, giving personnel more time to focus on strategic goals.

While 2018 promises to be a more rewarding year for investment banks, it will not be without risk. Technology can help mitigate this risk by limiting human error and providing more accurate insights. Even so, banks will still be tasked with finding the right balance between pursuing short-term profits and achieving long-term sustainability.