The COVID-19 situation has created challenges for the real economy and financial services, yet markets have proven remarkably resilient. Financial institutions were bolstered through effective regulatory measures introduced after the global financial crisis and supported by government and central bank stimulus to tackle the health crisis and its economic impacts.
Capital markets firms have secured increased trading revenue in volatile markets and fees from record debt and equity underwriting, accelerating significant operational change simply as circumstances left no other choice. The shape of the recovery and the global geopolitical outlook, including regulatory equivalence decisions remain key uncertainties.
This has seen some investment banks return to profit and seek to invest again and private equity firms hoard cash in anticipation of 'fire sales' in 2021 as restrictions are eased and creditors start seeking cash.
Here are 10 key themes that will impact the market over the next 12 months:
1 Macroeconomic recovery
Coronavirus may still be at a peak wave and sentiment gloomy, but financial markets remain resilient, and equity capital markets have boomed in response to successful vaccine developments, as well as the changed outlook in US politics, shrugging off chaos during the transfer of power.
The Brexit transition period ended with a late deal that moved exchange rates favourably. It signalled some goodwill that may be beneficial, as bilateral negotiations critical to protect UK financial services are continuing.
There might be light at the end of the tunnel, but the economic recovery after coronavirus will have challenges, that are likely to affect business activity, debt burden and employment in some sectors more than others.
Restoring government finances is expected to involve significant tax rises, while the post-Brexit economic impacts have only started to manifest. Leveraging areas of strength will be critical to retain a competitive advantage in the evolving geopolitical landscape.
2 The evolving regulatory framework
The appeal of post-Brexit deregulation has been constrained by the need for regulatory equivalence to retain market access.
The Financial Services Bill gives UK regulators new powers, and their aim for the UK’s future legislative and regulatory framework remains to protect markets and consumers. Hence, provisions aim to ensure LIBOR transition and prioritise reforms to the UK prudential framework, with implementation of the Basel III, and a new Investment Firms Prudential Regime (IFPR), while Market Abuse Regulation (UK MAR) is also tightened.
UK competitiveness clearly remains in focus, too. UK market access for overseas firms under UK Markets in Financial Instruments Directive (MiFID), as well as for funds, has been addressed, while European Market Infrastructure Regulation (EMIR) amendments aim to improve clearing access.
UK regulators have been leading on climate risk and sustainability, and coronavirus has increased focus in those areas further. Green tax credits can open new opportunities, incentivising innovation and attracting firms from the increasing number of global jurisdictions aligned to the same objectives.
Strengthening operational resilience remains high on the regulatory agenda, with BoE, FCA and PRA policy statements due in the first quarter and implementation progressing throughout the year.
3 Building more agile and resilient operating models
The impact of coronavirus has driven a need to adopt greater agility and better resilience in bank operating models, in order to flex and meet changing service delivery requirements. This includes improved burst capacity processing, as well as greater operational resilience.
We anticipate a shift towards much more remote working as employees seek to retain some of the benefits obtained by recent circumstances, although regulatory expectations that home working and office arrangements should be equivalent in terms of market abuse controls, as well as the need for social contact in offices, will still drive a switch back to office working.
This revised focus will also drive wider stress testing and updates to recovery resolution, operational continuity in resolution and wind-down plans.
4 A reinvigorated sustainability agenda
Given the increased focus across the financial services industry with regards to environmental, social, and governance (ESG) considerations and particularly climate change initiatives, capital markets need to consider their relationship with their clients and their transaction activities. In particular, M&A activity, debt raising, and IPO transactions need to consider the climate risk impact.
As an example, climate change frameworks have debt raising clients employed to ensure use of funds do not contribute to ‘additional harm’ to the economy from inappropriate carbon based investments: how does M&A activity contribute to a ‘greener’ outcome and have due diligence processes explored the ‘end state structure’ and its contribution to a greener economy.
Capital Markets have a significant role to play in achieving government and regulatory ‘green’ initiatives and goals and need to review the alignment of their strategies and risk appetites.
5 Accelerating cost reduction and restructuring
After a turbulent 2020, all capital markets institutions will need to continue to accelerate their cost reduction and restructuring efforts.
This is even true for institutions with global markets businesses that have benefited from recent higher trading volatility. In order to position for macro-economic recovery and increase operating model agility, initiatives to prioritise capital and resource allocation to core and periphery business lines will progress at pace.
Typical initiatives will reshape product and service offerings across target client segments, as well as streamline and standardise high volume business areas, such as FX.
In a number of cases, business or product exits in marginal markets will be executed in order to redeploy capital. In order to meet aggressive targets, investment banks are likely to look for alternative solutions for platform modernisation with ecosystem partners, as well as to commercialise intellectual property from existing technology assets.
6 Increasing fintech adoption and innovation
Trading technology architectures remain cumbersome. Due to acquisitions and regulatory demands, many banks have added to this complexity, failing to simplify and reduce costs.
The UK government is seeking to drive a wave of fintech innovation post-Brexit and coronavirus has further increased the need for geographically dispersed scalable architectures from the major cloud providers. Regulators are supporting these changes and adapting regulation to enable businesses through, for example, mandating recording of calls when off site.
Distributed ledger offerings are emerging, focused on digital assets and crypto-currencies, and central banks, such as The Bank of England, are developing support for digital currencies. Pure ledger offerings are being applied where significant change can be implemented, such as contract digitisation in insurance and supply chains.
7 Deglobalisation
Recent circumstances have accelerated the take up of digital technologies that make frictionless working from anywhere a reality.
Paradoxically, however, momentum is building towards deglobalisation.
Trade disputes, the erection of protectionist trade barriers between economic spheres of influence, state sponsored cyber attacks and an emerging cold war with China will increasingly shape the listing, footprint, supply chain and operational resilience strategies for global institutions.
Firms may, ultimately, be forced to choose between competing economic spheres and ecosystems. Decisions will depend on political alignments, where the majority of highly profitable customers reside, and hence the greatest returns on capital. These customers will be serviced by value and supply chains based largely within the chosen sphere to ensure security of supply and avoid the risk of regulatory sanctions.
8 Understanding and responding to increased M&A activity
2020 saw a wave of consolidation across southern Europe and we anticipate this continuing in 2021. After Brexit, the core European banks will need to continue navigating the distressed assets and country imbalances with the creation of national champions.
The Big 6 banks in the UK are likely to remain. However, the role of investment banking and position of the US houses will likely evolve as the regulatory landscape becomes clearer. Those banks with limited retail and real estate exposure are likely to prosper and there will be opportunities for expansion in their less well capitalised peers.
9 The emerging new capital markets ecosystem
Until there is some clarity on the future trading landscape after Brexit, we see a lot of uncertainty in central counter parties and exchanges and it's not clear how it will evolve.
The recent move of some trading to Europe will create capacity in the UK markets and this may reduce the pressure to change. Recent activity, such as the approval of the LSE/Refinitiv deal, indicates that there is ongoing appetite for change. We also anticipate further fintech engagement around the development of digital assets.
10 Reinvesting for growth
Pure investment banks are well positioned to secure profit from increased uncertainty and volatility. These revenue streams should allow them to invest in the new technologies and position themselves better for the future. The universal banks will face tougher times, with increased provisioning likely to consume any new revenues. They will need to invest in better credit and arrears processes, although there are opportunities to exploit technology and advance businesses.
Unlike the global financial crisis, this crisis is an exogenous shock. Capital markets and financial intermediaries are essential to its resolution. Firms can individually and collectively innovate capital markets operations, reset their culture and reputation, and renew their purpose, by focusing on the customer franchise, understand adaptive behaviours and evolving needs of customers across segments that have been at the heart of this human crisis.
