Minority Report (2003)

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June 2003

Minority report: Capital markets in the 21st century By Sean Park, global head of debt syndicate and investment grade trading Everything you can imagine is real — Pablo Picasso would imagine that for those bankers involved in the birth of the Eurobond market, the global capital markets and their workings would seem to harbour only vestigial similarities with their own early endeavours. Forty years is a long time at the turn of the 21st century. I wonder if our reality bears resemblance to their vision. Globalization, Moore’s Law, the end of the Cold War, the Euro…did they imagine? In the end, all visions are necessarily reflections through the kaleidoscope of the present. With respect to the financial world this is doubly true: for despite the selfattributed importance given to them by bankers and financiers, financial markets are no more than the grease that oils the machine of human progress. They are a means not an end. The markets reflect the world they exist to serve; envisioning their future involves a correspondingly complex escheresque reflection upon a reflection. Heisenberg’s uncertainty principle states that you cannot know both the position and momentum of a particle at once as the very act of observing one will change the other. Financial markets follow a similar principle: asking where we are today inevitably and inexorably changes where we will be tomorrow. So in the full knowledge that the laws of nature are aligned against any prediction I may make, I nevertheless will hazard to project a vision of how the future of capital markets banking will develop in the coming years. Much has been written (by people eminently more qualified than I) about the productivity miracle – or lack thereof – brought about by the revolution in information technology. Without re-opening this debate and ignoring any quantitative data, it would seem anecdotally obvious to most in the industry that the impact on the financial services industry has been enormous. Can you imagine trying to publish real time prices (and spreads and yields) on thousands of bonds simply using an AIBD calculator? Or pricing and distributing the trillions of euros of new securities issued

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every year using only a telephone and a telex machine? The examples are endless. Yet due to the continuous, incremental nature of the adoption of new technologies much of this massive increase in productivity and capacity has gone relatively unnoticed by most industry professionals. However, every so often a number of factors accumulate and precipitate a quantum shift in behaviours and organizations. I believe we are in the early stages of just such a phase. A giant asteroid struck the earth millions of years ago, wiping out the dinosaurs and setting the scene for the emergence of a new wave of evolution and allowing a new lifeform, mammals, to thrive. The dislocations and turbulence of the past two years in the financial markets may be a similar ‘extinction level event’. Set against the massive increase in the power of communication and information technologies, it has set the scene for the emergence of a new model for investment banking. Only three basic ingredients are involved in a capital markets business: financial capital, information technology and infrastructure and human capital. Until recently, only the former and the latter were seen as relevant to competitive advantage, with technology seen only as a (necessary) utility. Going forward this relationship will be turned on its head. While all three elements are needed, financial capital will increasingly be seen as a pure commodity – valuable and scarce but no longer in and of itself a driver of competitive advantage. Human capital will continue to play a pivotal role in creating value however not in the current or traditional sense. It will

be the ability to leverage this human capital with powerful technology and infrastructure that will differentiate the best firms. This does not mean simply throwing more powerful servers and fatter pipes at the front, middle and back offices but inventing completely new organizational conventions and workflows in order to harvest an entirely new set of opportunities and circumstances. Firms in our industry are constantly reshaping themselves: merging this business and that, creating new teams and silos, breaking down walls on one hand and building up new ones on the other. For the most part this combinatorial ballet has avoided real innovation and has yet to break free from the chains of past experience. It is a classic example of turkeys not voting for Christmas. But clinging to the status quo only avoids the inevitable. The death of the salesman. And the trader. And the syndicate manager. Etcetera. The job titles may yet survive as a primordial reminder of our evolutionary antecedents (think of it as our reptilian brain) but the functions themselves will change beyond recognition. (Imagine the captain of a 16th century galleon trying to captain the space shuttle…) Although his star may now be somewhat tarnished, Jack Welch’s “destroyyourbusiness.com” initiative at GE was prescient in its underlying philosophy: if you don’t engineer the obsolescence of your business model someone else will.

Daunting challenge

The current model of investment banking relies on the judicious management and manipulation of information, confidentiality and relationships. Stripped down to its New model Old model barest facets it relies on arbitraging a heretofore Information Data scarce commodity — information — against a privileged position Confidentiality Transparency within the population of actors. Information, however, is no longer Customer Service Relationships scarce and is increasingly difficult to ration or arbitrage. Changing success factors in a capital makets business One commentator

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June 2003

recently drew the parallel between processing information in the internet-enabled world to drinking water from a firehose: the problem is not getting enough information, it lies in using it effectively. Tomorrow’s model of investment banking will rely on altogether different drivers of success. Data, transparency and customer service will become the factors that will challenge the current incumbents to the very core of their organizations and philosophies. The ability to store, manage and manipulate data is the single most daunting challenge faced today in the capital markets arena and will ultimately play a determining role in defining leadership in the new era. As financial markets harness the exponentially growing power of information, their reliance on complete, robust and accurate data multiplies accordingly. Unfortunately for most financial institutions and investment banks this is an area that is too often delegated (or relegated) to the dusty corners of operations or IT and does not enjoy either the focus or the understanding by senior management that it deserves. After all, who wants to discuss the minutiae of six- sigma-quality reference entity data mapping with hundreds or even thousands of measurable market data points, when you can talk about the next big deal or the next round of cost cutting? If nothing else, Basle II should at least get these items on the radar screen at board level, but a compliance based approach to data will only get you so far in terms of unleashing a true revolution in downstream production benefits. In a world where competitive advantage was predicated on the ownership and exploitation of scarce and guarded information, it is only natural that investment banks built cultures of secrecy and fiefdoms as these rules were also applied within the organization. This is perhaps the most challenging of changes that must be faced as it goes to the core of how many bankers define their selfimage: I ‘know’ this fact, I ‘know’ this person (and you don’t!). It also touches a sensitive nerve with respect to the ideal of a bank as the ultimate secure repository, the guardian of trust and confidentiality. While it is clear that any bank that wishes to remain in business must protect the trust and the contract they have built with their clients and customers, it is equally clear that they must marry this legacy with a future where the value of information is transitory, and even then only insofar as it can be processed and leveraged at speed, more often than not in real time. The only way that this can be possible is to throw open the gates and embrace transparency. Rather than worry about who knows what, worry about who doesn’t know and what it is they don’t know. We no longer have the luxury of rationing and measuring as we go along,

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Sean Park Vision of the future but need to make information available to as broad a population as feasible so that we can tap the entire power of the organization allowing it to constantly reinvent itself to the ever changing problems and opportunities afforded to it.

Customer service If the ability to manage and distribute data and information in a seamless and transparent fashion across the organization are prerequisites for success in investment banking and capital markets going forward, the driver of that success surely lies in adopting a culture and structure predicated on customer service. Putting aside the business of proprietary risk taking that is an important pillar for most investment banks, the customer side of the business is in need of a complete overhaul.

“I am among the last of a generation who did not grow up with a computer in their bedroom” Much is promised by banks in terms of ‘putting the customer first’ and ‘delivering solutions not products’ however the reality is that, even if this is the good faith intent, the current structure of the banks is still aligned to the delivery of financial products as a holistic package with all the ancillary bits (settlement, research, payments, etc.) thrown in to a greater or lesser extent. An essentially analogue model for an emerging digital world. The ‘digital’ model breaks down all aspects of the business into discrete component parts and allows for each to be optimised (either in-house or outsourced) and then packaged and delivered to the client according to their needs. Through this industrialization of the process, the skills and functions of the bankers must equally realign, with expert designers, engineers and manufacturers on the production side, and state of the art customer service representatives on the other.

In this way the investment bank of the future is more likely to closely resemble a service company like IBM or Oracle and/or a distribution powerhouse such as Walmart. Certainly the interface with customers needs to change with the traditional securities salesperson, trader, and originator going the way of the dinosaur and a more intelligent adaptive combination of customer service representatives and product/technology experts taking their place with realigned focus. There is no way to summarize even the most cursory of forecasts and ideas on the future of any industry in two pages, however recognizing this I hope the above gives some food for thought on the subject. The main point remains the idea that the stunning progress in information and communication technologies that continues apace will undermine the current shape and structure of our industry in ways that we can hardly imagine and that while change is not new (witness the last forty years!) and will remain a constant, we are currently in the midst of a particularly fundamental shift in our paradigm. The single most important driver of this shift (and the reason why I am convinced of its inevitability) is not the technology itself but the people involved in our industry. Throughout the years investment banking has continued to draw some of society’s best and brightest, and perhaps uniquely in industry, from all walks of life. This I believe will continue. More importantly, and not unique to banking, the bankers of the future will have grown up with these new technologies and this new culture. To the leaders of today, these technologies are a novelty. They may or may not have first hand experience with them and they will still remember carbon paper and long distance calls. I am among the last of a generation who did not grow up with a computer in their bedroom. I did not use a word processor or a spreadsheet until university. I did not surf the net until well into my adult life. The next 40 years will see leaders emerge for whom the novel technologies of today are ubiquitous, innate. Marshall McLuhan once said, “In this electronic age we see ourselves being translated more and more into the form of information, moving toward the technological extension of consciousness.” For those joining our industry today and in the years to come, this will be their reality. For the older generation and current leaders, maybe some (of Randy Bachman’s) words from their youth will help sum it up: “B-b-b-baby, You just ain't seen n-n-n-nothing yet…” (Oh and by the way, if you don’t already know it, you should probably learn the meaning of ;-). ) ✩

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