The next 30 years of the capital markets
Since 1987, when EuroWeek started publishing, the global capital markets have been through several revolutions, but there are still plenty of working practices in 2017 that would be recognisable to someone from the fixed income market of 1987. What might the capital markets of 2047 look like? Owen Sanderson makes some predictions .
Predicting the future is a mug’s game, but barring disaster, the world of 2047 will still have capital markets — and we will still be writing about them.
Nearly every financial product that can exist has already existed. Basic concepts of asset security, risk transfer, interest payments and ownership rights can be mixed together and formatted in a huge variety of legal wrappers, and for hundreds of years, some of the smartest minds have tried to find an edge doing that.
Before Monte dei Paschi started its recent programme of securitizing non-performing loans, or its early-2000s securitizations of investment loans, it was securing loans on cattle grazing rights. Long before there were mortgage-backed securities, banks in 1830s America had figured out how to secure bonds using slaves as collateral.
But new technology does change things. Securitization might have existed before, but could only work in its modern form thanks to the advent of computers. Keeping track of the cashflows for tens of thousands of mortgages, let alone modelling the effects of interest rate changes on these cashflows, needs technology to be efficient.
Derivatives, too, rely on computing power in their modern form. Risk transfer, through swaps, guarantees and insurance, has existed forever — but daily margined, collateral optimised trades, where funding costs, counterparty credit and wrong-way risk are all baked in and priced accurately, requires computer power, and lots of it.
Whatever else the next 30 years brings, expect a lot more of this kind of progress. The ideas and aims of finance may not be new — but the technological horizon will keep expanding.
At the heart of it all will be some form of blockchain. Like mobile phones in 1987, or the internet in 1995, blockchain technology is taking its first awkward steps today. There are trials and there are proofs of concept, but so far, not much of the promised revolution.
Blockchain: believe some of the hype
But the blockchain boosters are right that the technology has huge potential to change the way capital markets function.
This, GlobalCapital predicts, will take a tediously long time to become reality. By 2018 or 2019, lots of market infrastructure — stock exchanges, clearing houses — might be running on blockchains in the background, smoothing out some execution and settlement issues.
But a full-scale leap into blockchain, where the billions of contracts that underpin financial markets become, as a matter of course, self-executing smart contracts, is a long way off. To be truly useful, it requires money itself to be issued and tracked via distributed ledger, and then for this digital money to be hooked into securities services and banking.
A world of instantly updated, globally-agreed, self-executing money and finance means an instant risk dashboard for regulators and counterparties, instant settlement for any transaction, and the virtual elimination of know-your-client, anti-money-laundering and market structure from the back office of financial firms.
The obstacles, though, are considerable, and centre around co-operation, not technology. A world where immutable blockchain contracts are king is a world where hundreds of institutions, from central banks down will have to give up power, for the sake of improving efficiency for everyone. That might happen in 30 years — but don’t hold your breath.
The long term future of the investment bank is also in doubt. The last 30 years have witnessed huge consolidation in the industry, but the pendulum could easily start to swing the other way.
Deregulation of the London Stock Exchange in October 1986 was preceded by the disappearance of dozens of tiny broking firms, and the jobbers which intermediated trades on the LSE floor.
Morgan Grenfell swallowed jobbers Pinchin Denny, and brokers Pember & Boyle, before itself being swallowed by Deutsche Bank. Most of the other Stock Exchange minnows have ended up as tiny corners of huge universal banks.
The 2000s brought another wave of consolidation, as the UK merchant banks disappeared into commercial banks, surviving, if at all, as brand names like JP Morgan Cazenove, RBS Hoare Govett, or Dresdner Kleinwort. The financial crisis shrank profits, and shrank the number of active firms, as Bear Stearns and Lehman Brothers sank or were dismembered.
But it doesn’t have to be this way and in the next 30 years, divestment is more likely than consolidation. The commercial reasons for building integrated investment banks have looked sketchy for years. Equities trading is increasingly a game of dark pools and systematic market-making, alongside prime broking and maths-heavy derivative structuring. That has taken it further away from the blue-blooded corporate financiers who originate equity offerings, to the point where it’s not clear why they should be under the same roof, using the same capital.
Fixed income give
Fixed income is still bound closer together, but as banks adopt lower touch sales strategies, e-trading comes to the fore, and bond mandates have less and less to do with execution and more to do with lending (at least in EMEA and Asia) — it’s not obvious that the glue holding DCM and fixed income trading together will last the next 30 years.
Regulators are already pushing hard for more transparency on certain products which have historically been bundled together — the free provision of research to the buyside is under attack from MiFID II, for instance — and that’s anathema to the integrated investment bank.
Once clients have to buy their research, advice, execution services and lending separately, then why not buy them from different providers as well? If that happens, conglomerate banks will start to break apart, not always to the benefit of those who use the services. Cross-subsidies can feel pretty good at the time.
Squint, and you can already see it. With a couple of exceptions, banks restructuring after the crisis have abandoned the attempt to be truly global and comprehensive. That has created opportunities for smaller specialist brokers to occupy niches in fixed income, while M&A boutiques seem unstoppable. Some institutions want access to the capital markets to serve wealth management clients; some want to execute hedges and raise finance for corporate clients. There’s no guarantee these functions have to be housed in the same bank — or in a bank at all.
Green finance on the much
The capital markets 30 years from now will also have to be a lot greener, if we’re going to carry on living on this planet. The US president may be happy to see the world burn in a haze of dirty coal, but chief executives, bankers and the rest of the world’s leaders are not, and green finance is on the march. Right now, that’s taking the form of two parallel markets — a green bond, ethical finance, solar and wind infrastructure market that taps into a fair chunk of conventional money (and a small but growing set of ethical funds).
Meanwhile, ordinary capital markets thrill to the chance for a slot on the Saudi Aramco IPO, and DCM bankers jostle over bond deals for BP, Shell and Total. The big energy firms still tie up a huge amount of capital, and so, inevitably, absorb the attention of the global capital markets.
But there are encouraging signs that this dirty dominance is coming to an end. Increasingly, banks are turning away from coal finance — but the next 30 years will have to mean shutting it down entirely, and likely conventional oil as well. Maybe the markets will have financed a retooling towards synthetic fossil fuels, geo-engineering or carbon-scrubbing, but the world is in big trouble if equity investors are still gambling on new oil strikes.
But in 30 years, there may be no green finance at all. In the same way that investors have some hygiene standards for purchases now, a basic level of greenness may simply be ordinary, unremarkable, and necessary for all capital markets products.
Values-driven finance may wither on the vine or become the preserve of religious fundamentalists; already today there are ETFs allowing investors to avoid funding homosexual-friendly companies. GlobalCapital abhors this, but all the structures of green finance can be applied to any set of morals one chooses.
What stays the same
While plenty of things will be different in 30 years’ time, lots will stay the same. Capital markets might be increasingly commoditised and low touch — ETFs and robo-advisers steering money mechanically to securities, intermediated by automatic market-makers or high frequency algos. But investment banking, and related businesses, like DCM, will still be people businesses, probably still relationship-based with punishing travel schedules.
Futurologists say business travel has been on the verge of becoming obsolete for decades, as video conferencing improves. But barring a shift in human nature, face-to-face still wins the race.
A big bond deal, or a strategic trade like a capital raising or an acquisition, requires high levels of trust, commitment, and a sense that a bank is consigliere, not just counterparty. A world of blockchains, artificial intelligence and machine learning isn’t going to take that away.
Any changes there are likely to be to the form, not the content. A pitch from 2017 is not far different to a pitch from 1987 — there might be a few more iPads and a lot more Powerpoint (the programme was only launched for Windows in 1990) — but the idea would be instantly recognizable.
The pitchbook of 2047 will probably still make sense to the bankers of ’87. Perhaps there will be virtual reality, perhaps holograms, and maybe data will be drawn from satellites and neural nets rather than Bloomberg (surely the monopoly will be broken by then?). But it’s purpose, rhythm, and tone will hold firm.
It is even possible that bankers will still be failing to exploit the new technology to the full. Holographic editing packages may be purchased at huge expense, with a group of holo-artists to bring them to life — and be used to conjure a virtual reality group of DCM bankers holding up a “best bookrunner” award.