Capital markets are undergoing a structural shift as investment banks move away from legacy, self-operated back office functions toward shared, collaborative systems capable of supporting AI, says Joe Channer
The Thatcher government’s Big Bang reforms transformed the City of London from an old boys’ club into a global electronic marketplace 40 years ago this month. Top hats were replaced by red braces, open outcry gave way to computer screens, fixed commissions disappeared faster than the brick mobile, and exploding trading volumes turned investment banking front offices into the global epicentre of financial innovation.
Today, another seismic structural shift is well underway. But this time, instead of happening on the trading floors, the revolution is taking place deep inside the infrastructure that keeps the beating heart of capital markets pumping.
In the subsequent years since the legislation was passed, investment banks have built and operated much of this infrastructure themselves. The less glamorous post-trade operations like settlements, reconciliations, confirmations and regulatory reporting have largely sat inside individual investment banks across the Square Mile. At the time, ownership was seen as control to these financial goliaths.
The trouble is that, today, that model increasingly looks unsustainable due to how complicated financial markets have become. In stark contrast to the 1980s, investment banks are managing sprawling operations spread across multiple parts of the world.
Subsequently, this has taken up a huge amount of management resource and capital expenditure. If this wasn’t enough, artificial intelligence (AI) is now testing infrastructure built in yesteryear to its absolute limits.
Often talked about as though it can be just plonked on top of existing banking architecture and mercurially improve productivity, the reality of AI is that it works best in well-governed environments. The issue is that many banks still operate heavily customised operational estates stitched together over decades through acquisitions which means they do not have modern infrastructure capable of supporting AI.
Big Bang 2.0
That is one reason why capital markets are beginning to move towards the Big Bang 2.0 if you like. Investment banks used to think they had to own everything themselves, but now they’re starting to share with others. However, it’s not like the old way of just sending work to another country to save money, now banks are working together to create big systems that lots of banks can use at the same time. These systems are all working together in one place like the technology equivalent of Wework – a big shared space that lots of banks can use rather than each one having its own separate systems.
This new way of doing things is very much a team effort where banks work in tandem to create something that’s good for everyone. The logic is relatively straightforward in the sense that no investment bank doesn’t want lower operational complexity or for fixed costs to become more variable. This mirrors a shift that already transformed the wider technology industry with few companies today insisting on owning their own data centres.
Investment banking may finally be heading in a similar direction, and the implications could be profound. It’s certainly no longer just about exchanges and clearing houses anymore when it comes to defining market structure. These days, banks are getting more into the service sector with their own infrastructure. The difference between what happens inside a bank and what external infrastructure providers do is getting more fuzzy. As a prime case in point, some big banks are already handing over all their OTC derivatives post-trade work to outside providers. This shift is happening at a rate of knots, and it’s changing the how banks work with external companies. As a result, the traditional lines between internal bank operations and external services are becoming more and more blurred.
The way markets work is about to change in a big way. But this time, it’s not going to be like it was back in the 80s, with all the flashy trading floors and champagne toasts. Instead, the investment bank of the next few decades will be based around the invisible infrastructure that, at least in theory, should make everything run without a hitch. One could call it a silent revolution, but it will certainly be one that will have a huge impact on how capital markets run. Ultimately, the key to success for investment banks will be finding a balance between keeping the basics running smoothly and innovating in the areas that matter most.
Joe Channer is CEO of Delta Capita