New business models for transaction banking IBM Financial Services Banking and Financial Markets As...

IBM Financial Services Banking and Financial Markets

Executive SummaryFinancial institutions’ business and operating models have not evolved to reflect the changes in their clients’ business models. Clients are demanding accelerated services, whether real-time payments or high-frequency trading. At the same time, banks and market infrastructures are facing competition from non-financial outsiders which are not hampered by legacy systems.

Banks also face regulation focusing on resolution plans, ringfencing and, increasingly, on operational and IT risk. In addition to having to create new legal entities and break down silos, financial institutions need to reduce costs, generate new revenues to compensate for declining transaction fees, tailor services to their clients’ specific needs and proactively anticipate their requirements. Can their systems cope?

To compete, financial institutions must “return to basics”, align their operating models with their clients’ new business models across counterparties and infrastructures, join forces on shared utilities and leverage the data they possess to reduce risk and achieve customer intimacy. Failure to do so will result in inefficient use of capital, inability to improve margins, disintermediation, and increased financial and reputational risk.

After some introductory remarks, this paper examines client and regulatory forces driving change for participants and infrastructures across payment and securities processing services. It then offers some recommendations for financial institutions to adapt their business and operating models and gain competitive advantage within the value-chain.

New business models for transaction banking

Contents1 Executive Summary

2 Why does the industry need to change business models?

3 Payments, cash management, treasury and supply chain finance services

7 Securities processing: new trends in markets infrastructure and buy/sell side

14 Conclusions and recommendations

2


Why does the industry need to change business models?Fundamentally, the business and operating models governing transaction banking have barely changed in half a century. Standardisation and technology may have increased reliability and execution speed, but the financial services industry is struggling to respond to the demands that globalisation, extended supply chains, accelerated trading and enhanced connectivity are placing on their diverse customers.

Clients are frustrated that banks often cannot “get the basics right”, while demanding tailored services to meet their specific needs. Potentially guided by the views of peers on social media, clients are recognising that it is easier than ever to compare services and switch to a different provider, particularly to new entrants outside the financial sector.

How can financial institutions and infrastructures change their business and operating models to respond to:

• Empowered clients facing changes in their business and operating models

• Rising volumes, but decreasing fees and margins• Evolving, uncertain and fragmented regulation• Rising cost of capital and liquidity• Rising crime and fraud losses• Competition from non-financial entrants?

They must simplify their operating environment, not only to reduce costs, but also to rapidly bring new services to market to meet client demands and increase revenues.

Regulatory pressures to increase capital, deleverage and ringfence (or even separate) retail from investment banking activities will force banks to review their business and operating models: can such obligations be turned into opportunities?

Regulators are also increasingly focusing on operational risk. IT has become “Finance’s fifth column1” following the recent failures of some banks’ payment processing systems, the Nasdaq glitches during the Facebook IPO and the disruptions at major exchanges. Following rapid expansion through acquisitions when disparate systems were patched together, “the legacy is a complex web of thousands of programmes linked by fragile connections2”.

As compliance and maintenance costs rise, budgets shrink, and large investments in new platforms become more difficult to fund in the current economic climate, few institutions can “go it alone”, so pooling resources and setting up shared utilities are becoming increasingly attractive options.

As an example of this new realism, one major investment bank is launching an open source initiative to collectively develop markets and trading software: “Overall, we’ll cut costs as an industry and we can pass that on to our customers,” says Deutsche Bank3.

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Payments, cash management, treasury and supply chain finance servicesClient pressuresThe J.P. Morgan Asset Management Survey highlights significant changes in banking relationships: “Before the financial crisis, the survey demonstrated a gradual trend towards fewer bank relationships. However, in 2008 the majority of treasurers either increased their relationships or kept them the same, and this has continued in subsequent years. The continued focus on counterparty risk in the wake of the financial crisis is reflected in the fact that the financial strength of the institution is now the most important criterion for treasurers when selecting a primary bank, overtaking the quality of relationship management for the first time this year, and with a clear margin.4”

The same survey also highlights “a gradual move towards a global cash management structure, as the events of the financial crisis have emphasised the importance for treasurers of having immediate access to information including cash balances, counterparty exposures and foreign exchange across their entire firm.”

Can treasurers use mobile tablets to access the same dashboards, alerts and authorisations as on their desktops, and with the same level of security?

These demands for real-time information come in addition to calls at every payments conference to “get the basics right”: full remittance information, end-to-end payment tracking, reconciliations and speedy handling of exceptions.

Addressing payments correctly is also becoming increasingly difficult, particularly for consumers: few people can memorise a 20+ character IBAN!

Finally, competition is emerging from internet-based start-ups, such as TransferWise, CurrencyFair and The Currency Cloud. These were initially aimed at consumers, but are also now targeting small companies.

“Large multinationals with large transactions get very good prices from banks, but small companies have never had that access. This is democratising access to financial services” says the head of product marketing at The Currency Cloud5.

Ultimately, banks must develop a better understanding of their clients’ business environment and requirements, deepen customer intimacy to rapidly offer them differentiated services adapted to their needs, optimise balance management and proactively anticipate their demands for liquidity and working capital.

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Regulatory pressuresClearing and Settlement Mechanisms (CSMs) can today be classified as follows:

• Systems offering real-time settlement finality, normally used for high-value payments; these are either Real-Time Gross Settlement Systems (RTGS) or netting systems with a legal framework guaranteeing immediate settlement finality (e.g. CHIPS, Euro1).

• Clearing Houses (ACHs) which clear low-value payments for subsequent settlement through an RTGS system, with delays to credit the beneficiary extending sometimes up to three days. Settlement times have steadily improved through real-time clearing and increasing the number of intraday settlement cycles.

• New generations of real-time low-value payment systems, such as Faster Payments in the UK, offering near-instant final crediting to the beneficiary’s account, but with limitations on the amount, albeit gradually increasing as confidence builds up. The planned G3 system in Singapore will offer real-time funds transfer for all business and consumer payments.

In June 2012 the Reserve Bank of Australia published the conclusions of a strategic review of Innovation in the Payments System, setting out five strategic objectives for the industry to meet within five years:

• “same day settlement of all DE [Direct Entry] payments • the ability to make real-time retail payments • the ability to make and receive low-value payments (Direct

Entry, real-time payments and crediting of card payment receipts) outside banking hours

• the ability to send more complete remittance information for payments

• the ability to address payments in a relatively simple way.6”

When implemented, this will finally eliminate the traditional paradigm differentiating between high- and low-value payments, as real-time settlement finality would be required 24/7, 365 days/year. We can anticipate that these demands for immediate availability of funds to the beneficiary will spread, as forecast in a recent report by the BIS: “Real-time or near real-time payment processing represents one example of a successful implementation of a demand-oriented business case.7”

In addition to this drive for acceleration, payment service providers must also prepare for SEPA in the EU and respond to other regulatory pressures such as Dodd-Frank, FATCA, and so on.

New business and operating models. How can CSMs and payment service providers change their operating models to respond, at least partially, to these challenges?

The move to real-time retail payments will require CSMs such as Faster Payments to be scaled to handle the millions of retail and corporate payments (payroll, pensions and benefits, bills and invoices, etc.), but ever-increasing and cheaper processing power allied to cloud computing make this already a foreseeable reality.

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As these “low-value” payment systems will provide real-time settlement finality, it is likely that the volumes on RTGS systems will strongly diminish, and that these systems will ultimately be used for systemic payments such as transfers between central and commercial banks and settlement of low-value clearings and trading operations (e.g. ACHs, CLS and DVP for securities settlement).

The integral transmission of remittance information has been a source of long-standing complaints from the corporate sector, as incomplete or corrupted details hamper their automated reconciliation procedures. While it is understandable that CSMs cannot handle an unlimited number of characters, they could transmit references to access full remittance data held on file if it exceeded the prescribed limit. Cloud computing could provide the foundation for a shared cross-border utility.

As a simpler way to address payments, initiatives are under way in several countries to create shared databases linking bank accounts to mobile telephone numbers or email addresses.

End-to-end tracking of payments is reasonably straightforward in the context of domestic services. SWIFT provides tracking information between sending and receiving banks, but intermediary banks for onward domestic and/or clearing banks for settlement in a third currency render the problem more difficult across an increased number of counterparties.

Here again, a cross-border cloud-based shared utility to which each institution would report progress could provide a useful solution for self-service end-to-end payment tracking.

Trading hubs, B2B e-Commerce and e-Invoicing platforms (e.g. Ariba, OB10) are gradually dematerialising supply-chain processes such as selection, ordering, logistics and invoicing. Corporations are now seeking integration with Supply Chain Finance (SCF) to optimise working capital.

Alongside the move to Open Account trading, instruments are emerging such as the Bank Payment Obligation (BPO), an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date, after a specified event has taken place.

Tracking and confirmation that conditions have been fulfilled are provided by matching utilities such as SWIFT’s cloud Trade Services Utility (TSU), leveraging progress in rules engines. Event-based SCF requires information to be gathered, aggregated and normalised from multiple points and systems, providing a single view to all counterparties across orders, inventory, shipments and financial transactions.

The biggest challenge will lie, however, with the banks’ back office legacy systems to process these volumes, credit the beneficiaries’ accounts and notify them in real-time, as well as establishing links with the above utilities.

How can the banks simplify their payment processing models and reduce costs while complying with uncertain and fragmented regulation, reducing time to market for new services and developing customer intimacy?

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Firstly, banks operating in several countries must implement a global, centralised operating model and IT systems, mirroring the global cash management structures that their corporate clients are adopting. Non-competitive processes such as fraud detection, format conversion, repairs and even bulk retail payment processing should be outsourced to operators benefiting from economies of scale and/or shared utilities.

This is becoming increasingly relevant as the deadline approaches for full migration to the SEPA schemes within the EU. Cloud computing, using private and/or public clouds, offers significant benefits in terms of scalability, resilience and usage-based cost models.

But most banks have failed to leverage their major competitive advantage: the wealth of data they possess, but often cannot access across fragmented databases or do not analyse. Financial institutions should invest in deep real-time predictive analytics to minimise risk, and to better understand and serve their clients.

Banks can forecast corporate and institutional clients’ payment flows at start of day and intraday to optimise balances, sweeping and pooling; this information can then be used by relationship managers to proactively discuss management of balances and adjustments to limits and credit lines.

An analysis of clients’ supply chains and working-capital demands can enhance SCF services by enabling “just-in-time” financing to be offered. A bank’s ability to analyse country economics, companies and news reports can enable it to anticipate supply chain disruptions and suggest alternative suppliers.

Analytics can also enhance customer insight by identifying “best customer” profiles by product segment, revenue and profitability to predict traffic, adjust fees and propose “next-best” service extensions. This analysis can also be extended to refine product management, analyse product profitability, adjust pricing and sunset products if necessary.

The analysis of clients’ flows, combined with the bank’s proprietary payments and settlement obligations for low-value clearings, can be used to forecast intraday and end-of-day positions at high-value systems, to optimise payment scheduling and collateral, and to minimise liquidity risk.

All banks are facing the need to increase investment in fraud prevention, including anti-money laundering (AML), anti-terrorist financing and sanctions screening. Shared utilities and data collaboration offer increasing opportunities to reduce this burden.

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The greater the insights, the more complete the picture of a client. This is true both as a positive approach to selling new products and services, and as a means of assessing fraud and credit risk. Financial institutions have some history of collaboration regarding fraud, some more limited experience with credit risk, but very little when it comes to client insights for better serving clients and increasing revenues in both the corporate and the consumer world.

Why? Primarily because banks are traditionally protective of their data for fear of losing clients if they share information with other institutions. However, the world is changing: much higher volumes of more diverse data are available from an increasing number of sources around the world and, as a minimum, banks need to tap into these sources – including social media – and digest the information to gain greater insights. Market disintermediation is happening, and collaboration is the name of the game for the emerging leaders. This is most evident in the consumer space, but it is extending also to the corporate world.

Ultimately, the savings realised through reduced operating costs can be allocated to the recruitment and training of advisory and relationship-management staff, to improve customer intimacy and develop more mutually beneficial relationships.

Securities processing: new trends in markets infrastructure and buy/sell sideBusiness drivers that dictate change and transformationRecent years have witnessed unprecedented levels of volatility, creating pressure on exchanges and CSD infrastructures. Trading volumes are erratic with substantially increased, albeit controversial, high-frequency trading (HFT) driving higher throughput performance and a low-latency arms race in the industry.

Will regulators demand pre-trade risk controls that may change this latency landscape? Some regulators are calling for HFT - which accounts for most of the volume in certain markets - to be banned rather than regulated. These pressures on exchange infrastructures are spilling over into the post-trade infrastructures. CCPs are mushrooming and starting to cannibalise CSD volumes, whereas in Europe settlement is being split off from asset servicing.

Competition is increasing for listings, order flow, new products and clearing. For-profit exchanges must strengthen and diversify revenue sources as demand for (shared) risk and collateral management and portfolio optimisation increases, whereas the convergence of market and trading data creates new opportunities for big data plays in added-value analysis services.

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Improved time-to-market to introduce new products and services to new customers is critical. A first ‘exchange community cloud’ was launched by NYSE Euronext and others are likely to follow pace to reduce cost and facilitate proximity-based liquidity-hub value propositions. With many new entrants and services, should some infrastructures abandon clearing?

Exchanges are under pressure to reduce the cost of trading, while clearing houses and CSDs are under pressure to lower their fees. In terms of cost reduction, the cost of innovation is often underestimated. Innovation calls for supporting technology architectures which allow for the creation of new functions and products on time and within budget.

Also, to achieve economies of scale, we are witnessing domestic, cross-border and even cross-continent horizontal (across products and markets) and vertical (along the trade value-chain) consolidation. Cross-continent consolidation, however, meets strong regulatory resistance, so we foresee more cooperation agreements in the near future than mergers and acquisitions.

Regulatory drivers that dictate change and transformationExchanges must provide the highest possible levels of reliability, capacity and performance at close to the speed of light: throughput and latency without compromising continuous availability. No single point of failure in architecture, technology or operations is acceptable, and regulators have began to sanction execution venues and participants that lack acceptable operational service levels both in trading and risk models.

Recent technical glitches have negatively affected trading operations in several exchanges in all three major geographies, and regulators around the globe are gearing up to take action with respect to microsecond trading and its potential negative effects on continuous operation.

ASIC in Australia is proposing to test algorithms before they can be used in the market and may impose annual reviews of systems involved in trading. The FSA in the UK is formulating a plan further to a study on ‘market conduct controls’, whilst in the US the SEC is holding a Market Technology Roundtable focusing on error prevention and error response, all in the same spirit of curbing the excesses in automated trading that are increasingly responsible for operational issues.

Dodd-Frank in the US, MiFID II, louder calls for interoperability in Europe and, globally, the fall-out of the 2008 Systemic Risk events will continue to drive increasing regulation and create the need for new and larger volumes of data to be provided to answer growing concerns in terms of liquidity risk, stress testing and counterparty risk, and to provide early warning systems to both regulators and policy makers. Exchanges have prepared themselves to derive new opportunities from the emerging regulation of dark pools and a regulatory drive to bring OTC derivatives back to the exchange.

The regulatory drive for creating a level playing field may create new utility model opportunities to reduce the cost for commodity functions in the value-chain such as surveillance and MIFID II-driven smart order routing (as opposed to the algos and routing logic) utility in Europe.

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It is clear that by sharing services in a utility model, the overall cost of financial markets’ core operations will be optimized for all players and will allow participants to focus on competitive edge through the provision of differentiating functions. In the case of T2S, banks need to assess to what extent it represents an opportunity to just play, or to differentiate in terms of client offerings and service.

The positive side of this equation is that some of the initiatives coming down the line create opportunities for new services, or to differentiate existing services, or to reduce cost. The most obvious example of the former is the opportunity to provide clearing services for centrally cleared derivatives. Banks need to decide what services to offer, what functions they will need, and to make fundamental buy versus build decisions.

However, understanding the business case for such services can be difficult. IT costs may be hard to estimate, market differentiation may be uncertain, and pricing strategy may be hard to assess.

How do markets-infrastructure players and market partici-pants transform?The above regulatory and business drivers open new opportunities to compensate for lost transaction revenue with new income. Indeed, the WFE (World Federation of Exchanges) half yearly report suggests that overall global equity trading activity has decreased by 14 percent over the first half of 2012 or as much as18.9 percent over the last year, whereas SIFMA recently indicated that US equity trading had decreased by 14.1 percent in the first half of 2012.

In addition to the increasing demand for CCP and enhanced (risk-mitigating) clearing services in general, the migration of OTC products to SEFs/MTFs and centralized clearing is driving an increased need for collateral which, for many firms, will be increasingly difficult to deliver. This represents both an opportunity and threat to market participants.

The systemic risk issues and the resulting high cost of capital are also driving the industry to reduce the need for (costly) capital via portfolio and collateral optimisation, and the associated cross-asset classes/multi-legged trading services. This creates a growing potential for market infrastructure players to capture new revenue through shared services such as collateral management services (lock in participants via global access and added-value services, produced or hosted within the exchange’s “cloud”).

Market conditions seem to suggest that the drivers for transformation and change will incent all market participants to further embrace new business models that will trigger the creation of shared services models between themselves.

Overall, we can see a trend emerging to create more industry utilities, or extend the use of existing ones, to share the burden of commoditised processes (e.g. T2S in Europe) and/or to provide functions which are required by all (e.g. LEI and other reference data, trade repositories). Such utilities can also be used to create a level playing field amongst all execution venues (e.g. a surveillance utility) and/or to create an affordable route to best execution (e.g. a Smart Order Routing utility).

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To add insult to injury, many exchanges have seen their market share of this decreasing trading volume further eroded by alternative trading systems. As an example, one result of this is that NYSE Euronext’s equity trading volume has decreased by as much as 40 percent over the last two years.

New business models are emerging across the central securities industry players. Hence, it comes as no surprise that some exchanges or groups of exchanges, such as NYSE Euronext, have transformed themselves from a financial services company to a technology services company. NYSE Euronext’s goal is to provide a liquidity platform, capable of linking central market infrastructures, financial services contributors and market participants globally, with a single, standardised interface covering the whole securities lifecycle from pre- to post-trading, including analytics and risk management services, using its SFTI (Secure Financial Transaction Infrastructure) network model as a vehicle.

Leveraging the above, NYSE Euronext launched a first ‘Exchange Community Cloud’ at the end of 2011, and others are set to follow in its footsteps.

Deutsche Börse has reorganised itself to enable the offering of combined information and technology services in the future. The London Stock Exchange has acquired a technology company, Millennium IT, to ensure its own internal technology keeps pace with market demand, and is also selling technology assets and services externally. Several large exchanges, including Deutsche Börse and the London Stock Exchange, are providing outsourcing services to other, smaller, exchanges and may expand these services from matching services to other areas and client types.

Overall, we believe that the recent activity in mergers and acquisitions, which has seen as many failed attempts in the last couple of years (NYSE Euronext and Deutsche Börse, SGX and ASX, LSE and TMX) as successful transactions (BATS and Chi-X Global, HKEx and LME, TSE and OSE, TMX and Alpha), will be complemented by other forms of consolidated approach to the markets. These may include the creation of new players (CME recently announcing the creation of a London-based derivatives exchange) and the use of cooperation agreements rather than straightforward mergers.

We also believe that we will continue to see the creation of new players and acquisitions in the clearing (first and foremost) and settlement areas through the creation of more CCPs, with the compulsory clearing of OTC derivatives and certain categories of structured products at the forefront.

LME has announced that it will do its own clearing (and the organisation has in the meantime been acquired by the HKEx), while LSE has appointed a head of clearing and successfully launched a bid to acquire LCH.Clearnet. SIX has announced that it may use the proceeds of the sale of its share in Eurex to buy a clearing and settlement institution in ‘another country’ than Switzerland.

In AP, SGX is likely to refocus on cooperation agreements after the failed takeover of ASX, whose new CEO recently announced it may consider the acquisition of another exchange. And global player CME recently announced the creation of a new derivatives exchange in London, with an initial focus on FX products.

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With the regulators pushing ahead to make new classes of assets, including OTC derivatives, subject to clearing, the clearing landscape is rapidly changing with exchanges moving to create new business for themselves in that area.

LME has announced that it will develop its own clearing capabilities, and NYSE Euronext has announced the creation of a London-based clearing house and given notice to LCH.Clearnet to terminate its white-label agreements with the clearing house. Eurex in Europe and ICE in the US have become the leaders in CDS clearing. CCPs are mushrooming around the globe. Many players are upgrading their clearing systems with new functions and the capability to absorb higher volumes of an increasing number of asset classes.

Several exchanges are expanding into new products and asset classes (e.g. FX products) and into new clients, for example, providing retail access. NYSE Euronext first, and then NASDAQ OMX Group Inc., Bats Global Markets Inc. and Direct Edge Holdings LLC, have all announced programmes to attract retail investors through superior stock prices. NASDAQ OMX Group Inc. has announced the creation of benchmark orders and algorithmic trading software tools competing with brokers, and will launch a NASDAQ integrated platform for media monitoring and market-sentiment analysis.

Indeed, most – if not all – exchanges are turning their commodity transaction service into an added-value provision of information (turning data into information) and risk-management services (such as pre-trade risk checks) to add revenue potential or to compensate for lost transaction revenue.

Exchanges may increase the remuneration they seek for the use of the market data they own (for example, NYSE Euronext is planning to charge a flat monthly fee to each media company broadcasting its market data). There will be expansion in areas including reference data, trade repositories, and analysis services such as sentiment analysis.

Exchanges and alternative trading venues have embarked on technology projects that are geared to provide ultra-high performance and ultra-low latency at the lowest possible cost, since it has been suggested by market conditions that liquidity tends to end up with the providers of the fastest execution technology.

By the same token, as indicated before, regulators are keeping an eye on operational excellence and increasing pressure on all market-infrastructure players who provide mission-critical execution services to make sure their systems keep running at all times, sanctioning those who do not comply with these demands for continuous availability. The consequential damage which may result from failing systems can be quite onerous, as the NASDAQ OMX problems with the Facebook IPO and the issues with Knight Capital have demonstrated.

Also, it is believed that the markets will move towards a new approach to surveillance and market monitoring. Regulators may act, either for themselves or through specially-created companies such as FINRA in the US, to federate surveillance services across all execution venues, exchanges and alternative providers alike in order to restore confidence in the financial markets and to create a level playing field across all execution providers in their territory.

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New technology will enable the monitoring of the exponentially increasing set of unstructured data which plays a role in price setting on the financial markets, such as social media.

All in all, the sheer volume of regulatory change is daunting and has a substantial impact on the market participants. One bank alone has 400 separate regulatory initiatives. A recent study by IBM and Broadridge found that only a third of the 120 respondents felt they were on top of the regulatory onslaught.

With all this change, the need is to progress on a “smart basis”: identifying how the firm’s operating model needs to evolve to pay sufficient attention to regulatory change. The IBM/Broadridge survey found that 79 percent of respondents rated regulation as having a bigger impact on their operating model than client drivers.

This, in turn, calls for a more architected approach, identifying common elements in terms of data, analysis, reporting and so on. As previously noted, regulators may start to impose a review of algorithms before they can be used, as well as a yearly review of trading systems.

Many of the market-infrastructure initiatives referred to above also represent opportunities to move functionality from each institution into centralised utilities. A prime example may be LEI, referred to above. LEI may provide the opportunity to consolidate and centralise legal-entity data within a firm.

Firms need to decide on the relative positioning and prioritisation between their internal shared service and application-consolidation initiatives versus their adoption of market-infrastructure initiatives such as LEI.

As for the market participants, what new business models may emerge among them in the securities world? We believe this can be described in terms of three main trends: back to basics, client first and the new utilities.

Back to basicsMost would agree that the securities industry, like the broader wholesale financial markets, has become too complex and opaque. In particular, the industry’s fundamental purpose of facilitating the movement of capital from those who have it to those who need it has in part been obscured by the need for short-term returns.

As the capital markets struggle to re-establish their core purpose, identity and client buy-in, we expect to see business models emerge that will reinforce a “back to basics” theme.

For example, with many buy-side firms offering actively managed long-only funds with less than stellar returns compared to their benchmarks, the trend to more end-client-friendly index-tracking funds must surely continue. High fees charged by traditional players for FX, payments and other services will be challenged by new providers offering new approaches.

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In part driven by regulatory change, financial products are becoming less complex and more transparent, albeit at the cost of customisation to individual client needs. While the exact shape of future business models may be hard to predict, they will surely enshrine the core principles of why the securities industry came into being in the first place.

Client firstOne major investment bank’s CFO said “we need to move from making money from our clients to making money for our clients”. In many ways, this illustrates the client-trust issue that many firms now face; rebuilding trust is a complex and challenging process. Regulatory change is creating a platform for greater transparency, which is a pre-requisite for trust.

With the migration of products from OTC to exchange-traded, and as complex structured products become unprofitable due to their regulatory capital burdens, the question arises: what business models will emerge to take advantage of these changes and to facilitate the rebuilding of trust?

Fundamentally, these trends will cause firms to evaluate what is the true nature of the value they bring to their clients, be it specific insights on the details of their clients’ business and its risks, or access to particular markets or liquidity. In short, it causes a sharp delineation between those capabilities of a firm that differentiate its proposition to its clients, versus those that fundamentally do not.

The new utilitiesThe flip side of this equation is what to do with the capabilities of a firm that do not add a sufficient degree of client value. Historically high levels of RoE made this a rare question, but, to many, that time is over.

Building on the initial regulatory-inspired momentum of “utilities for free”, as indicated before, we can expect to see many new initiatives to mutualise non-client differentiating functions.

The instigators of these may be systems integrators, investors, technology companies or indeed the banks themselves. The route to achieving them is complex, however. Of course, traditional competitive positioning needs to be put aside, but compromise is needed to ensure that the needed degree of commonality of back-office process can be agreed in order to gain the economic advantages of mutualisation.

In summary, the combination of changes to the roles that banks play in global economic terms, the impact of regulation and market conditions, the public perception of the role of banks and the changes witnessed in market infrastructure, are causing a major sea-change in the industry landscape, and the creation of new business models at a level of change reminiscent of the dotcom era.

The difference is that then, the mantra was about embracing innovation, new markets and virgin frontiers; now, the mantra is about survival and redesigning a new profitable and client-valued purpose in the new normal.

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Conclusions and recommendationsSome overarching themes are arising across transaction banking, common to payments and securities services. Both activities are process-driven, relying heavily on efficient workflow to minimise costs, exceptions, outages, fraud and illegal activities. Both activities also require proactive counterparty-risk monitoring, liquidity and collateral management.

Firstly, it is imperative to provide the basic services and information that clients demand in real time or as close as possible, in a way that can be seamlessly integrated with their own systems: “get back to basics and get them right”!

In order to take full advantage of the inevitable transformation that the above business and regulatory drivers will create within transaction banking, all players, market infrastructures and participants alike will need to align their newly defined business models with a matching operational model agreed after joint business-process modelling. This will have far-reaching consequences in enterprise resource planning and optimisation.

Market conditions suggest that much of the transformational change will focus on the creation of new revenue in compensation for lost, mainly transactional, income and on the reduction of overall operational costs.

As the creation of new revenue is likely to materialise in the implementation and provision of tailored added-value services to the financial institutions’ clients, market players will need to substantially increase their Big Data capability to capture and analyze the petabytes of data that flow into and through their systems, in order to create the advisory, risk management, collateral management and other added-value services that will bring a competitive edge and margin.

The impressive progress in technology supporting the transformation of raw data from within and outside the institution into marketable information will undoubtedly foster such development. These insights can be leveraged to develop customer intimacy in order to proactively offer customised services and to optimise the product/services portfolio.

Analytics should also be used to reduce operational risk. An analysis of operational bottlenecks and fails, correlations with market events and customer failures, combined with real-time monitoring of process flows, can predict triggers and anticipate bottlenecks, system failures and SLA breaches.

These predictions, combined with cloud computing, facilitate the optimisation of systems and network capacity. Institutions should also create a global data repository to rapidly respond to changing and fragmented regulatory reporting requirements.

As the much-needed cost reduction will primarily be supported by optimised operational efficiency, market infrastructures and participants alike will want to consider joining forces for the creation of new, or the expansion of currently existing, shared utilities based on open standards which can deliver both global access and substantial cost reduction in the processing of low-value commodity activities. The same philosophy applies to outsourcing, sharing developments and data analysis.

IBM believes that the transformational changes we are living today will create substantial future opportunities for those players that can get the basics right, that can best adapt to the need for new high-margin business models, that can be best in class in supporting such new business models with the appropriate operational models, that can embrace the principle to use shared utilities for low-margin commodity processes and that can leverage analytics to reduce risk and gain customer intimacy.

Failure to embrace these new operational models will however result in inefficient use of capital, inability to improve margins, reduced competitiveness, and increased financial and reputational risk.

References1. The Financial Times: “Finance’s fifth column”, 26 July 2012

2. Ibid.

3. The Financial Times: “Deutsche Bank seeks a more sharing world”, 14 September 2012.

4. J.P. Morgan Asset Management: Global Liquidity Survey 2011, LV-JPM4645.

5. The Financial Times: “Start-ups cross currency transfer frontiers”, 3 August 2012.

6. Reserve Bank of Australia: Strategic Review of Innovation in the Payments System: Conclusions, June 2012. ISBN 978-0-9872589-7-7 (Online)

7. Bank for International Settlements, Committee on Payments and Settlement Systems: Innovation in Retail Payments, May 2012.

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AuthorsKeith Bear is responsible globally for the strategy and development of IBM’s business in Financial Markets. Keith works extensively with major clients to help them achieve transformational change through the deployment of IBM’s industry insight and solutions. Prior to his current role, Keith led the IBM Consulting Practice for Financial Markets and Risk Management. He is frequently interviewed on aspects of financial markets and has co-authored several articles and white papers.

Davide Girompini is Global Leader for Payments and Securities within the IBM Banking Industry Framework organization. He brings his 18 years of experience in projects and solutions in the payments and transaction banking area with particular focus on international payments, integration platforms and fraud management, helping leading banks to develop new business models and operating processes. He has published a variety of articles and participated as speaker in many international events on payments.

Gerard Hergenroeder is a Global Payments Executive at IBM, responsible for solution sales. He has also served IBM in client-facing roles and as a senior management consultant. He is a known banking and payments expert with thirty-five years of hands-on industry and consulting experience. Gerard has managed lines of business for twenty years as a former banking executive when he was heavily involved in the development and delivery of shared banking services, innovative retail and commercial payment services, e-commerce and emerging payment systems.

Alec Nacamuli is Global Payments Executive at IBM, focusing on payment infrastructures, corporate payment and cash management offerings. Alec was previously EVP at SWIFT, which he joined at its inception, with final responsibility for strategy and sales, heading SWIFT’s expansion towards value-added services and the securities markets. He is the editor of the “Journal of Payments Strategy and Systems” and the co-author of “Payment Systems – from the Salt Mines to the Boardroom”.

Pierre (Piet) Van de Velde is global Business Development Director, Markets Infrastructure at IBM, working with the executive management of many exchanges worldwide. He has initiated a major investment program for IBM in the exchanges space including the development of reference architectures for exchanges and clearing houses and the development of specific high-performance/low-latency messaging software. He was previously a Senior Officer at a major Belgian bank and CEO of EuropeanInvestor. He is a frequent speaker at industry conferences.

James Wallis is Vice President, Global Payments Industry at IBM. James brings over 20 years of financial services industry experience and expertise to developing and executing business and customer strategy, market development and sales management, with particular focus on payments systems and infrastructure. He works with leaders of financial institutions and payment companies worldwide on industry trends and on creating innovation to enable smarter payment solutions, and cost optimization through more efficient and effective payments infrastructure.

For more informationIf you would like to ask a question or request more information about the topics discussed in this paper, please contact one of the authors below:

Keith Bear [email protected]

Davide Girompini [email protected]

Gerard Hergenroeder [email protected]

Alec Nacamuli [email protected]

Piet Van de Velde [email protected]

James Wallis [email protected]

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