Our unique competitive advantage rests in our collaboratively integrative team thinking and in our rigorously disciplined contract execution. We integrate the best of "either or" choices into an optimum solution.
We are client centric needs focused. It forms the basis of all our choices in the development of any solution. The final test is that our solutions serve the greater ethical good. These criteria are central to our engagement.
8/04/2009
STAYING AHEAD OF THE CHANGING MARKETPLACE FOR CONSUMER TECHNOLOGY DEVICES AND SERVICES: THE BOOMERS ARE MOVING AHEAD OF GEN Y
June 2009, No. 1
By Kumu Puri
Kumu Puri is a senior executive with Accenture's Consumer Technology industry group.
Mobile devices, social networking applications and other consumer-related innovations have gained notoriety and generated significant revenues for high-tech, communications and content companies in recent years. These devices and applications are dramatically reshaping the way consumers communicate, learn and entertain themselves.
Baby Boomers Versus Gen Y
For the last two years, Accenture has conducted primary research into the usage patterns of various types of consumer technology devices and services among US consumers. The most recent round of research, conducted in late 2008 among 3,000 adult consumers in the United States, reveals several interesting trends related to different take-up rates for applications and devices among Baby Boomers (consumers over the age of 45) compared with Generation Y (those aged 18 to 24).
Although the popular image of the consumer technology marketplace seems dominated by the Facebook generation, older consumers are jumping on board at a fast pace. Penetration of the Gen Y population is still much higher for many applications and devices, but our research found that a kind of saturation point is being reached among that age group. Thus companies would do well not to ignore older consumers: the rate of take-up among Boomers for popular consumer technology applications is now nearly 20 times faster than that of the younger generation.
The Accenture survey also found that the much-anticipated embrace of mobile video by consumers is not yet happening among any age group. Most consumers still see their mobile handset as a communications device. Mobile Web browsing is on the rise, but the ability to watch videos or stream content live to their mobile phones isn't stirring consumers' imaginations or opening their wallets—yet.
Reality Check
Usage surveys are often an interesting reality check against marketplace perceptions, which are often driven by an understandable hype about compelling new applications. One of the most interesting questions in the Accenture survey asked consumers to note how many hours they spend during a typical week using various kinds of devices and applications.
The usage patterns that emerged reveal that the "blogging, podcasting, mobile-video-watching, virtual-world-playing" consumer is a fairly rare animal at this point. For example, 91 percent of respondents say they spend zero hours per week participating in virtual worlds; 86 percent say they never watch videos on a mobile device.
So who is actually using what? For younger consumers, the mobile device is clearly king. Fifty-one percent of Gen Yers prefer mobile phones over all of their other consumer technology devices. For that age group, the importance of mobile voice is still rising (up 6 percent) as is mobile data (up 600 percent, though still at a relatively low penetration rate). By contrast, 50 percent of Baby Boomers prefer their computers—27 percentage points higher than mobile phones.
The Booming Boomers
For example, Boomers posted a 59 percent increase in use of social networking sites such as Facebook—30 times greater than Gen Y (2 percent). Boomers also increased watching/posting videos on the Internet by 35 percent—while Gen Y usage decreased slightly (down 2 percent).
Even though Gen Y consumers still have higher overall usage rates for these applications, uptake is decelerating compared with Boomers even for those applications that do not have significant usage. For example, use of social networking applications stayed relatively flat at 80 percent of Gen Y—not surprising, given already high penetration rates. However, reading blogs and listening to podcasts also stayed flat among Gen Y, but at a much lower usage rate of 45 percent.
Devices and Desires
What do consumers want from their mobile devices? Across all age groups, services beyond voice communications, text messaging and e-mail are not yet generating significant interest. In fact, 79 percent of all survey respondents still view the mobile handset primarily as a means of voice communications and messaging rather than a source of entertainment.
Our research also found that most consumers (54 percent) don’t want to use mobile handsets for multimedia connectivity services such as watching videos or streaming content. When participants were asked to what extent availability of mobile content drives them to upgrade their mobile plan, 70 percent said “to a very little extent.”
There are some bright spots on the mobile multimedia front, however. Thirty-three percent of consumers say that Web browsing on mobile phones is a top-three mobile application. And almost 25 percent indicated that listening to music on a mobile phone is in the top three.
Igniting consumer interest in the “connected home” is also something that has yet to take place to any significant extent. Survey respondents were asked about the importance they place on consumer technology devices being connected to the Internet, either directly or through a home network. Far more consumers indicated this capability was more unimportant than important for most devices.
However, trend data shows a slow but positive increase in acceptance of networked devices. For instance, the percentage of consumers who consider the networking of TVs to be important rose from 25 to 29 percent. Similar increases were seen for game consoles (from 21 to 24 percent), mobile handsets (from 27 to 32 percent) and portable music players (from 26 to 32 percent).
Implications
What does the 2009 Accenture Consumer Electronics Usage Survey mean to high-tech, communications and content companies? The following points are among the important takeaways from the research.
Time to focus on the Boomers
In terms of the marketing of innovative devices and applications, younger and more technology-savvy consumers have been to this point a kind of low-hanging fruit for many companies. Gen Y users hardly needed to be convinced of the value of technology innovations. Baby Boomers have come along at a slower pace, but that pace is now picking up. Older users are starting to see the value of applications that connect them to their personal and professional networks.
Companies would do well to begin targeting applications and services to the unique needs of the 45-and-older crowd. For example, the right kind of converged mobile handset and computing device (often called the “Mobile Internet Device”) may accelerate Boomers' participation in the mobile world.
Don't take Gen Y for grantedThe slowdown in Gen Y take-up of consumer applications and services points to a saturation of the population, but also a saturation of interest. As with any product lifecycle, with maturation comes the need for variety. Companies need to step back and ask if they are keeping their applications fresh. Are they experimenting enough to keep products and services relevant to a generation with short attention spans?
New types of mobile data services, as well as extending choices for anytime, anywhere video, are critical opportunity areas given Gen Y usage patterns. At the same time, consolidation and aggregation of applications—pulling them into bundles of services as features, rather than separate applications all to themselves—will be ever more important to retain mindshare in an increasingly crowded marketplace.
Customize consumer offerings
Finally, maturation of the consumer technology marketplace also means that one-size-fits-all offerings will begin to decline in terms of mindshare and revenues. Therefore, it’s time for companies to look to more customization of their offerings in the marketplace. Satisfying diverging consumer needs will require consumer technology companies to think differently about their businesses—and to provide greater flexibility in functions from product development to supply chain to marketing.
The Accenture research shows that differentiation and specialization will increasingly be the keys to success in the converged high-tech, communications and content marketplace. By more closely understanding the different needs of different generations, and by refreshing the marketplace with continuously relevant devices and services, companies can gain an edge in the race toward high performance.
Accenture
08 04 2009
By Kumu Puri
Kumu Puri is a senior executive with Accenture's Consumer Technology industry group.
Mobile devices, social networking applications and other consumer-related innovations have gained notoriety and generated significant revenues for high-tech, communications and content companies in recent years. These devices and applications are dramatically reshaping the way consumers communicate, learn and entertain themselves.
Baby Boomers Versus Gen Y
For the last two years, Accenture has conducted primary research into the usage patterns of various types of consumer technology devices and services among US consumers. The most recent round of research, conducted in late 2008 among 3,000 adult consumers in the United States, reveals several interesting trends related to different take-up rates for applications and devices among Baby Boomers (consumers over the age of 45) compared with Generation Y (those aged 18 to 24).
Although the popular image of the consumer technology marketplace seems dominated by the Facebook generation, older consumers are jumping on board at a fast pace. Penetration of the Gen Y population is still much higher for many applications and devices, but our research found that a kind of saturation point is being reached among that age group. Thus companies would do well not to ignore older consumers: the rate of take-up among Boomers for popular consumer technology applications is now nearly 20 times faster than that of the younger generation.
The Accenture survey also found that the much-anticipated embrace of mobile video by consumers is not yet happening among any age group. Most consumers still see their mobile handset as a communications device. Mobile Web browsing is on the rise, but the ability to watch videos or stream content live to their mobile phones isn't stirring consumers' imaginations or opening their wallets—yet.
Reality Check
Usage surveys are often an interesting reality check against marketplace perceptions, which are often driven by an understandable hype about compelling new applications. One of the most interesting questions in the Accenture survey asked consumers to note how many hours they spend during a typical week using various kinds of devices and applications.
The usage patterns that emerged reveal that the "blogging, podcasting, mobile-video-watching, virtual-world-playing" consumer is a fairly rare animal at this point. For example, 91 percent of respondents say they spend zero hours per week participating in virtual worlds; 86 percent say they never watch videos on a mobile device.
So who is actually using what? For younger consumers, the mobile device is clearly king. Fifty-one percent of Gen Yers prefer mobile phones over all of their other consumer technology devices. For that age group, the importance of mobile voice is still rising (up 6 percent) as is mobile data (up 600 percent, though still at a relatively low penetration rate). By contrast, 50 percent of Baby Boomers prefer their computers—27 percentage points higher than mobile phones.
The Booming Boomers
For example, Boomers posted a 59 percent increase in use of social networking sites such as Facebook—30 times greater than Gen Y (2 percent). Boomers also increased watching/posting videos on the Internet by 35 percent—while Gen Y usage decreased slightly (down 2 percent).
Even though Gen Y consumers still have higher overall usage rates for these applications, uptake is decelerating compared with Boomers even for those applications that do not have significant usage. For example, use of social networking applications stayed relatively flat at 80 percent of Gen Y—not surprising, given already high penetration rates. However, reading blogs and listening to podcasts also stayed flat among Gen Y, but at a much lower usage rate of 45 percent.
Devices and Desires
What do consumers want from their mobile devices? Across all age groups, services beyond voice communications, text messaging and e-mail are not yet generating significant interest. In fact, 79 percent of all survey respondents still view the mobile handset primarily as a means of voice communications and messaging rather than a source of entertainment.
Our research also found that most consumers (54 percent) don’t want to use mobile handsets for multimedia connectivity services such as watching videos or streaming content. When participants were asked to what extent availability of mobile content drives them to upgrade their mobile plan, 70 percent said “to a very little extent.”
There are some bright spots on the mobile multimedia front, however. Thirty-three percent of consumers say that Web browsing on mobile phones is a top-three mobile application. And almost 25 percent indicated that listening to music on a mobile phone is in the top three.
Igniting consumer interest in the “connected home” is also something that has yet to take place to any significant extent. Survey respondents were asked about the importance they place on consumer technology devices being connected to the Internet, either directly or through a home network. Far more consumers indicated this capability was more unimportant than important for most devices.
However, trend data shows a slow but positive increase in acceptance of networked devices. For instance, the percentage of consumers who consider the networking of TVs to be important rose from 25 to 29 percent. Similar increases were seen for game consoles (from 21 to 24 percent), mobile handsets (from 27 to 32 percent) and portable music players (from 26 to 32 percent).
Implications
What does the 2009 Accenture Consumer Electronics Usage Survey mean to high-tech, communications and content companies? The following points are among the important takeaways from the research.
Time to focus on the Boomers
In terms of the marketing of innovative devices and applications, younger and more technology-savvy consumers have been to this point a kind of low-hanging fruit for many companies. Gen Y users hardly needed to be convinced of the value of technology innovations. Baby Boomers have come along at a slower pace, but that pace is now picking up. Older users are starting to see the value of applications that connect them to their personal and professional networks.
Companies would do well to begin targeting applications and services to the unique needs of the 45-and-older crowd. For example, the right kind of converged mobile handset and computing device (often called the “Mobile Internet Device”) may accelerate Boomers' participation in the mobile world.
Don't take Gen Y for grantedThe slowdown in Gen Y take-up of consumer applications and services points to a saturation of the population, but also a saturation of interest. As with any product lifecycle, with maturation comes the need for variety. Companies need to step back and ask if they are keeping their applications fresh. Are they experimenting enough to keep products and services relevant to a generation with short attention spans?
New types of mobile data services, as well as extending choices for anytime, anywhere video, are critical opportunity areas given Gen Y usage patterns. At the same time, consolidation and aggregation of applications—pulling them into bundles of services as features, rather than separate applications all to themselves—will be ever more important to retain mindshare in an increasingly crowded marketplace.
Customize consumer offerings
Finally, maturation of the consumer technology marketplace also means that one-size-fits-all offerings will begin to decline in terms of mindshare and revenues. Therefore, it’s time for companies to look to more customization of their offerings in the marketplace. Satisfying diverging consumer needs will require consumer technology companies to think differently about their businesses—and to provide greater flexibility in functions from product development to supply chain to marketing.
The Accenture research shows that differentiation and specialization will increasingly be the keys to success in the converged high-tech, communications and content marketplace. By more closely understanding the different needs of different generations, and by refreshing the marketplace with continuously relevant devices and services, companies can gain an edge in the race toward high performance.
Accenture
08 04 2009
7/15/2009
CUSTOMER CENTRICITY IN THE MULTI - POLAR WORLD
Executive Summary
In an era of rapid globalization, extreme volatility and heightened risk,
maintaining a strong customer focus is essential to achieving high performance:
to withstand short-term pressures while laying the groundwork for growth in the
upturn.
Being “customer-centric” is undeniably more difficult today. The long-term
effect on consumer psychology of hard - to - quantify factors such as diminished
spending power, government intervention and increased competition for share of
wallet is still unknown. What is clear, however, is that there is no stepping
back from globalization and the ongoing diffusion of economic power across
multiple geographic markets.
Even in a down economy, many of the world’s emerging markets have continued
to enjoy solid growth in consumer spending, bolstered by long-term
fundamentals such as population growth, an emerging middle class of aspirational consumers, rising per capita incomes and greater credit availability.
These new sources of consumer spending may help businesses counteract sagging demand in Western economies and build a base of new consumers for the upturn.
However, many traditional approaches to identifying, reaching and satisfying
buyers will need to be refreshed or even retooled for these emerging consumer
segments.
The organizations likely to achieve high performance during this current period
of extreme change and volatility will be those that invest now in understanding
the changing global customer base, that are willing to experiment with and
master new routes to reaching new customers, and that focus going forward
on fostering trust-based relationships to the same degree they have focused, historically, on managing customer transactions efficiently.
Accenture
07 15, 2009
7/01/2009
CAN A NEW BUSINESS MODEL SAVE INVESTMENT BANKING?
Transparency, liquidity and increased oversight will be prominent features of the new capital markets landscape. The key to growth in this industry: customer-focused financial-product innovation that helps clients identify and manage risk.
By Robert P. Gach and James R. Sproule
Outlook Journal, June 2009
The axiom is as simple as it is sobering: The current global economic downturn began with the sudden widening of credit spreads in August 2007, which precipitated a crisis that soon engulfed financial markets around the world. Until strength and stability return to those markets, there can be no sustained recovery.
The damage to the banking system has been staggering. As of the beginning of March 2009, banks worldwide had announced losses of $840 billion. Total damages could run as high as $1.4 trillion.
Capital markets and investment banking play a key role in the global financial system and the overall economy. They are an important source of the financing critical to the health of the economy, as well as the ultimate arbiters of where value is being created. This article focuses on that sector by exploring the five areas.
1. Revenues
Revenues are being hit by the flight from complexity and a slowing economy. But new products will emerge that deliver transparency and reduce risk or offer the possibility of significant outperformance.
No amount of cost cutting or margin enhancement can compensate for steeply falling revenues in this sector. Yet robust revenues are essential to everything from innovation to the extraordinary returns that financial services have been able to generate over past decades.
At least in the longer term, Accenture remains optimistic. We believe that the demand for traditional financial products such as equities and bonds will continue its historic trend of running up to 3 percent ahead of the supply. This demand is driven by both global demographics and the clear need to save for retirement. Savings in 2008 alone totaled $5.8 trillion globally, and the trend will continue to support revenue growth as well as the creation of a host of new financial products and services.
Given their size, maintaining sales and trading revenues is crucial for investment banks’ overall performance. Indeed, Accenture research has calculated that sales and trading accounted for 75 percent of investment banking revenues during the recent boom years. At the same time, traditional corporate advisory work fell to 20 percent of revenues (although advisory revenues rose to 40 percent of total revenues in 2008, in light of losses in the credit markets).
Before the credit crunch, the financial markets may well have reached a high point in terms of both margin and volume. But for management, this may not prove to be as controversial a notion as might be imagined.
As investment banks are absorbed into larger, traditionally more conservative retail banking operations, their ultimate parent organizations may be less willing to take on risk or pay out commensurate reward. In fact, some banks’ managements may prefer lower but possibly more stable earnings. For an industry accustomed to rapid change and high profits, this would be a radical shift indeed.
Scope for recovery
Does this mean that a chastened industry will abandon the complex, high-margin products—entire new classes of securitized and monetized assets—that fueled the money-spinning trading operations before the credit crisis?
In analyzing what caused the house of complex financial products to collapse, two factors stand out: The potential for illiquidity should have been more carefully considered; and calculating liabilities for products was nearly impossible when those products had to move through multiple iterations to ultimately determine a valuation.
But Accenture believes that labeling all complex products as “excessively risky” is too sweeping a judgment. Although there have been clear failures across a wide range of new financial instruments, there is scope for recovery; it all depends on the product in question.
For products like collateralized debt obligations, the principle of diversification remains sound and relevant, and this alone points to an eventual rebound. Where a financial product’s underlying principle or added value is less apparent—as is the case in a number of complex and illiquid over-the-counter instruments, such as credit default swaps—demand and, hence, revenues have fallen and will not soon recover.
Successful, profitable financial products will be those that address liquidity concerns, have transparent ultimate liability and still offer an attractive risk-to-return ratio. These are most likely to be based on cross-product complexity, the linking together of highly liquid financial instruments.
The high degree of liquidity would mean that each piece could be priced separately. At the same time, these products would tie the pieces together in such a way that they would offer investors attractive returns for risks undertaken. What margins these products will command remains to be seen. But if complexity is to be profitable again, it must be more transparent, more liquid and utilize a wide range of financial products.
2. Risk and liquidity
Risk parameters have expanded to include liquidity. Efforts to increase liquidity and transparency will mean more on-exchange trading as well as new capital structures. At the same time, changes in accounting rules could promote the development of new structures that are capable of accepting illiquidity risks.
Although liquidity has always been vital to financial markets, the lack of it was seldom seen as a financial risk by investors and bankers—until the credit crisis. A combination of banks losing faith in counterparties that were assumed to be financially sound and a more general uncertainty about future losses as the economy slid into recession has led to a collapse in liquidity.
This collapse has already had a significant impact on bank balance sheets and will have a similar impact on future bank revenues and profits. Exact percentages naturally vary, but with some investment banks generating up to 50 percent of trading revenue from proprietary positions, it is clear that illiquidity can quickly impair assets necessarily held on a balance sheet as a natural part of business operations.
As a result, some more conservative retail bank managements and shareholders, even regulators, may seek to scale back investment banking operations that take significant proprietary positions. Clearly, there is a need for better reporting and pricing transparency, as well as for risk assessment and liquidity support. Ultimately, some capital markets firms may simply become less willing to accept risk than they were in the past.
Transferring risk
Where risks are known, informed judgments can be made about the wisdom of particular investments. The greatest danger comes, of course, where risks are unknown. Therefore, assuming that risks can be identified and assessed, an equally likely approach for other firms will be to transfer risk to new kinds of entities or to standalone divisions within more traditional existing institutions.
It is notable that funds simply write down the value of their investments rather than recapitalize their balance sheets. In a world where illiquidity risks are evaluated and these evaluations become an integral part of the calculations aimed at delivering outperformance, it may well be that fund-like structures become the most appropriate home for potentially illiquid financial products.
Concerns over liquidity are also going to have an impact on the once high-margin business of complex, custom-made derivatives. Banks are going to be increasingly unwilling to create illiquid over-the-counter financial products in light of investor reluctance to buy such products. This does not necessarily mean complex derivatives will disappear, but their use will increasingly shift to financial institutions that can better accommodate illiquidity risk.
For financial markets, the need for demonstrable transparency and liquidity is likely to lead to greater standardization and, thus, on-exchange trading. These moves will be further enhanced by the exchanges themselves, which will encourage liquidity providers to enter the market.
Once something approaching normalcy returns to the markets, so too will the desire for outperformance. When this happens, banks are likely to move away from structures where illiquidity and attendant capital requirements are an issue, and create new corporate structures better able to cope with significant market fluctuations.
In accommodating new illiquidity risks, banks and funds will be able to take advantage of new opportunities and a new route to outperformance. But the need for better transparency and reporting will be absolute. The premium on illiquid products is certainly likely to rise, giving higher potential returns to investors who are less constrained by immediate capital requirements. Hedge funds could be one of the principal investors to take on this risk as they look to maintain returns in a world of lower leverage.
3. Capital requirements
The rising cost of capital is likely to hit financial institutions’ returns, and lending dependent on a deposit base is not going to be sufficient to fund long-term growth.
While arguments will certainly continue about the origins of the credit crisis, there is no doubt about its chief impact on the banking sector: Substantial write-downs of assets have left banks around the world in need of significant recapitalization.
Part of the debate over bank solvency has focused on the application of fair-value accounting to complex financial instruments, something that becomes particularly complicated in illiquid markets. Prevailing rules have forced banks to “mark to market” products held on their trading books, resulting in valuations significantly lower than those implied by discounted future cash flow models. This undervaluation has amplified pressures on banks’ capital reserves and has led to calls to recognize only realized losses and gains.
Proposed reforms include shifting a portion of trading-book assets to the banks’ own accounts, essentially reverting to cost accounting and using the acquisition price and discounted future cash flows to determine an instrument’s value. Although this would ease solvency pressure, it would also mean less transparency for investors.
There is no clear and simple solution to this problem. But whatever the final outcome, capital adequacy will in all likelihood be the driving force in determining how firms and funds accommodate risks.
Revisiting leverageBanks traditionally have had three principal sources of capital.
In the past, equity played a relatively minor role on banks’ overall balance sheets—although this may well be changing with the injection of substantial government capital.
While banks will undoubtedly continue to use leverage, the higher cost of debt means leverage levels will fall, and banks will find it difficult to maintain their historic return on assets. A reduction in leverage from 95 percent of capital to 66 percent, for example, could reduce average ROE from approximately 15 percent to 10 percent.
Although there may be little risk of regulators stipulating leverage levels, more cautious integrated-bank shareholders will undoubtedly demand a curtailing of the appetite for the sort of high-risk business models traditionally favored by investment banks. Where governments have become shareholders, the appetite for risk is likely to be even lower.
Retail deposits have once again become a key source of funding, especially as a number of commercial banks absorb formerly independent investment banking operations and as former investment banks refashion themselves as bank holding companies.
Once established, a retail deposit base is a relatively low-cost source of financing and tends to be reasonably static. However, accumulating deposits is a slow and expensive process, and the most obvious way to attract more deposits—paying higher rates of interest—increases banks’ cost of funding. In the medium term, growing an industry on a stable (even stagnant) depositor base is going to prove difficult.
For the moment, banks rightly remain focused on working through their current losses and assessing the length and depth of the global recession. In the medium term, however, banks will be unable to raise sufficient capital to accommodate future economic expansion unless they utilize the capital markets.
Banks, therefore, face two challenges. They need to reassure potential investors that in the future, they will not face the same risks that led to the present crisis. And they must find ways, without resorting to excessive leverage, to give investors an attractive return for the risks they are undertaking.
4. Innovation
There will continue to be a premium on financial-product innovation. But innovation will shift increasingly to the buy side. High fees will be dependent on demonstrable performance.
During the past decade, there has been a notable shift in power in the financial markets to the buy side, the end-consumer of most financial products. With this shift, sell-side investment banks no longer provide free research, control access to corporate clients, determine what financial products will be made available or, in many cases, even provide liquidity. This gradual change in the balance of power across financial markets has been accompanied by an equally important shift in the source of innovation.
Much of the recent innovation in financial markets has been driven by hedge funds. This does not mean, however, that fund managers are not feeling a good deal of pressure. Not only have their portfolios been decimated; even before the crisis, they were grappling with a number of challenges—the higher costs of doing their own research, a reduction in the number of brokers they could work with and significant competition from low-cost index funds.
The capital markets will nonetheless continue to see rapid innovation. But precisely where innovation will occur—and what sort of risks and rewards will be involved—shall be subject to a good deal of change in the future.
What is certain is that product innovation will be more focused on customer needs, such as liquidity and transparency, than it has in the recent past. This customer-focused innovation will ultimately include process innovation and other ways to help clients better understand and assess risk, including risk associated with products that have already been developed.
Adding value
The search for returns will force high-cost active fund managers, particularly at hedge funds, to look where few others have gone before. This will drive managers to increase their funds’ presence in areas such as less liquid, small company stocks and to continue their expansion into private equity. Fees will become more closely tied to performance, which will reinforce the need for innovation. Firms that can build on this innovation—by adding value or allowing value to be effectively added by others—are going to be the industry’s high performers of the future.
As for the growing sentiment that hedge funds are something of an endangered species, this is certainly a possibility. But if they do disappear, they will be replaced by actively managed, leveraged funds with broad mandates—in other words, a more highly evolved version of precisely the same thing.
Innovation may well require flexible capital structures. For products with an inherently high risk, it may well be that corporate entities that can accommodate illiquidity are more appropriate. These entities could be captives of larger integrated banks or completely independent.
As long as uncertainty grips the markets, large amounts of money will remain in cash or cash-equivalent instruments. Once this money reenters the market, there will be more than enough of it chasing top fund managers for them to maintain generous fee structures.
The rewards are potentially substantial. But more than ever before, they will fall to those who can deliver innovative instruments that offer a reasonable balance of risk and reward.
5. Regulation
Effective regulation will need to take a global, coordinated, flexible and holistic view of risk across all instruments and segments of the market.
The crisis in the financial markets has exposed two conflicting truths: Any regulatory scheme that does not seek to harmonize rules on an international scale is likely to be ineffective. But only a national government is going to have sufficient money and political clout to effectively underwrite a system in trouble.
What is needed today is a coordinated and structured global regulatory framework that actively identifies and manages shocks throughout the financial system. Moreover, any such global approach must strive to resolve a number of difficult and, at times, conflicting issues—including concerns over moral hazard and a culture of excessive risk taking; an increasingly interrelated and complex global financial system; and the lack of consistency across markets.
Clearly, reaching broadly based agreement on what such a system will look like and how it will function is going to be a slow and difficult process.
Emphasis on oversight
Regulatory regimes will continue to foster competition and support a technologically enabled market infrastructure. But there will be a new emphasis on repairing gaps in oversight. There has long been an appreciation that international regulation is both necessary and should have some sort of risk assessment at its heart. What is now also being appreciated is that regulation cannot separate financing into various constituent parts.
The Basel II accords basically addressed commercial bank capital adequacy with little consideration for what was going on in the wider debt capital market. While the system is an improvement on what preceded it, Basel II has put rating agencies at the core of its risk assessments.
Risk weighting is undoubtedly to be welcomed, but there are serious questions about the ratings themselves as well as about whether the agencies were appropriately responsive to the credit crisis as it developed.
We believe regulators need to address five issues.
Accounting rules. Fair-value, historic-value and mark-to-model systems all have advantages. Looking at where each system might be best employed and by whom has to be a pressing priority as banks rebuild their businesses. Strict guidance as to when each set of rules should be employed may be necessary, but a greater degree of flexibility certainly looks to be desirable.
Capital adequacy. Rules for many complex financial instruments need to be reviewed. Transparency must be central to any solution, which obviously places a premium on the understanding of such instruments.
Emerging markets. Countries such as India and China are already major players in the global capital markets. If these countries are to be financed rapidly, with minimum risk to investors and at minimum cost to local companies, new capital adequacy regimes will need to be created to draw them into new international agreements.
Regulatory scope. Principles-based regulation will continue. However, regulators are going to take a much broader, more dynamic and interactive view of their role.
Transparency and liquidity. Both must be improved, although how this will be achieved in full remains to be seen.
Looking to the futureDeriving a definitive forecast from these trends is not our intention. Rather, it is crucial to understand that each of the five factors listed above will be important—no matter which scenario we consider most likely.
Two important variables will determine the shape of financial markets in the immediate future: how the economy recovers and how those markets are regulated. These two factors are obviously intertwined. Overzealous financial regulation could hinder an economic recovery, for example, just as a quick economic recovery could cool the current enthusiasm for tougher regulation.
Looking ahead, Accenture envisions three plausible scenarios for capital markets, each with its own challenges.
1. Deep regulatory engagementGovernments around the world have invested unprecedented sums of taxpayer money in their banks, just when recession is biting deeply into the global economy. In the first scenario, in an attempt to protect these investments as well as to shield electorates from the worst ravages of the economic downturn, governments, through their regulators, take a highly active role in banking operations.
Under this scenario:
Regulators determine, or help to guide, broad levels of bank lending and terms of lending. Historically, allowing political priorities to direct bank lending has seldom been successful. For the moment, there remains broad agreement that even where a government has invested considerable sums of taxpayer money, banks should be run at arm’s length from politicians. However, this general agreement has not entirely muted calls for using the financial system for largely political ends.The danger is that as recession progresses, political priorities overcome the best of government intentions to refrain from unduly influencing banking operations.
Businesses or activities deemed “too risky” by regulators are either discouraged or disallowed. By stipulating what sorts of products are allowed, or by closely circumscribing products, regulators will discourage the kind of financial innovation and product creation that sustained margins and, at least in part, returns over the past decade. Yields would fall in the broader financial markets as demand drives up prices, and any economic recovery would be slowed by a lack of dynamic capital.
Regulators seek to influence, if not set, executive compensation. The question of whether prevailing executive compensation schemes in the capital markets encourage disproportionate risk is a matter of considerable debate. For the moment, in those cases where no public money has been sought for a bailout, there is little regulators are proposing to do.But where there has been a government injection of public funds, there will undoubtedly be some danger of the regulation of executive compensation. This may lead to a flight of talent to lightly regulated funds, where far higher compensation (for taking far higher risk) can be earned away from the glare of public oversight. Whatever the outcome, executive compensation will remain a highly incendiary political issue as long as taxpayer money is involved.
Regulatory compliance becomes a major expense and an effective barrier to entry into financial services. Wide-ranging regulation would largely be dictated to the industry, which could become a serious burden. For example, regulatory compliance costs could rise considerably. As a consequence, competition would be reduced across capital markets as entrepreneurial firms would be discouraged from entering markets due to high initial costs and lower potential returns.
2. Ragged recoveryThis scenario, which we consider the most likely, foresees a normal recovery in due course. A ragged recovery is, in many ways, proof that life is fair. Those financial institutions that were most excessive in their risk taking in the past would be punished. The survivors would be those that had been conservative in their lending, effective in their risk management, or large enough to withstand losses.
However, the real winners would be those who have been brave enough to use this downturn to acquire new market share at steeply discounted prices.
A renewed emphasis on transparency and liquidity is a certainty and will be a feature of all three scenarios. But in a ragged recovery, once the financial markets begin to recover, so too will the desire for outperformance. For banks that have had difficulty coping with illiquid financial products on their balance sheets, the solution is not to abandon innovation but to move product innovation and complexity to new organizational structures that can cope with the changing marketplace.
The potential for financial product innovation is no more likely to fade than human ingenuity. In a ragged recovery, complex and potentially illiquid products are going to be manufactured, sold and held by entities that can cope with illiquidity. Furthermore, innovation is likely to shift from complex products to products that transparently meet a specific need and emerging-markets financial products where sustained outperformance is realistically possible.
As for regulation, under this scenario:
Regulators take a supervisory and directing role only in those firms they have rescued.
New dynamic risk measures are utilized by both investors and regulators.
It is accepted that mistakes have been made by both firms and regulators, and that the concerned parties work together on the next generation of regulation.
Regulation would seek to be principles-based and flexible enough to respond to changing circumstances within the wider market. This will push regulators and the regulated to work cooperatively on an ongoing basis. The cost of regulation under this arrangement would rise and may, in the process, curtail new entrants into the market. But this will have only a marginal effect on overall competition.
3. Rapid recoveryUnlikely as this now might seem, the potential for the global economy to recover more rapidly than is being forecast must be considered. For the capital markets, the most important feature of this scenario would be a rapid return of those underlying factors that drove the business during the past few years: demand for financial products and the push into emerging markets.
Considerable amounts of investor capital have been withdrawn from markets over the course of 2007 and 2008. In a rapid recovery, this money would quickly reenter markets. This would not only automatically repair many balance sheets and boost pension funds, it would also provide capital for a renewed expansion.
While there would be a new regulatory regime, the expanding recovery would reduce the political pressure to use intrusive or draconian measures to punish bankers. Under this scenario:
Regulators take a supervisory and directing role only in those banks they have rescued.
New dynamic risk measures are utilized by both investors and regulators.
Pressure for new regulations is lessened and international agreement becomes more difficult.
None of our scenarios foresees product complexity as it existed pre-crisis. However, a rapid recovery would quickly create demand for new products. This would lead to both a complexity of products drawn from across silos and a renewed interest in products from emerging markets.
This scenario would also take the pressure off politicians to act for the sake of acting, with the result that there would be relatively little regulatory change over the next few years. This would be particularly true for comprehensive international regulation, which, in the absence of an obvious imperative to act, becomes even more difficult to agree upon.
The danger of this scenario is that the lessons of the past few years are not absorbed, and that in the medium term, the imbalances that have led to the present difficulties will simply reemerge. And presumably, this is a path no one in the capital markets wants to go down again.
During the past seven years, financial markets were so buoyant that even capital markets firms with poorly conceived, undifferentiated strategies could prosper. But it is now clear that the business model that prevailed until the summer of 2007 was not sustainable. And any firm that seeks to resuscitate that model is bound to fail.
But turning their backs on the past is not enough. High performers in capital markets will be those who understand not only how the world has changed but also how, with the right market positioning, distinctive capabilities and performance anatomy, they can take advantage of those changes.
About the authors
Robert P. Gach is the New York-based global managing director of Accenture Capital Markets, responsible for the overall strategy of the industry group. Mr. Gach has spent his entire career serving the financial services sector, working with leaders in the global banking and capital markets industries in North America, Asia and Europe. His experience includes mergers and acquisitions, business strategy development, and architecture development and implementation. Prior to his current role, Mr. Gach served as managing director of Accenture Financial Services in Asia Pacific, during which time he was part of the team that secured Accenture’s entry into the People’s Republic of China.
James R. Sproule, a senior manager in Accenture Research, heads Global Capital Markets Research. Mr. Sproule has more than 15 years of experience as an economist in financial services. His work as a researcher and forecaster has entailed scenario planning, sensitivity analysis and competitor profiling. He has also focused on valuations and investment opportunities within the European small-and-midsize-companies sector. A former communications officer in the Royal Navy, Mr. Sproule is based in London.
By Robert P. Gach and James R. Sproule
Outlook Journal, June 2009
The axiom is as simple as it is sobering: The current global economic downturn began with the sudden widening of credit spreads in August 2007, which precipitated a crisis that soon engulfed financial markets around the world. Until strength and stability return to those markets, there can be no sustained recovery.
The damage to the banking system has been staggering. As of the beginning of March 2009, banks worldwide had announced losses of $840 billion. Total damages could run as high as $1.4 trillion.
Capital markets and investment banking play a key role in the global financial system and the overall economy. They are an important source of the financing critical to the health of the economy, as well as the ultimate arbiters of where value is being created. This article focuses on that sector by exploring the five areas.
1. Revenues
Revenues are being hit by the flight from complexity and a slowing economy. But new products will emerge that deliver transparency and reduce risk or offer the possibility of significant outperformance.
No amount of cost cutting or margin enhancement can compensate for steeply falling revenues in this sector. Yet robust revenues are essential to everything from innovation to the extraordinary returns that financial services have been able to generate over past decades.
At least in the longer term, Accenture remains optimistic. We believe that the demand for traditional financial products such as equities and bonds will continue its historic trend of running up to 3 percent ahead of the supply. This demand is driven by both global demographics and the clear need to save for retirement. Savings in 2008 alone totaled $5.8 trillion globally, and the trend will continue to support revenue growth as well as the creation of a host of new financial products and services.
Given their size, maintaining sales and trading revenues is crucial for investment banks’ overall performance. Indeed, Accenture research has calculated that sales and trading accounted for 75 percent of investment banking revenues during the recent boom years. At the same time, traditional corporate advisory work fell to 20 percent of revenues (although advisory revenues rose to 40 percent of total revenues in 2008, in light of losses in the credit markets).
Before the credit crunch, the financial markets may well have reached a high point in terms of both margin and volume. But for management, this may not prove to be as controversial a notion as might be imagined.
As investment banks are absorbed into larger, traditionally more conservative retail banking operations, their ultimate parent organizations may be less willing to take on risk or pay out commensurate reward. In fact, some banks’ managements may prefer lower but possibly more stable earnings. For an industry accustomed to rapid change and high profits, this would be a radical shift indeed.
Scope for recovery
Does this mean that a chastened industry will abandon the complex, high-margin products—entire new classes of securitized and monetized assets—that fueled the money-spinning trading operations before the credit crisis?
In analyzing what caused the house of complex financial products to collapse, two factors stand out: The potential for illiquidity should have been more carefully considered; and calculating liabilities for products was nearly impossible when those products had to move through multiple iterations to ultimately determine a valuation.
But Accenture believes that labeling all complex products as “excessively risky” is too sweeping a judgment. Although there have been clear failures across a wide range of new financial instruments, there is scope for recovery; it all depends on the product in question.
For products like collateralized debt obligations, the principle of diversification remains sound and relevant, and this alone points to an eventual rebound. Where a financial product’s underlying principle or added value is less apparent—as is the case in a number of complex and illiquid over-the-counter instruments, such as credit default swaps—demand and, hence, revenues have fallen and will not soon recover.
Successful, profitable financial products will be those that address liquidity concerns, have transparent ultimate liability and still offer an attractive risk-to-return ratio. These are most likely to be based on cross-product complexity, the linking together of highly liquid financial instruments.
The high degree of liquidity would mean that each piece could be priced separately. At the same time, these products would tie the pieces together in such a way that they would offer investors attractive returns for risks undertaken. What margins these products will command remains to be seen. But if complexity is to be profitable again, it must be more transparent, more liquid and utilize a wide range of financial products.
2. Risk and liquidity
Risk parameters have expanded to include liquidity. Efforts to increase liquidity and transparency will mean more on-exchange trading as well as new capital structures. At the same time, changes in accounting rules could promote the development of new structures that are capable of accepting illiquidity risks.
Although liquidity has always been vital to financial markets, the lack of it was seldom seen as a financial risk by investors and bankers—until the credit crisis. A combination of banks losing faith in counterparties that were assumed to be financially sound and a more general uncertainty about future losses as the economy slid into recession has led to a collapse in liquidity.
This collapse has already had a significant impact on bank balance sheets and will have a similar impact on future bank revenues and profits. Exact percentages naturally vary, but with some investment banks generating up to 50 percent of trading revenue from proprietary positions, it is clear that illiquidity can quickly impair assets necessarily held on a balance sheet as a natural part of business operations.
As a result, some more conservative retail bank managements and shareholders, even regulators, may seek to scale back investment banking operations that take significant proprietary positions. Clearly, there is a need for better reporting and pricing transparency, as well as for risk assessment and liquidity support. Ultimately, some capital markets firms may simply become less willing to accept risk than they were in the past.
Transferring risk
Where risks are known, informed judgments can be made about the wisdom of particular investments. The greatest danger comes, of course, where risks are unknown. Therefore, assuming that risks can be identified and assessed, an equally likely approach for other firms will be to transfer risk to new kinds of entities or to standalone divisions within more traditional existing institutions.
It is notable that funds simply write down the value of their investments rather than recapitalize their balance sheets. In a world where illiquidity risks are evaluated and these evaluations become an integral part of the calculations aimed at delivering outperformance, it may well be that fund-like structures become the most appropriate home for potentially illiquid financial products.
Concerns over liquidity are also going to have an impact on the once high-margin business of complex, custom-made derivatives. Banks are going to be increasingly unwilling to create illiquid over-the-counter financial products in light of investor reluctance to buy such products. This does not necessarily mean complex derivatives will disappear, but their use will increasingly shift to financial institutions that can better accommodate illiquidity risk.
For financial markets, the need for demonstrable transparency and liquidity is likely to lead to greater standardization and, thus, on-exchange trading. These moves will be further enhanced by the exchanges themselves, which will encourage liquidity providers to enter the market.
Once something approaching normalcy returns to the markets, so too will the desire for outperformance. When this happens, banks are likely to move away from structures where illiquidity and attendant capital requirements are an issue, and create new corporate structures better able to cope with significant market fluctuations.
In accommodating new illiquidity risks, banks and funds will be able to take advantage of new opportunities and a new route to outperformance. But the need for better transparency and reporting will be absolute. The premium on illiquid products is certainly likely to rise, giving higher potential returns to investors who are less constrained by immediate capital requirements. Hedge funds could be one of the principal investors to take on this risk as they look to maintain returns in a world of lower leverage.
3. Capital requirements
The rising cost of capital is likely to hit financial institutions’ returns, and lending dependent on a deposit base is not going to be sufficient to fund long-term growth.
While arguments will certainly continue about the origins of the credit crisis, there is no doubt about its chief impact on the banking sector: Substantial write-downs of assets have left banks around the world in need of significant recapitalization.
Part of the debate over bank solvency has focused on the application of fair-value accounting to complex financial instruments, something that becomes particularly complicated in illiquid markets. Prevailing rules have forced banks to “mark to market” products held on their trading books, resulting in valuations significantly lower than those implied by discounted future cash flow models. This undervaluation has amplified pressures on banks’ capital reserves and has led to calls to recognize only realized losses and gains.
Proposed reforms include shifting a portion of trading-book assets to the banks’ own accounts, essentially reverting to cost accounting and using the acquisition price and discounted future cash flows to determine an instrument’s value. Although this would ease solvency pressure, it would also mean less transparency for investors.
There is no clear and simple solution to this problem. But whatever the final outcome, capital adequacy will in all likelihood be the driving force in determining how firms and funds accommodate risks.
Revisiting leverageBanks traditionally have had three principal sources of capital.
In the past, equity played a relatively minor role on banks’ overall balance sheets—although this may well be changing with the injection of substantial government capital.
While banks will undoubtedly continue to use leverage, the higher cost of debt means leverage levels will fall, and banks will find it difficult to maintain their historic return on assets. A reduction in leverage from 95 percent of capital to 66 percent, for example, could reduce average ROE from approximately 15 percent to 10 percent.
Although there may be little risk of regulators stipulating leverage levels, more cautious integrated-bank shareholders will undoubtedly demand a curtailing of the appetite for the sort of high-risk business models traditionally favored by investment banks. Where governments have become shareholders, the appetite for risk is likely to be even lower.
Retail deposits have once again become a key source of funding, especially as a number of commercial banks absorb formerly independent investment banking operations and as former investment banks refashion themselves as bank holding companies.
Once established, a retail deposit base is a relatively low-cost source of financing and tends to be reasonably static. However, accumulating deposits is a slow and expensive process, and the most obvious way to attract more deposits—paying higher rates of interest—increases banks’ cost of funding. In the medium term, growing an industry on a stable (even stagnant) depositor base is going to prove difficult.
For the moment, banks rightly remain focused on working through their current losses and assessing the length and depth of the global recession. In the medium term, however, banks will be unable to raise sufficient capital to accommodate future economic expansion unless they utilize the capital markets.
Banks, therefore, face two challenges. They need to reassure potential investors that in the future, they will not face the same risks that led to the present crisis. And they must find ways, without resorting to excessive leverage, to give investors an attractive return for the risks they are undertaking.
4. Innovation
There will continue to be a premium on financial-product innovation. But innovation will shift increasingly to the buy side. High fees will be dependent on demonstrable performance.
During the past decade, there has been a notable shift in power in the financial markets to the buy side, the end-consumer of most financial products. With this shift, sell-side investment banks no longer provide free research, control access to corporate clients, determine what financial products will be made available or, in many cases, even provide liquidity. This gradual change in the balance of power across financial markets has been accompanied by an equally important shift in the source of innovation.
Much of the recent innovation in financial markets has been driven by hedge funds. This does not mean, however, that fund managers are not feeling a good deal of pressure. Not only have their portfolios been decimated; even before the crisis, they were grappling with a number of challenges—the higher costs of doing their own research, a reduction in the number of brokers they could work with and significant competition from low-cost index funds.
The capital markets will nonetheless continue to see rapid innovation. But precisely where innovation will occur—and what sort of risks and rewards will be involved—shall be subject to a good deal of change in the future.
What is certain is that product innovation will be more focused on customer needs, such as liquidity and transparency, than it has in the recent past. This customer-focused innovation will ultimately include process innovation and other ways to help clients better understand and assess risk, including risk associated with products that have already been developed.
Adding value
The search for returns will force high-cost active fund managers, particularly at hedge funds, to look where few others have gone before. This will drive managers to increase their funds’ presence in areas such as less liquid, small company stocks and to continue their expansion into private equity. Fees will become more closely tied to performance, which will reinforce the need for innovation. Firms that can build on this innovation—by adding value or allowing value to be effectively added by others—are going to be the industry’s high performers of the future.
As for the growing sentiment that hedge funds are something of an endangered species, this is certainly a possibility. But if they do disappear, they will be replaced by actively managed, leveraged funds with broad mandates—in other words, a more highly evolved version of precisely the same thing.
Innovation may well require flexible capital structures. For products with an inherently high risk, it may well be that corporate entities that can accommodate illiquidity are more appropriate. These entities could be captives of larger integrated banks or completely independent.
As long as uncertainty grips the markets, large amounts of money will remain in cash or cash-equivalent instruments. Once this money reenters the market, there will be more than enough of it chasing top fund managers for them to maintain generous fee structures.
The rewards are potentially substantial. But more than ever before, they will fall to those who can deliver innovative instruments that offer a reasonable balance of risk and reward.
5. Regulation
Effective regulation will need to take a global, coordinated, flexible and holistic view of risk across all instruments and segments of the market.
The crisis in the financial markets has exposed two conflicting truths: Any regulatory scheme that does not seek to harmonize rules on an international scale is likely to be ineffective. But only a national government is going to have sufficient money and political clout to effectively underwrite a system in trouble.
What is needed today is a coordinated and structured global regulatory framework that actively identifies and manages shocks throughout the financial system. Moreover, any such global approach must strive to resolve a number of difficult and, at times, conflicting issues—including concerns over moral hazard and a culture of excessive risk taking; an increasingly interrelated and complex global financial system; and the lack of consistency across markets.
Clearly, reaching broadly based agreement on what such a system will look like and how it will function is going to be a slow and difficult process.
Emphasis on oversight
Regulatory regimes will continue to foster competition and support a technologically enabled market infrastructure. But there will be a new emphasis on repairing gaps in oversight. There has long been an appreciation that international regulation is both necessary and should have some sort of risk assessment at its heart. What is now also being appreciated is that regulation cannot separate financing into various constituent parts.
The Basel II accords basically addressed commercial bank capital adequacy with little consideration for what was going on in the wider debt capital market. While the system is an improvement on what preceded it, Basel II has put rating agencies at the core of its risk assessments.
Risk weighting is undoubtedly to be welcomed, but there are serious questions about the ratings themselves as well as about whether the agencies were appropriately responsive to the credit crisis as it developed.
We believe regulators need to address five issues.
Accounting rules. Fair-value, historic-value and mark-to-model systems all have advantages. Looking at where each system might be best employed and by whom has to be a pressing priority as banks rebuild their businesses. Strict guidance as to when each set of rules should be employed may be necessary, but a greater degree of flexibility certainly looks to be desirable.
Capital adequacy. Rules for many complex financial instruments need to be reviewed. Transparency must be central to any solution, which obviously places a premium on the understanding of such instruments.
Emerging markets. Countries such as India and China are already major players in the global capital markets. If these countries are to be financed rapidly, with minimum risk to investors and at minimum cost to local companies, new capital adequacy regimes will need to be created to draw them into new international agreements.
Regulatory scope. Principles-based regulation will continue. However, regulators are going to take a much broader, more dynamic and interactive view of their role.
Transparency and liquidity. Both must be improved, although how this will be achieved in full remains to be seen.
Looking to the futureDeriving a definitive forecast from these trends is not our intention. Rather, it is crucial to understand that each of the five factors listed above will be important—no matter which scenario we consider most likely.
Two important variables will determine the shape of financial markets in the immediate future: how the economy recovers and how those markets are regulated. These two factors are obviously intertwined. Overzealous financial regulation could hinder an economic recovery, for example, just as a quick economic recovery could cool the current enthusiasm for tougher regulation.
Looking ahead, Accenture envisions three plausible scenarios for capital markets, each with its own challenges.
1. Deep regulatory engagementGovernments around the world have invested unprecedented sums of taxpayer money in their banks, just when recession is biting deeply into the global economy. In the first scenario, in an attempt to protect these investments as well as to shield electorates from the worst ravages of the economic downturn, governments, through their regulators, take a highly active role in banking operations.
Under this scenario:
Regulators determine, or help to guide, broad levels of bank lending and terms of lending. Historically, allowing political priorities to direct bank lending has seldom been successful. For the moment, there remains broad agreement that even where a government has invested considerable sums of taxpayer money, banks should be run at arm’s length from politicians. However, this general agreement has not entirely muted calls for using the financial system for largely political ends.The danger is that as recession progresses, political priorities overcome the best of government intentions to refrain from unduly influencing banking operations.
Businesses or activities deemed “too risky” by regulators are either discouraged or disallowed. By stipulating what sorts of products are allowed, or by closely circumscribing products, regulators will discourage the kind of financial innovation and product creation that sustained margins and, at least in part, returns over the past decade. Yields would fall in the broader financial markets as demand drives up prices, and any economic recovery would be slowed by a lack of dynamic capital.
Regulators seek to influence, if not set, executive compensation. The question of whether prevailing executive compensation schemes in the capital markets encourage disproportionate risk is a matter of considerable debate. For the moment, in those cases where no public money has been sought for a bailout, there is little regulators are proposing to do.But where there has been a government injection of public funds, there will undoubtedly be some danger of the regulation of executive compensation. This may lead to a flight of talent to lightly regulated funds, where far higher compensation (for taking far higher risk) can be earned away from the glare of public oversight. Whatever the outcome, executive compensation will remain a highly incendiary political issue as long as taxpayer money is involved.
Regulatory compliance becomes a major expense and an effective barrier to entry into financial services. Wide-ranging regulation would largely be dictated to the industry, which could become a serious burden. For example, regulatory compliance costs could rise considerably. As a consequence, competition would be reduced across capital markets as entrepreneurial firms would be discouraged from entering markets due to high initial costs and lower potential returns.
2. Ragged recoveryThis scenario, which we consider the most likely, foresees a normal recovery in due course. A ragged recovery is, in many ways, proof that life is fair. Those financial institutions that were most excessive in their risk taking in the past would be punished. The survivors would be those that had been conservative in their lending, effective in their risk management, or large enough to withstand losses.
However, the real winners would be those who have been brave enough to use this downturn to acquire new market share at steeply discounted prices.
A renewed emphasis on transparency and liquidity is a certainty and will be a feature of all three scenarios. But in a ragged recovery, once the financial markets begin to recover, so too will the desire for outperformance. For banks that have had difficulty coping with illiquid financial products on their balance sheets, the solution is not to abandon innovation but to move product innovation and complexity to new organizational structures that can cope with the changing marketplace.
The potential for financial product innovation is no more likely to fade than human ingenuity. In a ragged recovery, complex and potentially illiquid products are going to be manufactured, sold and held by entities that can cope with illiquidity. Furthermore, innovation is likely to shift from complex products to products that transparently meet a specific need and emerging-markets financial products where sustained outperformance is realistically possible.
As for regulation, under this scenario:
Regulators take a supervisory and directing role only in those firms they have rescued.
New dynamic risk measures are utilized by both investors and regulators.
It is accepted that mistakes have been made by both firms and regulators, and that the concerned parties work together on the next generation of regulation.
Regulation would seek to be principles-based and flexible enough to respond to changing circumstances within the wider market. This will push regulators and the regulated to work cooperatively on an ongoing basis. The cost of regulation under this arrangement would rise and may, in the process, curtail new entrants into the market. But this will have only a marginal effect on overall competition.
3. Rapid recoveryUnlikely as this now might seem, the potential for the global economy to recover more rapidly than is being forecast must be considered. For the capital markets, the most important feature of this scenario would be a rapid return of those underlying factors that drove the business during the past few years: demand for financial products and the push into emerging markets.
Considerable amounts of investor capital have been withdrawn from markets over the course of 2007 and 2008. In a rapid recovery, this money would quickly reenter markets. This would not only automatically repair many balance sheets and boost pension funds, it would also provide capital for a renewed expansion.
While there would be a new regulatory regime, the expanding recovery would reduce the political pressure to use intrusive or draconian measures to punish bankers. Under this scenario:
Regulators take a supervisory and directing role only in those banks they have rescued.
New dynamic risk measures are utilized by both investors and regulators.
Pressure for new regulations is lessened and international agreement becomes more difficult.
None of our scenarios foresees product complexity as it existed pre-crisis. However, a rapid recovery would quickly create demand for new products. This would lead to both a complexity of products drawn from across silos and a renewed interest in products from emerging markets.
This scenario would also take the pressure off politicians to act for the sake of acting, with the result that there would be relatively little regulatory change over the next few years. This would be particularly true for comprehensive international regulation, which, in the absence of an obvious imperative to act, becomes even more difficult to agree upon.
The danger of this scenario is that the lessons of the past few years are not absorbed, and that in the medium term, the imbalances that have led to the present difficulties will simply reemerge. And presumably, this is a path no one in the capital markets wants to go down again.
During the past seven years, financial markets were so buoyant that even capital markets firms with poorly conceived, undifferentiated strategies could prosper. But it is now clear that the business model that prevailed until the summer of 2007 was not sustainable. And any firm that seeks to resuscitate that model is bound to fail.
But turning their backs on the past is not enough. High performers in capital markets will be those who understand not only how the world has changed but also how, with the right market positioning, distinctive capabilities and performance anatomy, they can take advantage of those changes.
About the authors
Robert P. Gach is the New York-based global managing director of Accenture Capital Markets, responsible for the overall strategy of the industry group. Mr. Gach has spent his entire career serving the financial services sector, working with leaders in the global banking and capital markets industries in North America, Asia and Europe. His experience includes mergers and acquisitions, business strategy development, and architecture development and implementation. Prior to his current role, Mr. Gach served as managing director of Accenture Financial Services in Asia Pacific, during which time he was part of the team that secured Accenture’s entry into the People’s Republic of China.
James R. Sproule, a senior manager in Accenture Research, heads Global Capital Markets Research. Mr. Sproule has more than 15 years of experience as an economist in financial services. His work as a researcher and forecaster has entailed scenario planning, sensitivity analysis and competitor profiling. He has also focused on valuations and investment opportunities within the European small-and-midsize-companies sector. A former communications officer in the Royal Navy, Mr. Sproule is based in London.
6/29/2009
BRITISH REGULATOR BANS COMMISSIONS
Last week, the U.K.'s Financial Services Authority (FSA) issued rules that essentially codify a fee model for British investment advisors (IAs) and ban collection of commissions by IAs.
The rules will take effect in 2012.
The FSA's principles-based regulatory regime was savaged by investors, government officials and the media following its failure to catch or correct errant behaviour that led to the credit crisis-induced meltdown beginning last fall.
So the regulator responded with a clear-cut set of new standards aimed at raising the bar for financial advisors and scrutinizing how they are remunerated by the creators of investment products.
"The incentive trade-off between commission payments and suitability will be removed," the rules documents said. "All else being equal, this is expected to lead to an increase in the suitability of the products sold."
Under new rules covering compensation, advisors will be "required to set their own charges for advice" in an effort to remove "product provider influence over advisor remuneration." Both independent and captive advisory firms will be called upon to disclose the cost of advice separately from the underlying costs of investment products, according to the FSA's rules documents.
Consistent capital requirements will also be established for personal investment firms. Overall minimum capital requirements will be raised from £10,000 to £20,000, and expenditure-based requirements will be extended to every firm.
"Furthermore, firms will be required to hold additional capital, based on a sliding scale, as a provision against potential liability for any activities excluded by their professional indemnity insurance policies," the FSA said.
The regulator added that it will raise minimum qualification levels for advisors, institute a code of ethics and boost requirements for continuing professional development. The FSA is further considering the creation of a Professional Standards Board to oversee the implementation of the requirements.
Comment letters received by the FSA during the rules development phase indicated that some advisors may leave the business if barriers to entry are raised or income potential is diminished. The FSA acknowledged this, but added it's unlikely there would be enough departures to restrict consumer choice.
"Regulatory requirements for advisors, in the form of training, competency standards and capital requirements, may constitute a barrier to entry," the regulator said. "However, the high number of individual advisors still working in the industry seems to indicate that these may not be so significant as to give rise to a concentrated market."
(06/29/09)
Filed by Philip Porado, philip.porado@advisor.rogers.com
Originally published on Advisor.ca
The rules will take effect in 2012.
The FSA's principles-based regulatory regime was savaged by investors, government officials and the media following its failure to catch or correct errant behaviour that led to the credit crisis-induced meltdown beginning last fall.
So the regulator responded with a clear-cut set of new standards aimed at raising the bar for financial advisors and scrutinizing how they are remunerated by the creators of investment products.
"The incentive trade-off between commission payments and suitability will be removed," the rules documents said. "All else being equal, this is expected to lead to an increase in the suitability of the products sold."
Under new rules covering compensation, advisors will be "required to set their own charges for advice" in an effort to remove "product provider influence over advisor remuneration." Both independent and captive advisory firms will be called upon to disclose the cost of advice separately from the underlying costs of investment products, according to the FSA's rules documents.
Consistent capital requirements will also be established for personal investment firms. Overall minimum capital requirements will be raised from £10,000 to £20,000, and expenditure-based requirements will be extended to every firm.
"Furthermore, firms will be required to hold additional capital, based on a sliding scale, as a provision against potential liability for any activities excluded by their professional indemnity insurance policies," the FSA said.
The regulator added that it will raise minimum qualification levels for advisors, institute a code of ethics and boost requirements for continuing professional development. The FSA is further considering the creation of a Professional Standards Board to oversee the implementation of the requirements.
Comment letters received by the FSA during the rules development phase indicated that some advisors may leave the business if barriers to entry are raised or income potential is diminished. The FSA acknowledged this, but added it's unlikely there would be enough departures to restrict consumer choice.
"Regulatory requirements for advisors, in the form of training, competency standards and capital requirements, may constitute a barrier to entry," the regulator said. "However, the high number of individual advisors still working in the industry seems to indicate that these may not be so significant as to give rise to a concentrated market."
(06/29/09)
Filed by Philip Porado, philip.porado@advisor.rogers.com
Originally published on Advisor.ca
6/28/2009
OTTAWA NAMES FINANCIAL LITERACY TASK FORCE
Calls for increased financial education finally appear to have been heard, as the federal government has commissioned a new national task force on financial literacy.
The task force, announced by Finance Minister Jim Flaherty in Toronto on Friday, will be chaired by Sun Life CEO Donald Stewart. The task force was promised in the 2009 federal budget.
"Our economy is built on millions of everyday financial decisions by Canadians. Recent events have shown us that there are major risks and that financial literacy is an important life skill," Flaherty said. "Whether it is a question of saving for retirement, financing a new home or balancing the family chequebook, improving the financial literacy of Canadians will add to the stability of our financial system and make our economy stronger."
The first job of the task force will be to establish the current state of financial literacy, and identify best practices in other countries. The task force is scheduled to report back to the Ministry of Finance in late 2010.
"I was delighted when the Government of Canada invited me — and a group of eminent Canadians — to consider and report on ways to support all generations to grow into knowledgeable managers of their personal savings, taxation, investments, debt and protection," Stewart said.
Also named to the task force was Advocis president and CEO, Greg Pollock, who said it was an honour to be appointed to such an important project.
"We've all talked about the importance of literacy and numeracy to surviving in society, but its just as important that we have a basic understanding of financial issues," he told Advisor.ca. "Our association is of the view that if Canadians have more knowledge, they'll be able to make informed decisions."
He says the topic has become popular on a global scale, in recent years, after a 2005 report by the Organization for Economic Co-operation and Development called for improved financial literacy among its members.
Increased financial complexity has made this education more important than in the past.
"I think a lot of us were conservative in days gone by. We had paper money, and if we had the money in hand, we were able to purchase something; if we didn't, then we didn't purchase it," Pollock says.
At the end of the project, he hopes that improved financial literacy will make life easier for advisors, as clients will already be educated on the basics of the a financial plan.
"Advisors do take a lot of time sitting down with clients and educating them as best they can," he says. "I think the consumer with more knowledge will ask better questions and more questions, which in the end can only serve the consumer well."
The only practicing financial advisor on the task force is Ted Gordon, with Freedom 55 Financial in Ottawa.
"I really feel like I can make a meaningful contribution to the task force," Gordon told Advisor.ca. Not only is he a financial advisor, but he is also an accountant and teaches the Personal Financial Literacy course at Algonquin College in Ottawa.
"Overall, I'd say financial literacy is quite poor, because we receive no training," he says, pointing out that most people learn what little they do know from their parents, who were equally ill-equipped.
Financial literacy is more important than ever, he says, because the retail sector has become very sophisticated in its marketing strategies. Teaching consumers how to manage their money would help to level the playing field between those selling goods and services and the consumer they target.
The task force's first meeting will take place July 20, at Sun Life's head office in Toronto. This first meeting will focus on designing the process for consultations, which Gordon says will likely best be achieved with a cross-country tour.
Also serving on the task force are:
• L. Jacques Ménard, who will serve as vice-chair. Ménard is the chairman of BMO Nesbitt Burns and president of BMO Financial Group, Quebec.
• Edward (Ted) Gordon, financial security advisor with Freedom 55 Financial in Ottawa
• Evelyn Jacks, founder and president of The Knowledge Bureau
• Laurie Campbell, executive director of Credit Canada/the Credit Counselling Service of Toronto.
• Marcel Côté, founding partner of SECOR Consulting, as well as sitting on the board of directors for Intact Insurance.
• Patrick C. Foran, CTV News journalist and host of that network's nightly "Consumer Alert," segment
• Ruth Kelly, president and CEO of Venture Publishing Inc.
• Janice MacKinnon, professor of Fiscal Policy at the University of Saskatchewan, a fellow of the Royal Society of Canada, chair of the Research Institute on Public Policy, and member of the Board of the Canada West Foundation.
• P. Mitchell Murphy, career education consultant with the Western School Board in Prince Edward Island.
• Bill Schwartz, principal of Polestar Communications Inc.
• Jean Vincent, president and general manager of the Native Commercial Credit Corporation (NACCC).
The Canadian Life and Health Insurance Association was quick to cheer to creation of the task force, as well as such prominent positions for the insurance industry.
"As one of Canada's most respected and experienced leaders in our financial services sector, we are delighted that Donald Stewart has been chosen to chair this important task force," said CLHIA president Frank Swedlove.
The government has already launched a website for the task force, at www.financialliteracyinCanada.com.
(06/26/09)
Filed by Steven Lamb, steven.lamb@advisor.rogers.com
Originally published on Advisor.ca
The task force, announced by Finance Minister Jim Flaherty in Toronto on Friday, will be chaired by Sun Life CEO Donald Stewart. The task force was promised in the 2009 federal budget.
"Our economy is built on millions of everyday financial decisions by Canadians. Recent events have shown us that there are major risks and that financial literacy is an important life skill," Flaherty said. "Whether it is a question of saving for retirement, financing a new home or balancing the family chequebook, improving the financial literacy of Canadians will add to the stability of our financial system and make our economy stronger."
The first job of the task force will be to establish the current state of financial literacy, and identify best practices in other countries. The task force is scheduled to report back to the Ministry of Finance in late 2010.
"I was delighted when the Government of Canada invited me — and a group of eminent Canadians — to consider and report on ways to support all generations to grow into knowledgeable managers of their personal savings, taxation, investments, debt and protection," Stewart said.
Also named to the task force was Advocis president and CEO, Greg Pollock, who said it was an honour to be appointed to such an important project.
"We've all talked about the importance of literacy and numeracy to surviving in society, but its just as important that we have a basic understanding of financial issues," he told Advisor.ca. "Our association is of the view that if Canadians have more knowledge, they'll be able to make informed decisions."
He says the topic has become popular on a global scale, in recent years, after a 2005 report by the Organization for Economic Co-operation and Development called for improved financial literacy among its members.
Increased financial complexity has made this education more important than in the past.
"I think a lot of us were conservative in days gone by. We had paper money, and if we had the money in hand, we were able to purchase something; if we didn't, then we didn't purchase it," Pollock says.
At the end of the project, he hopes that improved financial literacy will make life easier for advisors, as clients will already be educated on the basics of the a financial plan.
"Advisors do take a lot of time sitting down with clients and educating them as best they can," he says. "I think the consumer with more knowledge will ask better questions and more questions, which in the end can only serve the consumer well."
The only practicing financial advisor on the task force is Ted Gordon, with Freedom 55 Financial in Ottawa.
"I really feel like I can make a meaningful contribution to the task force," Gordon told Advisor.ca. Not only is he a financial advisor, but he is also an accountant and teaches the Personal Financial Literacy course at Algonquin College in Ottawa.
"Overall, I'd say financial literacy is quite poor, because we receive no training," he says, pointing out that most people learn what little they do know from their parents, who were equally ill-equipped.
Financial literacy is more important than ever, he says, because the retail sector has become very sophisticated in its marketing strategies. Teaching consumers how to manage their money would help to level the playing field between those selling goods and services and the consumer they target.
The task force's first meeting will take place July 20, at Sun Life's head office in Toronto. This first meeting will focus on designing the process for consultations, which Gordon says will likely best be achieved with a cross-country tour.
Also serving on the task force are:
• L. Jacques Ménard, who will serve as vice-chair. Ménard is the chairman of BMO Nesbitt Burns and president of BMO Financial Group, Quebec.
• Edward (Ted) Gordon, financial security advisor with Freedom 55 Financial in Ottawa
• Evelyn Jacks, founder and president of The Knowledge Bureau
• Laurie Campbell, executive director of Credit Canada/the Credit Counselling Service of Toronto.
• Marcel Côté, founding partner of SECOR Consulting, as well as sitting on the board of directors for Intact Insurance.
• Patrick C. Foran, CTV News journalist and host of that network's nightly "Consumer Alert," segment
• Ruth Kelly, president and CEO of Venture Publishing Inc.
• Janice MacKinnon, professor of Fiscal Policy at the University of Saskatchewan, a fellow of the Royal Society of Canada, chair of the Research Institute on Public Policy, and member of the Board of the Canada West Foundation.
• P. Mitchell Murphy, career education consultant with the Western School Board in Prince Edward Island.
• Bill Schwartz, principal of Polestar Communications Inc.
• Jean Vincent, president and general manager of the Native Commercial Credit Corporation (NACCC).
The Canadian Life and Health Insurance Association was quick to cheer to creation of the task force, as well as such prominent positions for the insurance industry.
"As one of Canada's most respected and experienced leaders in our financial services sector, we are delighted that Donald Stewart has been chosen to chair this important task force," said CLHIA president Frank Swedlove.
The government has already launched a website for the task force, at www.financialliteracyinCanada.com.
(06/26/09)
Filed by Steven Lamb, steven.lamb@advisor.rogers.com
Originally published on Advisor.ca
6/13/2009
FINANCIAL LITERACY
It is remarkable that of all the basic life skill related subjects that we include in our children's early curriculum financial literacy is not one of them.......given that we live in a money economy. It is said that we each have a "Money Personality". Nothing could be more accurate and more life defining.
To successfully execute a plan for retirement an individual cannot succeed without a fundamental understanding of the time value of money. It is too late to become aware of the subject at age 45. By that age an individual will have foregone 85% of the potential capital accumulation possible had they begun their savings program at age 25. Tragically, they will be required to save at 6 times the rate they would have had to had they begun 20 years earlier. No variation of tax planning solves this problem.
The question is: "Why is this fundamental subject ignored by governments, educational institutions, financial institutions and the public at large?" The impact on our lives is profound.
The current global financial meltdown has had a seismic impact on our society in large part because of this dramatic shortfall in our personal development of financial literacy.
We are committed to its promotion through the best and the brightest professional financial retirement practitioners in Canada.
To successfully execute a plan for retirement an individual cannot succeed without a fundamental understanding of the time value of money. It is too late to become aware of the subject at age 45. By that age an individual will have foregone 85% of the potential capital accumulation possible had they begun their savings program at age 25. Tragically, they will be required to save at 6 times the rate they would have had to had they begun 20 years earlier. No variation of tax planning solves this problem.
The question is: "Why is this fundamental subject ignored by governments, educational institutions, financial institutions and the public at large?" The impact on our lives is profound.
The current global financial meltdown has had a seismic impact on our society in large part because of this dramatic shortfall in our personal development of financial literacy.
We are committed to its promotion through the best and the brightest professional financial retirement practitioners in Canada.
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