Technology is changing the very nature of investment banking, according to a report from data analysis firm CB Insights.
Goldman Sachs is among the long-established players investing in new digital products as core differentiators, as rivals pull out of some markets entirely – markets made less profitable by regulatory changes that have sought to curb high-risk investment activities. For example, UBS offloaded its fixed-income trading division in 2012, with Credit Suisse scaling back its interest rates trading division soon after.
Meanwhile, JP Morgan has embraced blockchain as a means of attracting new or more profitable business. The bank recently announced plans to use its own digital token, the JPM coin, to settle payments between clients.
Last year, it was one of 75 major banks to join the Interbank Information Network (IIN), an experimental programme designed to establish if blockchain could be used to speed up and authenticate payments that have been held up by compliance checks, errors, or missing data.
Also in 2018, Spanish bank BBVA partnered with France’s BNP Paribas and Japan’s MUFG to arrange a syndicated loan via the Ethereum and open-source Hyperledger blockchains.
Among tech providers, Hyperledger supporter IBM has moved into blockchain-based banking services too, with its Blockchain World Wire tokenising cross-border transactions in different currencies and recording the results in a distributed ledger on the Stellar blockchain.
Now with virtually every core function of traditional investment banking “under siege”, according to CB Insights, prestige in the finance world continues to flow away from traditional investment banks and towards tech-enabled service firms like BlackRock, Jane Street, and Citadel.
For long-established players, therefore, technology is seen as a means to stay competitive by launching new products or stripping costs out of transactions as margins are squeezed by the regulators.
According to the report, Killing the I-Bank: The Disruption of Investment Banking, nowhere has the combination of post-crisis regulation and digital disruption had more of an impact than in investment banks’ sales and trading departments.
Just before the financial crash in 2009, JP Morgan, Citigroup, Bank of America, Goldman Sachs, and Morgan Stanley together made almost $100 billion from trading alone. But now, banks can only make money in trading by charging their clients a commission on each trade. As a result, the combined trading revenues of those five banks had fallen by almost one-third by 2017.
This sea change began with the Volcker Rule, which was passed as part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. This banned investment banks from making bets with their own capital – a measure introduced to reduce the risk of a bank being fatally wounded by a high-risk investment.
At the same time, regulators ordered all banks to hold more capital. The knock-on effect of these changes has been that, at Goldman Sachs, for example, trading has gone from providing 65 percent of total revenues to just 37 percent.
While the majors have been looking for ways to trade more competitively, the likes of Jane Street and Citadel have stepped into the breach, says the report, bringing new technologies to help themselves and their clients generate bigger profits faster.
The result has been that the centre of gravity has shifted away from the biggest i-banks to quantitatively-driven funds and other firms, where “traders can take more risks, enjoy a less encumbered regulatory environment, and generate higher returns”, says the report.
The implication is that – as ever with Wall Street in recent years – the thrill of high-stakes gambling still attracts traders and financiers more than the safety and predictability of compound interest. As a result, the industry is still locked in a boom and bust cycle.
In this sense, potential flashpoints and risk centres simply move to new areas, and are not stripped out by the commoditising effects of new technology. Indeed, in some cases, new technology enables them.
The big investment banks have responded in kind to the competitive threats within the sector, by automating parts of their trading functions to keep profits as high as possible. In the UK, for example, Goldman Sachs rolled out its automated platform, Marquee, in 2018.
Today, big investment banks operate more like utilities, says the report, with the majors generating most of their trading revenues from helping clients complete their own trades.
The effect of all this is that 2018 was one of the best trading years for investment banks since the financial crisis, says CB Insights, but the industry’s performance overall is still far off pre-recession levels.
Given that the industry is still freighted with risk by the high-risk behaviour of some traders, that may be a good thing for the rest of the world.