IBM Center for Applied Insights

Beating market mandates:How winners are re-engineering financial markets operations

In collaboration with Broadridge Financial Solutions

About the studyTo understand how operations within financial markets firms are changing, IBM in collaboration with Broadridge Financial Solutions surveyed 133 operations strategy decision makers.1 More than 80 percent of the respondents are senior business executives (38 percent – C-level, 44 percent – Senior Vice-Presidents, Vice Presidents and Directors); 2 percent are Business Department Managers; and the remaining 16 percent are IT decision makers.

Survey participants hold positions in companies of various sizes, both global and regionally focused. Thirty-seven percent work in universal banks, 29 percent in broker-dealers and 35 percent in other types of non-bank asset management firms. Spanning a sample of trading locations around the world, 47 percent are from the United States, 27 percent from the United Kingdom and 26 percent from either Singapore or Hong Kong.

About Broadridge Broadridge Financial Solutions is a leading provider of technology-driven solutions and investor communications to banks, broker-dealers, mutual funds and corporations globally. For more information about Broadridge, please visit www.broadridge.com.

Financial markets firms are facing a much higher bar as clients become more technically savvy and accustomed to anytime, anywhere access. Clients expect customized products and services, faster execution, transaction status visibility and unfettered access to information so they can develop their own insights. Unfortunately, many firms can’t respond. They’re stymied by rigid processes and systems, overwhelmed by regulatory change and have largely tapped out cost-reduction strategies, such as labor arbitrage and optimized processes.

Yet, forward-thinking firms are able to excel amid today’s new realities. How? These Leaders are building a different kind of operating model – one designed to embrace rapid, continuous change. And as they look for better ways to do things, all options are on the table, including partnering in a variety of forms.

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What Leaders do

• Thinkmarketplacefirst,“factory”efficienciessecond

• Designoperationsaroundclientinteractions,notviceversa

• Cultivateagility –andanabilitytoseewhatothersdon’t

• Buildandusescale,butnotalwaysinexpectedways

• Partnertoextendtheircapabilities–andtheirthinking

Through the wringer of change With decades of relatively comfortable growth fading from memory, financial markets firms face softening revenues. The battle to retain customers and grow share is intense. Industry analysts estimate that 15-20 percent of wholesale and investment banking market share will be reshuffled in the next few years.2

Clients are demanding information in real time, unbiased advice, better reporting as well as customized products and services. Also, as clients have grown more technically savvy, they want access to information when, where and how they want it. Their rising expectations are shaped not just by innovative financial markets competitors but also by experiences in entirely different industries.

Locked into legacy systems and processes, many firms are struggling to respond. One executive described his firm’s shortcomings rather bluntly, “We’re a batch processor. Clients are expecting real time.”

“The better/more efficient our operations are, the more customized products can be offered; this will allow us to differentiate.”

– COO, Investment Manager, United States

While they’re grappling with client demands, firms are facing a steep surge in regulation – Dodd-Frank, Basel III, Large Trader Reporting, Foreign Account Tax Compliance Act, Cost Basis Reporting and European Market Infrastructure Regulation (EMIR), just to name a few. Many legislative details are still unfolding, creating substantial uncertainty and angst. As one executive put it, “The securities industry is now undergoing a total revamp. Between Dodd-Frank and the Volcker Rule, there’s more work than anybody can do in the next 20 years.”

But it’s not just the expense of altering processes and systems. New rules are also limiting revenue and reducing the profitability of certain businesses. This is forcing some firms to radically change approaches – or withdraw entirely from these businesses.

The one-two punch of overwhelming regulatory change and rapidly rising customer expectations is putting tremendous pressure on the operating models of financial markets firms (see Figure 1). Making matters worse, these two drivers often compete for the same resources. Between the cost to run the business and the expense of complying with mandates, firms have little left to invest in change-the-business initiatives that could create competitive advantage.

4 How financial markets leaders tune their operations for competitive advantage

Even though regulation and customer demands are the dominant drivers of operational change, they’re certainly not the only concerns. Firms are also wrestling with a host of industry efficiency initiatives, sluggish mature-market economies, ongoing globalization and the constant pressure to manage risk in a low-margin environment.

So, how can firms – in the midst of so much change – keep clients happy and win a bigger share of a very volatile revenue pool? Moreover, what role does operations play in this strategic dilemma?

“A lot of resources are tied up in dealing with regulatory changes. Other areas–new products, building scalability or efficiency, building new functionality or services – have to take a backseat.”

– COO, Universal Bank, Singapore

Lessons from the Leaders: Efficient is not good enoughTo learn how effectively firms’ operations are addressing these simultaneous demands, we looked at our survey respondents in terms of two dimensions: regulatory support and innovation speed. This led us to identify three groups:

• Leaders– These firms excel at meeting both regulatory and marketplace requirements, typically introducing new products and services in three months or less. Just over 20 percent of the surveyed firms fall in this group.

• Followers– Totaling just over half of the sample, these firms tend to major on mastering one priority or the other, compliance or innovation.

• Laggards– Nearly one-quarter of the surveyed firms lag their peers in both regards. They grapple with adapting their operations to new regulations, and it takes longer for them to support new products and services.

We then compared these groups to see how they’re responding to the threats facing their industry. We examined their business priorities, their actions in evolving their operating models and the resulting business outcomes.

External market drivers triggering changes

in operating models

Regulatory requirements 77%

Demanding customers 59%

Slow market growth in mature economies 39%

Expansion to global emerging markets 35%

Industry consolidation 35%

Low interest rates 30%

Expansion to global mature markets 29%

Figure 1. Regulatory requirements and customer demands are forcing significant changes in firms’ operating models.

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The clearest distinction between Leaders and Laggards is reflected in their business priorities (see Figure 2). Leaders are focused on competitive differentiation and addressing new market needs. Laggards still think in terms of tuning the back office, focusing on high efficiency at low cost.

For Leaders, the “operating model” extends well beyond the back office. And improving operations doesn’t just happen inside the processing “factory.” It’s about redesigning the operating model with a more holistic view – across front, middle and back offices and into the clients’ operations.

“We must make sure changes enhance the whole process. It’s no good having a Rolls- Royce in the front and a Mini in the back.”

– COO, Universal Bank, United Kingdom

External factors Internal factors

2012 business priorities to address critical market challenges

Respond to regulatory changes

Differentiate from competitors

Improve agility in the market place

Expand geographically

Improve flexibility of internal operations

Reduce post-trade operating costs

63%67%

54% 54%

42%

25%

38%

20%25%

32%

20%21%

29%

43%

50%

17%22%

38%

Leaders Followers Laggards

Everyone has to respond to regulation

To excel in today’s rapidly evolving business landscape, Leaders are adopting a different type of operating model – one that is more client-focused, agile, scalable and collaborative (see Figure 3).

Client-focusedAmong Leaders, differentiated customer service is a key design principle for their operations. Often, this puts a premium on technology – not just back-office systems, but front-office and client-facing solutions as well. As one executive shared, “Innovative back offices are on the cutting edge, with all the different IT upgrades like front-end compliance and iPad apps.” And clients expect the same high-quality experience regardless of channel or line of business. For firms, this requires tight integration across silos.

Not surprisingly, given their intense focus on clients, Leaders report significantly higher levels of customer satisfaction with their operating models – with the consequent benefits of differentiation and improved revenue prospects.

Figure 2. Leaders are more attuned to external, market-oriented priorities, while Laggards focus on internal challenges like reducing costs.

6 How financial markets leaders tune their operations for competitive advantage

“From an operational perspective, we’re bringing platforms together and building a system that can move as quickly as our clients want to move.”

– Operations Vice-President, Broker-Dealer, United Kingdom

Innovation speed is another key customer expectation. “The faster and more innovatively operations can support a new product – valuing it and getting it into client statements – the quicker we get to market,” one executive advised. Leaders know how to quickly source expertise that enables this speed to the market; compared to peers, they’re more inclined to obtain capabilities externally.

This unrelenting pressure to innovate is prompting firms to constantly scan the market for new thinking – and even look outside the industry or tap external partners. Outsiders can often see opportunities insiders miss because of long-held industry conventions, assumptions and norms.

AgileCompared to Laggards, Leaders are far more focused on stripping complexity out of their operations, creating “agility by design.” This is one reason they can address significant regulatory change – like EMIR and Dodd-Frank –more nimbly and launch new products and services faster than their peers.

Leaders’ more agile operating models are likely to prove even more advantageous as the industry works to shrink the settlement window. The industry’s move toward “trade date plus one (T+1)” emphasizes the need to further simplify and reduce risk in clearing and settlement processes.

Profile characteristics – maturity in delivering outcomes from operating models

Achieve high customer satisfaction

Differentiate customer experience

Improve access to analytics

Reduce complexity

Provide scalability

Innovate through globalization

Outsource extensively

Share operational risk

Laggards Followers Leaders

16%

63%

21%

29%

21%

33%

13%

21%

45%

73%

37%

43%

20%

57%

30%

31%

46%

92%

51%

67%

54%

67%

33%

46%

Client-focused

Agile

Scalable

Collaborative

Traits Outcomes

1.5x

2.9x

2.3x

2.4x

2.0x

2.6x

2.2x

2.5x

Leaders to Laggards

Figure 3. When compared to their peers, Leaders’ operating models are more client-focused, agile, scalable and collaborative.

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“Outsourcing has helped us to scale our operating environment, to expand the business as much as we’re able to sell.”

– CFO, Universal Bank, United States

However, how firms build scale varies. Large firms may decide to develop capabilities internally, but other firms often use sourcing options to quickly gain similar scale advantages.

Another way Leaders are using scale to their advantage is through globalization. Spreading operations capabilities across various geographies can improve availability and responsiveness to clients – and help accelerate processing. For example, according to one executive, “If I can get my reconciliation done by people in India in their morning, so that when the people in U.S. operations arrive, they have all the reconciliation performed, that’s definitely an advantage.”

Alternatively, global operations also provide Leaders with opportunities to centralize processes in specific regions. In addition to cost savings, the act of consolidating processes offers a chance to improve them. As one executive explained, “When you bring together global operations in one area, you give employees an opportunity to look at it end to end. That creates the platform to then ask, could we innovate it?”

Whether they centralize or not, firms are finding they must design globally and act locally. Having similar functions that operate differently in every part of the world is no longer affordable.

Another key contributor to leaders’ agility is better insights. More than two-thirds of Leaders indicate their operating models provide improved access to analytics, more than double the percentage of Laggards who report such benefits.

For financial markets firms, sophisticated analytics and the ability to gain insights and make decisions more quickly is especially critical in the area of risk. Operating model improvements need to address more than just operational risk and compliance – they also need to support risk requirements on the trading side. As one executive described, “The Asian market looks for innovative products with very high risk and very high volatility. If you have to offer these products quickly and effectively, and manage them internally from a risk point of view, your risk management infrastructure becomes extremely important.”

Interestingly, across the entire sample, operations executives ranked risk management infrastructure as their most differentiating securities processing attribute, even above trading and order management. With the end of the global financial crisis not even in sight, it’s not surprising that nearly half admitted their risk management infrastructure is only moderately effective at best. Even Leaders are challenged in this area.

ScalableThe investment cycle and prioritization within firms has frequently led to investment in front-office requirements at the expense of funding longer-term transformational change in the back office. Consequently, firms often face significant scalability constraints imposed by legacy systems and processes. This is particularly problematic in today’s business environ- ment where fixed costs continue to rise and scale is key to lowering costs per transaction.

In fact, some industry analysts have asserted that operational scale is becoming more important than financial leverage and trading expertise.3 Our study findings certainly corroborate this view. Among our respondents, Leaders are more than twice as likely as Laggards to be adapting their operating models to provide greater scalability.

8 How financial markets leaders tune their operations for competitive advantage

Level of outsourcing by platform

Settlement and clearance

Back-office accounting and valuation

Reporting and statements

Trading and order management

Risk management infrastructure

Laggards Followers Leaders

17%

29%

30%

15%

21%

27%

38%

35%

30%

17%

55%

60%

35%

53%

23%

Process area

2.0x

3.2x

3.5x

1.2x

1.1x

Leaders to Laggards

CollaborativeCompared to their peers, Leaders are far more inclined to build collaborative operating models that leverage partners’ expertise, technology, scale and continuing investments. They recognize that an internal solution is not the only way to create greater agility and best-of-breed operational capabilities. These collaborative sourcing approaches can take many forms – from traditional outsourcing to cloud solutions to mutualized processes shared across the entire industry.

The rationale is not just about cutting costs – it’s about increasing competitiveness. External sourcing can free up capital and management attention from areas where firms lack competitive advantage, allowing firms to refocus resources on differentiating areas.

Sourcing can also provide direct benefits in terms of market competitiveness. As one executive said, “By finding the right partner, we can gain speed to market and best-in-class offerings for our customers.” Other respondents described how service providers helped them stay in sync with rapidly changing market demands. As the pace of both customer demands and regulatory changes continues to accelerate, firms’ current capabilities may not be sustainable at the same level over time, making partnering an increasingly attractive alternative.

“If we outsource, we get expert advice, and it’s faster for us to launch a new product or process.”

– Head of IT, Universal Bank, Singapore

Leaders also report significant benefits from sharing operational risk with service providers. Given their scale, degree of specialization and broad base of client experience, providers may be better positioned to manage operational risk. And the extra scrutiny by a third party provides additional safeguards. However, firms were quick to point out they’re not “transferring” risk. They are still ultimately accountable –and must maintain controls and governance processes for managing their providers. And as the propensity to partner rises, firms may also need to develop skills to integrate and manage third-party providers effectively.

Across segments, we saw clear differences in where firms are most likely to engage partners. Compared to Laggards, Leaders are substantially further along in outsourcing settlements and clearance, back-office accounting and valuation, and reporting and statements (see Figure 4).

Figure 4. Leaders are more than twice as active as Laggards in outsourcing highly standardized back-office processes.

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Who will inspire and lead operating model change?

Intermsofinstigatingandinfluencingoperatingmodelchange,COOsrankedasthechiefdrivers(84percent),onparwithCEOs(83percent).Respondentsalsotoldus,giventhenatureandmagnitudeofchangeunderwayintheiroperations,theCOO’sroleandresponsibilitiesareshifting.Asoneexecutiveshared,“Therolehaschangedinthelastcoupleofyearsfromfocusingontheday-to-daystufftohigh-levelbusinessstrategy.It’sabouttakingastepbackandlookingatthewaywedothingsfromalargerperspective.”Amongthosesurveyed:

• Morethan60percentindicatetheirCOOsaredrivingstrategicbusinesschange.

• Nearly60percentsaidtheirCOOsaredrivingorganizationalagilityanddeliveringbenefitsbeyondcostsavings.

• MorethanhalfsaidtheirCOOsaredrivingproductandserviceinnovation.

FirmsclearlyrecognizethattheoperationalchangesrequiredtodrivegreatercompetitivenesstranscendtheusualspanofcontrolandmindsetofITandoperationsmanagers.It’snolongersufficienttosimplyloweroperat-ingexpenseswithinindividuallinesofbusiness–amoreholisticapproachisrequired,whichmeanstheCOOwillbeshoulderingmoreofthesetransformationaldecisions.ItalsomeansCOOswillshiftfrommanagingprimarilyinternalresourcestomanagingabroadecosystemofpartnersandproviders–andtakeonbroaderriskmanagementresponsibilities.

Arguably, these processes are easier to outsource. As one executive suggested, “Clearing and settlement is the best place to start, because everybody does the same thing.” Conversely, firms tend to keep in house those functions – like risk management and trading and order management – that are closer to the front office. According to another executive, “There are certain functions that are unlikely to be given to anybody else, like trading and execution, aspects of port- folio management and major parts of a firm’s risk manage- ment capabilities.”

Although Leaders may have started with routine processes, they’re often sourcing for market-driven reasons – to gain speed, scale and access to industry-leading practices and ongoing innovation, with lower levels of investment. Success in these areas will likely encourage leaders to forge ahead into sourcing more complex functions such as reconciliations, data management, tax reporting and corporate actions.

An urgent mandate for operational changeWhat if industry analysts are right and 20 percent of clients are shopping for a new provider? Will you be on the gaining or losing end?

It’s possible to be responsive to a rapidly changing marketplace –if you have the right kind of operating model. Regardless of how far a firm has progressed, the distinguishing traits of Leaders’ operating models provide an effective framework for assessing where further improvements are crucial.

10 How financial markets leaders tune their operations for competitive advantage

Client-focused: Design for differentiationIn the financial markets industry, the threat of commoditization is real. Efficiency can only take a firm so far – ultimately, firms must find ways to differentiate and grow share.

• How does your client service compare with your peers? What sets your firm apart?

• Would clients say their service relationship with your firm revolves around them or around your organiza- tional structure?

• Is your client service continually improving by design?

Agile: Move at market speedThat means getting faster and smarter. Given the degree of industry, regulatory and client-driven change underway, firms need to address operational roadblocks. At the same time, they need to better leverage data and analytics to uncover opportunities for differentiation.

• How quickly can your operational support move from an initial product concept to launch?

• How rapidly – and cost effectively – can you respond to new regulatory requirements and client requests?

• Where could additional insights help improve operational processes and decision making?

Scalable: Go for flowFacing volatile – if not flat – revenues, and rising fixed costs, many firms have no choice but to compensate with greater flow. But this strategy is only viable for those that can easily scale their operations.

• Even in areas where performance is currently satisfactory, are your current capabilities sustainable over time?

• When volumes decline, are you left with high stranded costs?• Which processes are most conducive to centralization? Are

you actively looking for opportunities to innovate through globalization?

Collaborative: Say good-bye to “not invented here”The securities industry is quickly approaching the point where it can no longer afford fixed costs, duplicated firm after firm, on processes that offer no real competitive advantage. Keeping everything in-house – in attempts to preserve the greatest degree of flexibility – is becoming unsustainable. The Legal Entity Identification (LEI) standard, Trade Data Warehouses and TARGET2-Securities (T2S) are demonstrating how mandate-driven change is being realized through multi-client collaboration.

• Should you be championing industry-wide shared services that reduce routine operational costs for all participants?

• How should such collaboration be realized? Would you look to trusted partners, regulators or market infrastructure providers to provide the necessary solutions?

• What criteria are you using when making sourcing decisions? Are you focused primarily on cost reduction or increased market competitiveness?

“If you get stuck in old-fashioned ways, it’s dry up, don’t make money, and then go out of business. The only way we keep up is by reinventing ourselves.”

– COO, Universal Bank, United Kingdom

As firms struggle to grow their top lines, they’re grappling with client demands for speed, innovation and interaction on their terms. The constant stream of industry-mandated efficiency endeavors is forcing firms to rapidly adapt their operations. Complicating matters further, the industry is embroiled in what’s been called the most significant period of regulatory change in four decades.

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Though arguably more intense at the moment, these are perennial challenges. There will always be new client demands, regulatory change and efforts to improve efficiency. The difference is Leaders are inherently equipped to adapt and thrive in these volatile environments.

To move up the evolutionary ladder, firms will need to re-evaluate their operating models, deconstructing what they do, to understand where they can create client value, differentiation and agility. For non-differentiating functions, they’ll want to build leverage by considering alternative ways to source those capabilities – through external providers, mutualized processing or other collaborative models. And they’ll need to build a roadmap to achieve identified changes, determine the associated costs and expected benefits, and put in place the leadership, governance and partnerships necessary to accomplish it.

For most firms, the mandate to rethink their operations, from end to end, has never been stronger. Fortunately, firms also have more transformational levers at their disposal than in the past – with new technologies and a growing range of partnering options. The pivot point that will continue to separate winners from losers is who can best harness these capabilities and make their operations more client-focused, agile, scalable and collaborative.

The IBM Center for Applied Insights (ibm.com/smarter/cai/value) introduces new ways of thinking, working and leading. Through evidence-based research, the Center arms leaders

with pragmatic guidance and the case for change.

About the IBM Center for

Applied Insights

About the authorsKeith Bear, Director, Financial Markets, IBM keith_bear@uk.ibm.com

Tom Carey, President, Securities Processing International, Broadridge tom.carey@broadridge.com

J. Michael Hopkins, President, Fixed Income and Risk Management, Broadridge jmichael.hopkins@broadridge.com

Ron Lefferts, Partner and Industry Leader, Financial Markets Global Business Services, IBM rleffer@us.ibm.com

Charlie Marchesani, President, Securities Processing U.S., Broadridge charlie.marchesani@broadridge.com

John Reiners, Principal Consultant, IBM Center for Applied Insights john.reiners@uk.ibm.com

ContributorsIBMEmily Baugher, Jim Brill, Angie Casey, Subrata Chatterjee, Stephen B. Rogers, Vijay Saxena, Jane Seaton, Robert Stanich

BroadridgeMichael Alexander, Michael Dignam, Anthony Iannuzzi, Pete Vill

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FME03006-USEN-00

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Notes and references1 This survey was conducted in double-blind fashion: the identities of the survey sponsors, IBM and Broadridge, were not revealed to the respondents, and the identities of the respondents were not shared with IBM and Broadridge. The quantitative research was also complemented by in-depth interviews with 14 percent of the respondents.

2 “Wholesale & Investment Banking Outlook: Decision Time for Wholesale Banks.” Morgan Stanley and Oliver Wyman. March 23, 2012.

3 Ibid.