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2012
Capital Markets
February 2012
V70:09CM
Report Coverage
Unfortunately, prospects for 2012 do not look any better. The biggest business driver
impacting brokerage firms and investment managers is uncertainty in the Euro Zone and the
risk of the euro collapsing. Besides the obvious global economic slowdown this would
cause, it would decimate the sovereign bond market and have serious spill-over effects in
the corporate bond market. Since 2008, major equity indices have not fully recovered and
Wall Street firms have been depending upon the fixed-income market for revenue growth,
so a slowdown in the debt market would be catastrophic. Even outside the extreme scenario
of the euro collapsing, continued Euro Zone uncertainty will put a damper on growth in IT
budgets, especially on the sell-side. TowerGroup expects global capital markets IT spending
to increase a modest one to two percent in 2012. Continued Euro Zone uncertainty in 2012
will also mean that US firms will further reduce their business exposure to Europe, on the
heels of MF Globals collapse due to its over-exposure to European debt. What Jefferies did
in 2011 reduced its Euro Zone exposure by 75% in less than six months will be
replicated by more firms in 2012. Ironically, this means the tide toward globalization that
capital markets firms have been riding for the last six to eight years will reverse itself, at
least temporarily.
In 2012, capital markets firms will also strive for greater transparency and disclosure,
pressured by various stakeholders regulators, clients, boards of directors, shareholders,
and the press. Requiring firms to disclose more information, and more frequently, is a very
clear theme across different regulations (Dodd-Frank Act, MiFID II, and Basel III). New
regulatory requirements include more detailed investment performance disclosure by hedge
funds and private equity funds and detailed transaction data required of systemically
important firms. For example, Form PF is a new requirement levied on hedge funds by the
Dodd-Frank Act and is proving to be very onerous and expensive for funds to complete.
Besides pressure from regulators, clients and shareholders are demanding greater insight
into the business workings of financial institutions, asking questions they never asked
The drive toward greater transparency and disclosure will have major consequences for IT
projects and operational practices in 2012. New requirements for additional data, more
frequently and in specific formats (XBRL) will mean firms will need to open up legacy
systems, write interfaces to applications, and invest in reporting infrastructure. This may
even spawn more outsourcing of reporting with several asset servicers and software
vendors hoping to offer reporting as a service.
Regulatory compliance and optimization will be the next driver. Despite multiple regulatory
delays in 2011, all major regulations are still on the agenda and 2012 will see firms
preparing to meet preliminary deadlines related to the Dodd-Frank Act, FATCA, Basel III,
and Markets in Financial Instruments Directive II (MiFID II). We will see new securities
trading rules in the United States including obligations for high-frequency trading (HFT) firms
and the rules governing dark pool activity. Buy-side firms will prepare to comply with the
large trade reporting rule passed in Q4 2010. Europe will witness further progress in
rulemaking on MiFID II and a possible formal combination of MiFID II and European Market
Infrastructure Regulation (EMIR). So in 2012, capital markets firms will continue working on
IT projects that help meet new regulations, and juggling deadlines imposed by all the
different regulations. A related business driver in 2012 will be regulatory optimization, which
refers to firms finding the right balance between investing adequately to comply with new
regulations, and yet not overspending on it. Another dimension of regulatory optimization is
the balance that firms need to strike in committing resources to comply with US and
European regulation. For example, firms need to comply with over-the-counter (OTC)
derivatives regulation in the United States and Europe, which entails optimizing investments
and achieving economies of scale.
The next business driver in 2012 in capital markets will be reassessing the IT operating
model. This refers to the importance for institutions to correctly manage the IT and
operations function, and to achieve the right IT operating model that meets multiple
objectives cost effectiveness, reliability, business agility, security, and regulatory
preparedness. Because IT has become a critical element of the capital markets business,
these issues have become business executive decisions rather than purely CIO/CTO
issues. Correctly managing the IT operating model has wide ramifications for securities
firms, from implementing their business strategy, to achieving financial targets and staying
clear of regulatory blowups. Reassessing and amending the operating model will cause
firms to answer questions such as: what should our IT budget be, to what extent should we
use third-party vendors, what and how should we outsource IT and operations?
The final business driver in 2012 that we discuss in this top 10 note is the need for firms to
better manage their global aspirations and current foreign operations. Theres no question
that the desire to expand overseas experienced a hiccup in 2011 due to softness in
emerging markets and Euro Zone instability. However, in the long-term, the financial
industry is definitely becoming a more global, integrated business and financial institutions
Exhibit 1
Capital Markets Top 10 Trends of 2012
Source: TowerGroup
TowerGroup has organized the top 10 technology initiatives into three themes as outlined in
Exhibit 2. They are 1) continued focus on risk and regulation, 2) invest in infrastructure,
analytics and data, and 3) realign and revitalize IT and operations. Each of the top 10
technology projects aligns with a particular theme, while some map across different themes.
Source: TowerGroup
Exhibit #: 70:09-E2
Exhibit 2
Three Themes in the Capital Markets Industry for 2012
Source: TowerGroup
Typical IT projects in this area include amending order management systems to support new
best execution requirements, improvements to risk management applications, new smart-
order routing applications, and implementing sell-side measures to monitor buy-side
sponsored order flow. All types of vendors will play a role here including firms such as
Charles River Development and Advent Software, as well as SunGard and IPC.
From a technology and operations perspective, the need to monitor and act upon changes
in exposure as a result of changing market conditions has put renewed focus on the two
challenges of risk management. First is the need to collect ALL the data that is required with
the right level of quality and timeliness, and second is the analytical capacity to translate raw
data into actionable insights.
Collecting and organizing large amounts of data and acting upon event triggers is the bread
and butter business of many horizontal technology providers, which offer buyers an acronym
soup with everything from ETL, BI, CEP, to MDM and many more. In 2012, there will be a
backlash against the idea that all you need for better risk management are tools to collect,
group, and visualize raw data. Risk-specific analytics capability, as well as integration with
line-of-business applications for problem resolution is the new hot topic. This creates
opportunities for traditional risk application providers like Algorithmics (now part of the IBM
stable), Sophis (now part of Misys), SunGard, Razor, QuIC (now part of MarkIT) to extend
their footprint, but also for accounting and portfolio management solutions from firms like
Murex, Calypso, DST, SimCorp, and SunGard to increase their appeal to firms looking to
consolidate vendor relationships and maximize their use of existing investments. 2012 will
be the third year in a row when global capital markets firms increase their IT/operations
spending on risk management by double digits. TowerGroup estimates risk management
spending to rise by 11% in 2012 after a similar increase in 2010 and 2011.
At the level of financial instruments and asset-backed securities, European loan level data
will become more widely available with the introduction of the ECB ABS data warehouse this
summer. Disclosure and transparency are also at the heart of the increased reporting
requirements for hedge funds and other private funds (Form PF in Dodd Frank and Review
of the Markets in Financial Instruments Directive).
There is an ongoing lack of academic and practical consensus on how to price assets and
value portfolios for risk management, performance, or compliance reasons. When mark-to-
market and mark-to-model are still compromised or unusable, the only thing that can restore
trust is a return to first principles where all component parts of any type of risk need to be
explicitly reported. This is a challenge to the basic risk-reward principle that underlies trading
and supplier relationships in our industry and 2012 might be the year when many market
participants decide the costs of radical transparency outweigh risk-adjusted prices.
Forward-looking firms are looking to leverage existing capabilities, and past investments in
straight-through-processing (STP) technology for equity and vanilla fixed income processing
are obvious candidates. The post-reform derivatives landscape will have increased volume,
standardized contracts, new connectivity requirements, centralized matching, new identifiers
Capital markets firms are usually years ahead in the use of new technology than other
financial sectors. However, when it comes to big data, they are learning from retail banks
that already employ big data in areas such as campaign marketing, credit card
management, and retail payments. For example, Bank of America has been successful in
employing big data technology to manage huge quantities of data using the open source
framework Hadoop.
Big data will remain a huge opportunity for vendors in 2012 and attract interest from all types
of vendors, both large and small. All the large diversified IT vendors are active in the big
data space including IBM, Sybase/SAP, Microsoft, Oracle, and Teradata. Then there are
smaller vendors such as Acxiom, Vertex and Attivio. Vendors will approach big data either
from a data acquisition, data management, or data visualization of data analytics
perspective offering solutions in each of those areas.
The lens through which firms evaluate data projects has become more short-term. Time-to-
market, usability, and access management are the differentiators in a market that agrees
with the long-term benefits of firm-wide data improvement, but needs to become more agile
to maintain the support of business sponsors. This will benefit segment specialists and
technology innovators including Cadis, PolarLake and First Derivatives, as well as more
horizontal offerings from Informatica, IBM, and Information Builders.
The supply chain for market and reference data is also set for fundamental change the
reporting requirements embedded in Dodd-Frank and EMIR will create an as-good-as-free
channel of pricing data, which challenges the commercial model of incumbent data vendors
even further. Technology innovation in standardization is for once moving at the right pace
standards for legal entity and contract identifiers are in the works and minor updates to
Financial Products Markup Language (FpML) and Financial Information Exchange (FIX) will
allow market participants to use existing export-transfer-load (ETL) and messaging
infrastructure.
This is not just the usual drive toward more efficient and cost-effective back-office
infrastructure; the changed requirements for trading, clearing, and reporting are creating an
interconnected trade execution and processing environment. The mechanics of transaction
cost analysis (TCA) will need to take into account margin and collateral requirements, and
the costs of membership and processing fees across the entire investment lifecycle. This
In 2012, capital markets firms will look to consolidate vendor relationships further, driven by
a desire to simplify IT, better manage external vendor relationships, and reduce vendor risk.
For example, brokerage firms are looking to rationalize the three-to-five order management
systems they use and standardize on one or two vendors. Further, they are extending their
relationship with those order management vendors and using other products they have
including compliance, post-trade connectivity and portfolio management. In response in
2012, we expect vendors to further expand their product functionality both up and down the
trade lifecycle. So order management vendors will expand further into the front office
offering portfolio construction and even investment research management functionality, as
well as extending into the back office offering portfolio accounting and similar functionality.
This will dramatically affect vendor competitiveness with firms that have a broader,
integrated set of functionality (one-stop shops) gaining over firms that support only one type
of service (one-trick ponies).
Another trend will be institutions seeking greater flexibility and multiple service delivery
options from their vendors. That means asking an application vendor to make its product
available as an installed application, as an application service provision (ASP), on an
outsourced service bureau basis, and as fully outsourced solution. Our research indicates a
major uptick in the adoption of ASP-based service delivery, even in areas like order
management and portfolio accounting, which firms were hitherto loathe to access via an
ASP. This will lead into service provision via cloud-based solutions, which adds a new
dimension to accessing IT services in capital markets. Expect more progress on this front in
2012.
Finally, BPO will gain further ground after an uptick in BPO services in the last few years.
Vendors that long offered just software applications and required clients to implement and
process transactions using them, are now responding to client demand and building BPO
services around their application. Such firms include Broadridge, Advent Software, and
SunGard Data Systems. At the same time, a slew of outsourcing vendors (e.g., Cognizant,
Typical IT projects involved will be: extending central IT capability to regional offices,
integrating with local providers (e.g., asset managers interfacing with local sub-custodians),
amending order management systems to accommodate local compliance rules, and
extending processing systems to support new products (e.g., Sharia-compliant investments).
An important element of aligning a firms IT to its growth plans is putting the right IT
governance structure in place, which balances regional autonomy with the need to control
budgets, prevent duplication of effort, and ensure compliance with internal IT standards.
TowerGroup believes this is an area where securities firms must utilize the help of service
providers that have experience with managing global IT, implementing projects across
borders and have mastered the global delivery model. Some good examples include Indian
offshore outsourcing firms like Infosys, TCS and Wipro, that have extensive experience
managing IT teams across multiple countries, both for themselves and on behalf of clients.
Other examples are Accenture, Sapient, and CapGemini Consulting.
Cloud computing will be biggest innovation attracting attention in 2012. Firms will build upon
the progress made by the Frankfurt Cloud (sponsored by Deutsche Bank), Bank of America
Conclusion
2012 will be the year that firms cannot afford to sweat the small stuff. All market participants
will have to assume new responsibilities, costs, and liabilities, and will have to do so without
the rewards they might expect from taking on additional risk. Regulators and governments
want to see transparency and market reform realized. Clients want full disclosure, reliability,
and service innovation. Shareholders want to preserve growth through diversification,
specialization, and once again globalization. Operations, risk, and finance executives are
being asked to challenge long held orthodoxies about core competencies and optimal
operating models.
The financial services industry is still working through the fallout from the last crisis, even
while the Euro Zone struggles and other sovereign debt challenges are threatening to make
us think the unthinkable all over again. With margins, volumes, and GDP growth under
pressure, firms have no choice but to be smarter, more focused, and agile enough to
capitalize on the new opportunities this market environment brings. Across these top ten
business and IT priorities for 2012, TowerGroups ongoing dialogue with institutions and
providers shows a very solid catalog of innovation in technology and service provision. More
than ever, firms and providers are aligned around partnership in adverse conditions: making
the most of mutual investments not just in smart technology, but of relationships that were
forged over many years of solving big challenges one step at a time.