18 Celebration of Excellence: Sponsor’s Foreword
An industrial revolution: new
capital markets paradigm
B
ankers have the unfortunate habit of
thinking of themselves as the best and the
brightest — products of unemotional
meritocracy — creative, entrepreneurial, cal-
culated risk-takers. After all, wasn’t Sherman
McCoy (Tom Wolfe’s apocryphal bond sales-
man) a certified master of the universe?
Although his world came crashing down
around him for reasons not directly related to
his job performance, his real world peers are
nonetheless fortunate that their jobs require
something far short of perfection in execution.
In a recent speech, Jack Welch, the former
chairman of General Electric, made exactly this
point: “...[if] you put six sigma in an invest-
ment bank, they would all gag!” In case you
think he was just engaging in some gratuitous
banker bashing, consider this: six sigma quality
means having fewer than 3.4 defects or errors
per million operations in a service process.
That is 99.99966% perfection.
Contrast this benchmark with the assurance
once made to me — by a senior syndicate man-
ager of one of the largest and most respected
global bond underwriters — that it was perfect-
ly normal and necessary to expect and reserve
for 5%-10% errors in the allocation of a jumbo
multi-tranche bond deal! Assuming an average
of 200 individual orders (including splits) on a
typical new issue, to reach six sigma quality lev-
els you would need to have fewer than four
errors over 5000 issues!
Some banks are lucky if they have less
than four errors per deal. Even if you change
the assumptions, it is obvious that our
industry is embarrassingly tolerant of poor
process execution.
So why do customers and clients accept
this level of service? Firstly, the direct costs
are largely borne by the banks themselves,
and secondly, it is very difficult for a cus-
tomer to objectively and quantitatively mea-
sure the quality of service. (Compare the
problem of an investor or issuer in identify-
ing variation from best/perfect execution on
a new capital markets issue to that of a com-
puter manufacturer, for instance, who is sup-
plied with a shipment of 100,000 micro-
processors of which x are defective.)
Assuming that the banks cannot and do not
indirectly pass on these costs, why have they
not made more significant progress in
addressing this problem?
A plea for perfectionism
My guess? In one word, hubris — fixing
this is all about the details. It requires
painstaking attention to process, to the
banal minutia of the obvious and an
unswerving dedication to perfection —
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qualities more often found in engineers
than masters of the universe. Fixing these
shortcomings is just not seen as exciting or
important to teams of bankers feverishly
searching for the next million dollar trade
or idea. However, intuition tells us that
even if the costs are difficult to measure and
are absorbed by the banks, they are no less
real for this, and ultimately result in one or
all of the following: higher capital costs for
issuers, lower investment returns for inves-
tors, and lower operating profits for banks.
And therein lies the next major opportu-
nity for capital markets bankers over the
next decade: to use technology not only as
an enabler of innovation (as has been the
case over the past 15 years) but as a driver
of industrial efficiencies.
Mapping out a paradigm shift
So what exactly does an industrial revolution
in investment banking (or more accurately
defined, capital markets) mean? Why is this
relevant now? What are the advantages for
issuers, investors and banks? What are the
costs? Who will be the winners (and losers)?
Is technology and/or the internet an enabler
of the revolution? And if so why?
Our industry is
embarrassingly tolerant
of poor process
execution
The industrial revolution in investment
banking is all about creating a new paradigm
for the execution of capital markets business.
It is about reinventing the organisational
mindset, replacing the traditional front, mid-
dle and back office with a highly flexible and
efficient product factory attached to a profes-
sional cadre of relationship managers and
solution providers who work with customers
and clients to tailor products and solutions to
be produced and executed by the factory. It is
about viewing the services we provide as two
distinct value propositions, one resting on
the creativity and knowledge base of the bank
and its bankers, and the other resting on the
efficiency and accuracy of production and
execution.
Two factors are driving the inevitability of
the paradigm shift: market size and cost-
effective technological solutions. The
incredible growth and globalisation enjoyed
by capital markets over the last 15 years has
given us a market where economies of scale
April 2002
Sean Park, global head of debt syndicate,
Dresdner Kleinwort Wasserstein
start to become extremely compelling:
rather than dealing with tens of issues, hun-
dreds of tickets, and tens or hundreds of
millions of trading and underwriting, the
typical medium to large sized investment
bank now deals with numbers that are a fac-
tor of ten or more higher than these. The
upfront and fixed costs of building the
(highly scaleable) factory are now justified
by the volumes of throughput.
Hand in hand with this growth in vol-
umes, the market has seen increasing stan-
dardisation including, but not restricted to
the introduction of the euro, debt issuance
programmes, benchmarking and so on and
so forth. As a result, for even the most
bespoke products and client solutions,
upwards of 80% (often more than 95%) of
the process can be stripped away and com-
pletely engineered to very high tolerances.
At the same time as the scale and homo-
geneity of the market opportunity have
increased, the (technological) inputs need-
ed to build the factory have become more
and more useful, flexible and inexpensive,
reducing not only the costs of building the
factory in the first place, but vastly improv-
ing time to initial delivery and limiting
future maintenance and capex require-
ments. The coming together of software,
novel programming techniques, processing
power and communications infrastructure
witnessed by the birth of the internet (or
any other private network for that matter)
is and will continue to be the technological
catalyst for an industrial revolution in capi-
tal markets.
One of the reasons why banks have been
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April 2002
slow to embrace (wholesale) process re-
engineering in their capital markets activi-
ties is that the incremental improvements
(in costs, revenues, business velocity, capac-
ity utilisation, etc) are in many cases rela-
tively small — sometimes invisible — when
considered in isolation. Fixing one part of
the process chain in isolation may save you
half a cent in the dollar. Fixing the whole
process chain, however, allows you to cut
real costs and raise productivity, by reduc-
ing headcount or reallocating human
resource to higher value added customer
facing activities. The key to success lies ulti-
mately in taking a holistic approach, with
real benefits accruing geometrically as the
weak links in the value chain are eliminated.
Consider as an example the new issue
process. I take this as an example as it is
probably one of the most obvious, most
straightforward and best understood of the
hundreds of processes executed in any
investment bank: pitch, mandate, docu-
mentation, marketing, bookbuilding, allo-
cation, pricing, trading. Any first year asso-
ciate could write the detailed process flow-
chart. The possible variations (currency,
documentation type, issuer type, etc) are
ultimately all more or less elaborate forms
of the same base case. (The underlying
process used in executing a 144A deal in the
US for a high yield company is hardly dif-
ferent to the process used to issue an FRN
for a bank off of an EMTN programme.) So
why is it that this is still such a labour
intensive, error prone and ad hoc process
across the industry?
Tools of revolution
Over the past 12-18 months, the seeds of
change have been planted to address this sit-
uation. Tools such as Dresdner Kleinwort
Wasserstein’s e-bookbuilding have pio-
neered a more professional and industri-
alised approach to the new issue execution
process. One of the most important innova-
tions was to open up our system to allow all
participants in a new issue to communicate
on a common basis. This was a necessary but
far from sufficient first step.
Over the past two years a
whole industry has emerged
to build bridges between
market participants
Perhaps the most valuable longer term
contribution of e-bookbuilding has been the
ability to clearly identify and understand the
details and bottlenecks in the new issues
process, which are often less than intuitive
and have emerged by using the system in live
production now for almost two years. As
indicated above, the basic new issues work-
flow or framework is relatively straightfor-
ward and easily defined. The devil, however,
is in the details.
An example of one of the bottlenecks dis-
covered through the use of e-bookbuilding
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Celebration of Excellence: Sponsor’s Foreword 19
Banks have Formula 1 drivers
racing around in anything
from a Trabant (for the worst)
to a BMW 3 series (for the
best), without any pit crews
and other similar utilities is the lack of
common investor identifiers. Just as securi-
ties have common codes (Cusips, ISIN
codes) it is important in the context of effi-
ciently measuring demand and allocating
new issue securities that investors be easily
and uniquely identifiable in real time
(imagine the chaos that would ensue if
every market participant had their own
unique identifier for each security). The
need for a common, unique investor identi-
fier has now been accepted by the market as
self-evident; as late as six to nine months
ago it was hardly on the radar screen!
Indeed, underwriters are now collectively
acting to address this omission.
A second issue that has now been made
obvious is the necessity for the various
banks’ new issue utilities to be able to com-
municate electronically with one another
(and ultimately with other participants:
issuers, investors, press, stock exchanges,
etc). While e-bookbuilding initially solved
this problem by opening its platform to
competitors and clients alike, this was and
remains a sub-optimal solution. Given that
most banks have their own new issue toolsets
(even if for the least advanced this can con-
sist of as little as an Excel spreadsheet) the
duplication of effort (and concomitant scope
for error) needed for data entry should rea-
sonably be avoided.
What is needed is the ability for systems
to communicate in real time. This can be
solved by creating individualised bilateral
APIs between systems, or more rationally by
agreeing a market standard common new
issue syntax that when used, for instance, in
an XML framework would allow all systems
to communicate effortlessly, irrespective of
their individual functionality. Indeed DrKW
has recently circulated a draft syntax to a
number of other major investment banks
for comment and discussion — due to our
extensive electronic deal experience we were
able to produce this in a day. But don’t
overestimate our contribution or generosity:
in essence, it is simply a list and standard-
ized formatting for the approximately 50-
100 variables needed to accurately define a
new issue and the bookbuilding and alloca-
tion process (of which some of the more
obvious are: issuer, coupon, currency,
maturity, order size, order status, split
amounts and so on).
Where technology is important, many —
perhaps most — of the big investment
banks have much of what is needed, or
could easily build or buy what they lack.
What is most often missing are the tools to
put the pieces together, whether that be
internally, externally or both. Ironically, as
evidenced by the example above, the cost
or technical difficulty of building these
tools is often relatively trivial. Indeed, see-
ing this, over the past two years a whole
(rapidly consolidating) industry has
emerged to build bridges between market
participants, with business models often
consisting of no more than standardizing
trading and data communication for con-
necting multiple counterparties. As com-
munication protocols, syntax and data for-
mats become standardised in the public
domain, many of these companies will find
their transaction-based value proposition
disappearing (if it ever existed) and sur-
vival, if even possible, subject to switching
to a software-licensing business model
(analogous to Red Hat for Linux) or a
fully-fledged exchange model. (Moral:
beware of people selling you what is essen-
tially available for free.)
Changing a bank’s culture
So if technology is not a fundamental bot-
tleneck or differentiator, what is? Culture
and attitude. It comes back to attention to
detail and a determination to impose
process standardisation and to demand
quality execution. The potential rewards are
strikingly obvious: higher productivity,
lower fixed costs, higher customer satisfac-
tion. But the rewards will only accrue to
those banks who embrace this vision with
an all or nothing mentality. Anything less
will result in a situation all too familiar to
many investment banks: higher costs and
lower productivity, as the benefits of better
process engineering, being incomplete, are
impossible to harness. Success depends on
unconditional institutional adoption of this
new paradigm.
I have taken only one very small example
of a standard capital markets process. There
are hundreds more repeated thousands of
times daily, some more efficiently than oth-
ers, but none I would guess coming any-
where close to six sigma quality and efficien-
cy. As valuable as re-engineering an individ-
ual process may be, the real opportunity
comes from the prospect of using this new
paradigm and technology to weave them
into an ever more powerful and efficient
whole greater than the sum of its parts.
The challenge ahead lies in building the
best capital market factory in the world.
Nice theory, but you’ll never get bankers
to think of their business in this way — so
let’s think about it another way. To use an
automotive racing analogy, banks have
Formula 1 drivers racing around in any-
thing from a Trabant (for the worst) to a
BMW 3 series (for the best), without any pit
crews. Don’t you think the first bank to get
an Aston Martin Vanquish or, better yet, a
Formula 1 car might win — even without a
Schumacher in the cockpit. Now what if I
told you that with the right connections and
a little determination, the Vanquish could
be had for the same price as the 3 series...?
Good bankers are just too expensive to
waste driving the equivalent of a Trabant.
Investment banks don’t have to embrace
the revolution, it’s just that they can’t
afford not to. ❙
EuroWeek