Wholesale Banks and Asset Managers – Learning to Live with Less Liquidity

QE, financial regulation and changes in market structure lie at the heart of a profound shift in liquidity risk from banks to investors. This year's joint report with Morgan Stanley, investigates the implications of these shifts for business models and winning strategies across the securities industry.

Christian Edelmann on the Challenges of the Industry at the Fund Forum 2016 Conference

Learning to live with less liquidity is something Asset Managers and Wholesale Banks have to focus on

Christian Edelmann, Partner and Head of Oliver Wyman's global Corporate & Institutional Banking and Wealth & Asset Management practices, Financial Services

Asset Managers will need to adjust processes and product strategies as they learn to live with far less plentiful and more expensive liquidity, and far more intrusive conduct regulation.

For Wholesale Banks, rethinking the operating model is the longer term prize on the road to rebuilding returns; but some will also need to resort to more tough strategic choices as they adjust to structural and cyclical shifts in the client set and revenue opportunity

For Market Infrastructure players, roles will continue to blur as they seek to attack new growth opportunities, while digesting growing risks and pressure on core earnings

Wholesale Banking Implications

Changing buy-side behaviour, along with waning revenues and the tail end of regulatory drag, set a challenging threshold for banks. We do not see the industry achieving its cost of capital through the cycle without another round of heavy pruning equivalent in size to what has been accomplished over the last five years – and an overhaul of the operating model. Business models will continue to diverge as banks are pushed to make sharper choices on where they look to drive scale.

Asset Management Implications

The industry has started to live with less liquidity but, as this journey is far from over, tougher choices on operating models and product structures will be required. In combination with a much higher regulatory focus on conduct risk, this will likely bring capital – a largely unmanaged resource – to the forefront of shareholder and investor attention. Many of the growth opportunities, we believe, will favour scale players or managers that can bridge the liquidity mismatch.

1What is this year’s report about?

This year we explore how the cumulative impact of QE, financial regulation and changes in market structure have driven a profound shift in liquidity risk from banks to investors, and how this is having enduring impacts on business models for banks, asset managers and market infrastructure players
2What are the implications for Banks?

The immediate earnings pressure caused by a cyclical downturn, the retention over the past 5 years of sub-scale businesses, and the limited upside coming from repricing, is likely to force some banks to undertake further strategic pruning; we estimate up to 5% of market share could be released as a result of this action, which would be as much as was given up by exits from 2010-14
Banks can deliver a 25% improvement in industry wide PBT by driving through fundamental operating model reform, but focus is shifting towards back and middle office functions. This will require banks to redeploy over $5BN of IT budgets towards platform improvements
3And what is in it for the Asset Managers?

We think the industry underestimates the conduct risk it faces
Cost pressures resulting from falling liquidity will be manageable for most, but bigger concern should be capital, governance and process reform
Contrary to common perception, ETFs could benefit in liquid assets, as could players with favorable lock up periods and those who use technology to manage mandate sizes as a liquidity barbell develops