Originally Published May 2, 2013, 12:01 AM ET

Economic turmoil, regulatory reaction and technological advances are bringing rapid change
to the capital markets sector, making this an especially challenging time for capital markets
firms around the world. We expect the remainder of 2013 to be a year of adaptation to a
rapidly evolving capital markets landscape, says Bob Contri, vice chairman, U.S. Financial
Services leader and U.S. Banking and Securities leader at Deloitte LLP.
Indeed, capital markets firms are expected to be challenged to redesign their industry and
themselves, according to Deloittes 2013 Capital Markets Outlook, as the industry faces
overcapacity, thin profit margins and a damaged reputation that has garnered regulators
attention and made it difficult to attract leading talent. The report, issued by the Deloitte Center
for Financial Services, identifies important macro issues expected to affect the capital
markets industry this year and emerging developments likely to drive significant changes in
the capital markets sector. The macro issues include:
The demise of proprietary trading. As a result of the Dodd-Frank Acts Volcker Rule,
firms that once generated substantial income by trading for their own account can no longer
count on this activity for much, if any, revenue. To offset this loss of income, firms are
considering new business models that focus on opportunities in wealth management,
emerging markets and other areas that offer growth potential.
Taming derivatives. As unregulated derivatives trades begin to migrate to over-the-
counter exchanges offering greater transparency, profit margins are likely to shrink and
capital markets firms will likely need to look elsewhere for new revenues to make up for these
diminished returns.
High-powered electronic trading. As more hedge funds, institutional investors and
high-frequency traders rely on their own quantitative specialists to help set strategy, it is to be
seen whether the traditional research-and-service brokerage model go the way of paper
confirmations.
Regulatory overhang. In many ways, the foundational issue challenging the industry is the
need for restructuring and realignment so the industry can work toward compliance with the
evolving regulatory landscape.
Four Transformational Challenges
The report also identifies and examines the implications of the following major
transformational challenges facing the capital markets industry.
Capital Markets Outlook: 10 Challenges in an
Evolving Landscape
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These transformational challenges have the potential to fundamentally alter the strategies,
revenue model and structure of individual firms and the industry as a whole, says Jim
Eckenrode, executive director of the Deloitte Center for Financial Services Deloitte Services
LP.
Regulatory. The devil may be in the details, but the regulators have yet to provide them.
Actions from regulators and legislators have the potential to force the separation of banking
from capital markets once again. These issues will likely resolve this year and could
accelerate restructuring of the industry in a once-in-a-lifetime way. Capital markets firms that
are part of larger bank holding companies should look to accelerate planning for potential
independence, Mr. Eckenrode says.
Meanwhile, the industry must wait for clarification on many important issues in Dodd-Frank. In
the U.S., continued uncertainty surrounding the impacts of regulatory actions such as living
wills and the Volcker Rule, combined with potential for actions related to high frequency
trading and the shifting of derivatives processing to more transparent exchanges, leaves
capital markets executives without a solid foundation for decision-making.
This uncertainty is compounded for firms operating more globally because of uneven
jurisdictional treatment of the industry. The regulatory unevenness has the potential to incent
firms to move operations to more accommodating jurisdictions. For example, there may be a
migration of activity from some of the most traditional markets, including the New York and
London markets, to markets in Asia and other regions.
Business Strategy. Momentum should continue to build around the fundamental
restructuring of specific capital markets firms and the industry as a whole. This is an industry
in transition. And it affects all the participants in various ways, says Mr. Contri.
As deleveraging continues, firms are anticipated to make some significant decisions about
which of their businesses to maintain and grow, and which may be candidates for divestiture.
These decisions are likely to result in the emergence of an industry where firms choose to
focus their energies at either end of the spectrum. Some can continue to push their
advantage as global, full-service firms, while many others may need to rationalize their
business models to focus on specific institutional strengths, observes Adam Schneider, a
principal with Deloitte Consulting LLP and chief advisor at the Deloitte Center for Financial
Services.
Repairing the Reputation. In an age where the pace of business is now measured in
milliseconds, reputation matters, perhaps more than ever. As capital markets firms look to
reshape strategy, reallocate capital and return to growth, investments in oversight of
operational processes, analysis of funding sources and de-risking of the client base should
receive attention in the coming year. Firms can focus on taking action to limit fraud and
liquidity risk, each of which can lead to severe challenges, Mr. Schneider says.
Market Structure. The fundamental business model for sales and trading will need to change
as capital markets firms transition from the more traditional high-touch trading to much leaner
electronic platforms. Deregulation and the need for differentiation have driven the
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development of alternative exchanges and dark poolsalternative trading systems that do
not display price quotations to the publicas well as the rise of new trading strategies. For
example, capital markets firms are creating their own central limit-order books. Firms can
then attempt to match buyers and sellers from their own order flows, or from order flows of
other privately managed dark pools before going through exchanges, where spreads are
narrower.
Firms can address the challenges of fragmentation caused by the development of alternative
exchanges and dark pools by reducing the complexity of their own environments. In many
cases, there are multiple instances of software that are in different versions based on
geographic region or product. Combining the new compliance reporting mandates with the
fragmentation issue, firms can focus on efforts to reduce and simplify their legacy back-end
trading platforms.
Six Transitional Challenges
The cyclical dynamics and evolutionary global trends around wealth and populations have led
to the following six transitional issues and challenges for the capital markets industry, which
are discussed further in the report:
Transparency vs. Margin. Dodd-Frank is driving a level of transparency in derivatives
trading and that is changing the way securities are cleared, says Eckenrode. The creation of
more standardized and shared utilities for initiation, clearing and settlement of trades will not
be the responsibility of a single firm. Indeed, some larger firms will try to corral trading volume
in order to lower their costs. But for the industry as a whole, the establishment of these
utilities could be a major contributor to the creation of a smaller, but more profitable industry,
Mr. Schneider observes.
Wealth Management Growth. The challenge for capital markets firms as they shift from
margin-based alpha businesses to a more fee-based income stream is how to get leverage
across these businesses. As in previous crises, capital markets firm executives should
decide whether these shifts are merely cyclical in nature or part of a more fundamental
realignment of industry revenue potential.
Globalization Opportunities. With stagnation in the developed markets of the U.S. and
Europe, many global firms are looking to emerging markets for growth. Firms should first
consider their overall strategy and competitive strengths as they chase revenue around the
globe.
Tying the Operating Model to Electronic Trading. The growth of electronic trading has
not been accompanied by a change in the business model. Most firms still maintain a more
expensive, sales and research-based model for their trading businesses alongside newer
technology-based trading platforms. Regulations prescribing improved trade monitoring and
clients demand for best execution at the lowest cost require ongoing and significant
investment in information systems.
Innovation. Despite the public outcry against financial engineering, the reality is that
innovation in product and process still offers a way forward for capital markets firms.
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Extensive product innovation will likely be more difficult in the short term as new demands for
transparency will take time to operationalize and potentially reduce product margins. The
focus on innovation may shift, even if just temporarily, from product to process as the industry
adapts to a new regulatory environment.
Compensation and Talent. Increasing pressure to change compensation models may
contribute to an exodus of talent from traditional sell-side firms to other segments of the
industry. Firms can prepare for a more competitive talent market by positioning their
corporate culture and compensation policies to ensure the environment and rewards they
offer prospective employees are commensurate, if not ahead of, those offered by other
employers vying for the same talent.
Related Resource
2013 Capital Markets Outlook: Its the End of the orld as e !no" it
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