Current trends in global capital markets

The World Federation of Exchanges (WFE), which represents more than 200 market infrastructure providers including exchanges and CCPs, recently published its H1 2016 Market Highlights.  According to it, cash equity markets experienced a decline of 24.0 per cent in terms of value traded, and 6.9 per cent in terms of number of trades in the first half of 2016 compared to the same period in 2015. These declines largely reflect a slow-down in trading activity in the Asia-Pacific region, particularly mainland China. FX and commodities exchange traded derivatives led a 1.4 per cent rise in all exchange-traded derivatives.
According to the WFE's half-year statistics, the key trends of the year include, inter alia,
(1) Global market capitalisation decreased 9.4 per cent from H1 2015, to reach $ 67.2 trillion compared with $ 74.2 trillion. Asia-Pacific accounted for $ 4.0 trillion of this decline, ending the half year at $ 23.3 trillion, down 14.9 per cent from the end of the first half of 2015. EMEA exchanges were down $ 1.8 trillion (a decline of nearly 10%) followed by the decline of $ 1.1 trillion in the Americas (nearly 3.6 per cent). The $ 29.14 trillion market capitalisation at end June 2016 in the Americas is, however, up slightly (4.3 per cent) on the number at end 2015.  
(2) The value of share trading decreased 24.0 per cent worldwide to $ 44.9 trillion in the six-months up to June 2016 compared with $ 59.2 trillion in the same period in 2015. Most of the decrease is attributable to the decline in trading activity in the Asia-Pacific region where the value of share trading decreased 47.0 per cent from what was seen in the first half of 2015. The Americas bucked this trend, with value-traded in H1 2016 up 2.3 per cent on H1 2015.
(3) Total number of trades in H1 2016 decreased 6.9 per cent from H1 2015. As the Asia-Pacific region accounted for 66 per cent of all trades in the first half of 2015, this decline is entirely due to a 20.6 per cent drop in the number of trades in this region. Both the Americas and EMEA experienced an increase in number of trades in H1 2016 compared to the same period in 2015 (up 22.9 per cent and 8.8 per cent respectively).
(4)    Exchange Traded Derivatives (ETD) volumes (as represented by number of contracts traded) ended this six-month period 1.4 per cent up compared to the first half of 2015. This was fuelled mainly by increases in the number of commodity and currency derivatives traded, up 46.8 per cent and 26.1 per cent respectively, versus the same period in 2015.
(5)    Revenues declined in 2015 for the global investment banking industry as trading in fixed income, currencies, and commodities (FICC) businesses continued to act as a drag on performance. Economic uncertainty, monetary policy change, and further implementation of bank regulations were the driving factors behind the negative change in market sentiment during the second half of the year.
(6) Global investment banking revenues declined to $228 billion in 2015, down 5.0 per cent from $239 billion in 2014 and 16 per cent from $271 billion in 2010. Total revenue was lower last year than at any point since 2009, as the prospect of central bank tightening in developed markets was swamped by a severe downturn in emerging markets. As we predicted in last year's Capital Markets report, investment banking ROE fell to a 6 per cent post crisis low (excluding fines and litigation costs) as revenues were dragged down by relatively weak performance in secondary trading and by high business costs overall
(7)    IPOs and investment flows: Total new listings in the first half of 2016 (including IPOs) were down 48.9 per cent overall compared to the first half of 2015. Similarly, investment flows channelled through exchanges declined by nearly 31.4 per cent in the first half of 2016 compared to the same period of 2015. Within this figure, capital raised through IPOs (which accounted for just under 10 per cent of total capital raised) decreased by 64.4 per cent and capital raised by already listed companies decreased by 24.1 per cent.
It has been observed that the first half of 2016 saw a marked decrease in global capital market, led by Asia-Pacific, but fell across all three regions; this is a continuing downward trend since the second half of 2015. It is interesting to note, however, the strong performance of both the Americas and EMEA in terms of number of trades.  Moreover, the growth in the value of share trading in the Americas also supports a robust H1 for the region overall. As ever, WFE provides a statistical view of underlying market activity, and demonstrates the role exchanges provide in serving the real economy. The uptick in volumes for exchange traded derivatives is of particular interest. This has been supported primarily by steady increases in the number of FX and commodity derivatives traded.
The role of capital itself is changing. Escalating capital costs, occurring simultaneously with the growth of buy-side assets and revenues, indicate that the industry is moving toward leveraging benchmarks and other index products aimed at passive investors. Both the ability to discover liquidity and the demand for risk transformation services are becoming less dependent on capital. If investment banks are to compete, they must recognise their ability to generate revenues as information companies.
Unfavourable economic conditions, escalating capital requirements, and stubbornly high costs continue to depress the performance of many investment banks. Their collective 6.0 per cent ROE in 2015 capped off five years of dismal revenue results. Yet the same cannot be said for the capital markets industry as a whole-the ecosystem that includes buy-side firms, sell-side firms, information service providers, and exchanges. Indeed, even as regulation forces investment banks to retrench and hinders their ability to compete, other players remain unaffected and will even, in some cases, benefit. Over the next five years, revenues in the capital markets industry will grow by an estimated 12 per cent, increasing to $661 billion from $593 billion in 2015.
In this premise, the asset base of buy-side entities is expected to reach around $100 trillion by 2020, up from an estimated $74 trillion in assets under management (AuM) in 2014. If this transpires, the buy side will generate nearly $300 billion in fees by 2020, constituting 45 per cent of the overall capital markets revenue pool (assuming favourable market conditions and current fee structures). However, investment banks, on the sell side, are expected to generate just over $205 billion by 2020, a decrease to 31 per cent of the total revenue pool from 53 per cent in 2006.
It has been presumed that yet even as competition intensifies, opportunities for investment banks will continue to arise. Some larger or niche players will be able to absorb market share from those that are retrenching. Others will require a change in mindset and approach to explore alternative revenue opportunities beyond their traditional roles as capital raisers and market makers. Such players might consider leveraging internal data and technology systems to diversify revenues and enhance their market positions. They should build on their already mature sourcing strategies to push to the next level of operational and process efficiencies. Opportunities include leveraging utility models for non differentiating business processes and driving factory-like efficiency in the back office through end-to-end process redesign. These players should also leverage their remaining positions of strength across the value chain. In particular, it is imperative that they help their clients achieve success, not only by offering high-quality products but also by providing valuable information, such as research, benchmarks, market prices, and other intellectual property. Yet they should avoid giving away this information in the hope of generating revenues through alternative channels, such as trading. Indeed, the industry as a whole is moving away from implicit charging and so-called soft-dollar arrangements. Investment banks must keep pace and consider charging explicit fees for the services that they now provide in addition to the products they supply.
Ultimately, investment banks will need to be the right size, develop the right model, and take the right approach to return to consistent profitability. Dealers must learn to compete within the critical sectors of the new capital-markets ecosystem-data and financial technology. How they fit themselves into increasingly electronic, standardised, and transparent markets will be crucial. They are losing the battle so far, but that does not mean they will lose the war.
Another empirical report, (BCG's fifth annual study of the global investment banking business) emphasizes the challenges that investment banks face and examines the consequences of new and diverse players in the overall capital markets ecosystem invading their territory. Traditional revenue streams are migrating to these entities, and it is still unknown whether-or when-this trend will reverse. Either way, the investment banking industry has entered a highly dynamic, largely unpredictable era. It is time for players of all stripes to assess their current strengths and weaknesses and to plan for the future.
Investment banks have struggled to rationalise their balance sheets in the face of increasing capital costs and leverage ratio requirements. In terms of capital consumption, a minimum leverage ratio of 3 per cent, as well as an enhanced leverage ratio for global systemically important banks (G-SIBs), will increase the cost of doing business relative to the size of assets held. US banks continue to be relatively better positioned than their European peers, which struggle with legacy, illiquid, long-dated instruments on their balance sheets. In Europe, the publication of final margin rules for un cleared derivatives means that additional funding in the form of initial margin will increase by €200 billion to €420 billion, according to analysis by the European Banking Authority.
Dr. Muhammad Abdul Mazid, former Secretary and Chairman, NBR, is Chairman of Chittagong Stock Exchange Limited.
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