Over the last decade, several trends in the global financial services industry have spurred firms to work together with fintech providers in order to modernise their operations and optimise their front-, middle-, and back-office functions. While the concept of mutualisation might not be new, the outbreak of COVID-19 presented entirely new challenges to the industry which has shone a brand new light on the benefits that mutualisation can bring.
The key drivers of change
Since the 2008 global financial crisis, financial services firms have faced pressures on their return-on-equity, particularly with the rise of new industry trends. For example, the shift from active to passive investing and the proliferation of zero commission trading has squeezed once-lucrative asset management and broker-dealer fees.
As a result, firms have been on the hunt for cost-reduction opportunities. In fact, between 2014 and 2020, banks have eliminated about a half-million jobs globally, mostly in the front-office. Post-pandemic, the search for savings is expected to intensify. A recent McKinsey survey of financial executives found that most do not expect global banking return-on-equity rates to return to pre-crisis levels for at least five years.
The financial crisis also spawned a raft of new banking regulations in its immediate aftermath, and financial services firms have been forced to grapple with an onslaught of new ones in recent years. To meet these new requirements, many financial services firms are undergoing, or will need to undergo, a radical transformation of their legacy infrastructure. Keeping up with these requirements does not come cheap. A report from Rice University found that the associated compliance costs for Dodd-Frank regulation alone cost US banks $50 billion a year.
Greater digitisation is also driving firms towards mutualisation. Customer expectations are evolving, and they expect interactions with their bank to be as easy as buying something on Amazon, taking a Peloton fitness class, or streaming a film on Netflix. Internally, many financial services firms have already embarked on digital transformation plans to transition historically manual back-, middle- and front-office functions to more modern, digital processes. The introduction of social distancing and the shift to remote working has accelerated this demand, and many firms have had to scramble to find digital alternatives to once-routing, paper-based tasks.
In terms of digital infrastructure, the pandemic acted as the ultimate stress test for financial services. The unexpected and extreme market volatility, and increased trading activity resulted in many institutions experiencing execution issues. Several high-profile broker-dealers saw their websites crash in 2020 due to the rapid fluctuations in trading volumes. These disruptions emphasise the need for greater operational resiliency, with rapid scalability and built-in flexibility. Nobody knows when the next black swan event will occur – only that it will, and next time firms need to be better prepared.
What benefits can mutualisation bring?
Traditionally, most financial services firms tackled each of these challenges individually. For example, they might have established an internal task force to address a change in regulation or a firmwide initiative focused on trimming costs. However, mutualisation represents a far more holistic and strategic approach, and one that reaps multiple benefits simultaneously.
Firstly, it can generate significant cost savings. This is because the sharing of the upfront costs of new technology development among peers can create strong economies of scale and allow firms to modernise both legacy and innovative functions at a much lower price.
Achieving this on a global scale captures even more scale, as global financial institutions can bridge duplicative functions and infrastructure across regions and lines of business. In turn, this can free up management’s time, attention and resources to drive value through the business’s other core functions. This is especially true for non-differentiated functions. Let’s take the example of post-trade processing. Each year banks spend in total between $6 billion and $9 billion processing trades in highly standardised asset classes. However, Broadridge’s research found that mutualising these functions could reduce expenses for the industry by between $2 billion and $4 billion annually.
Mutualisation also speeds, strengthens and simplifies regulatory compliance. When individual firms collect and store data, each typically does it in their own unique way. This lack of uniformity leads to reduced compliance, heightened scrutiny from regulators and a higher chance of regulatory fines. A mutualised model has the opposite effect. For example, Swift’s Know Your Customer (KYC) protocol was designed to help banks meet compliance challenges in response to KYC regulations announced in 2012. Today there are more than 5,500 financial firms using the protocol, solving what would otherwise be a manual, time-consuming and disconnected process.
There is also the advantage of greater operational productivity and enhanced resiliency.
When a FinTech provider develops solutions for multiple parties, it standardises processes and brings forth best practices so that firms can take advantage of those collective insights. Expertise and the ability to share infrastructure also creates more resilient systems.
Cyber resiliency is also strengthened since a mutualised service provider can spread the cost of a large cyber investment across multiple firms. These deployed shared defenses might be stronger than anything an individual firm could afford or provide on its own.
Finally, mutualisation creates the opportunities for new innovative technology solutions. It achieves this by creating network effects, which accelerate the adoption of next-generation technologies and innovation at scale. For example, some technologies, such as blockchain, when used for trade reconciliation, are impractical for a single firm to experiment with because they require multiple parties using the platform in order to reap the benefits.
Other technologies, such as artificial intelligence and machine learning, thrive on network effects because they rely on access to wide-reaching datasets. The more data input into their model, the more accurate and useful are the predictions and insights.
It also enables expert technology and solution providers – who are better positioned than individual financial services firms – to experiment with, assess the risk, and test the resiliency of new and potentially unproven technologies. Even in the case of failures, critical lessons can be shared with other firms within the ecosystem so that each does not have to experience the same failure themselves.
What does this new service delivery model look like?
A mutualised service delivery can take many different forms, but it is fundamentally underpinned by three main elements:
- Architectural flexibility – Using APIs, firms can easily integrate their services with outside parties, allowing them to access improved functionality from best in-class data and technology vendors, and delivering a better customer experience overall.
- Cloud-based applications – The cloud is truly the foundation that enables mutualisation. The modular, API-powered platform discussed above is simply unfeasible without it. The 2020 Broadridge survey of more than 1,000 C-Suite leaders and other senior executives at financial services institutions found that the cloud was the technology that firms are putting the most investment in over the next two years.
- Data-driven insights – One knock-on effect of using cloud-based applications is the opportunity to gain deeper business insights using data. This can help financial services firms automate processes, improve scalability and lower costs. Broadridge’s recent study of 1,000 C-suite executives and direct reports from financial services firms, 61% of respondents said they are using digital technologies for strategic planning and decision-making.
Lessons need to be learned
As the world starts to slowly re-open, it is clear that many of the trends that emerged during the pandemic will take a permanent hold. It is therefore so important that all firms across financial services reflect on the challenges that they have faced over the past 18 months and leverage these learnings to create a roadmap for the next post-pandemic chapter. Given nearly all firms will likely continue to face rising pressures from costs, regulation, digitisation and infrastructure shocks, mutualisation should certainly be an option explored by all.