CAPITAL MARKETS VISION 2022Relevance, Value and Growth in the Digital Era2 CAPITAL MARKETS VISION 2022MANAGEMENT SUMMARYA trillion-dollar industrybut prone to disruptionCapital markets are booming once again. The industry generates around $1 trillion in net annual revenue and shows high profitability overall. But while these headline figures suggest an industry in strong health, Accentures analysis reveals striking disparities under the surface. Other than buy-side players, only a few capital markets businesses are actually creating real shareholder value. Moreover, cost structures are highly fragmentedto an unsustainable degreemaking the industry prone to future disruption.Further change is coming to capital marketsThat disruption will be driven, primarily, by three industry trends: 1. A reshaping coreprice discovery is increasingly shifting to platforms and the traditional balance between sell-side, buy-side and market infrastructure is being reshuffled.2. Technology-led innovationnew technologies will be the principal drivers of change, with artificial intelligence first and then distributed ledgers set to bring far-reaching disruption and radical new opportunities to the industry.3. Digital value chainselectronic trading has just been the start; we see massive digitization needs and opportunities moving beyond top players throughout the whole industry in areas such as client management, advisory/sales and post trade.While many people might expect that capital markets will “normalize” to look similar to the pre-financial crisis scenario, we believe that the picture for 2022 and beyond will be fundamentally different. Quantitative easing will also have tapered off by that point. The US Federal Reserve is already on its way to becoming a net seller of securities, and the European Central Bank and the Bank of Japan will likely follow soon. 3 CAPITAL MARKETS VISION 2022The strategic implications of tapering, combined with the reshaping core and digital value chains as well as evolving technology in the industry, are profound. Revenue opportunities will shift between market counterparties, open up growth and consolidation opportunities for infrastructure players, and force institutions to reshape their investment bank (IB), corporate Accenture Research* $79bn considered other players contra revenue (hence additive), $28bn accounted for in other players costs (non additive) $12bn economic profit corresponding to full $107bn revenue* Illiquid alternatives include private equity, venture capital, real estate and infrastructure funds* Taxes, loan losses, adjustments for market infrastructure economic profits accounted for in other players cost18712310779*1772121001311076181801041,009*28+Figure 1: FY2017 economics by sector $bn5 CAPITAL MARKETS VISION 2022But while the capital markets industry averages show profitability, it is not spread evenly across different segments. On the one hand, buy-side players are the most profitable, keeping 10 to 15 cents per dollar of revenue as economic profit, with illiquid alternatives managers registering a blockbuster year and breaking the 20-cent mark on this metric. On the other hand, investment banks show a diverse picture: some create substantial economic profits (both large as well as mid- and small-sized institutions) while others do not earn their cost of equity. Market infrastructure players, such as exchanges and custodians, sit somewhere in between. There is, however, substantial variation within each subsector, as some players thrive while others tread water.Figure 2: IBs and CIBs economic profit dynamics per institution FY2017Note: Bubble size indicates size of economic profit (profit after taxes and cost of equity); hollow bubbles indicate negative profitSource: Company Financial Statements; Accenture Research-30%-25%-20%-15%-10%-5%0%5%10%15%20%0 5 10 15 20 25 30 35EconomicProfit/NetRevenueRevenue ($bn)6 CAPITAL MARKETS VISION 2022Investment banksThe IBs and CIBs around the world are very diverse in terms of profit. Our research has found that the top four players, all US-domiciled, generate around $20 billion or more in annual revenue, which is turned into substantial economic profit (see figure 2). Other firms with full-scale investment banking offeringsmostly European and some Asian banks are not earning their cost of equity. This is partly because they have not restructured their businesses fast enough (or are still in the process of doing so) or have not been able to afford necessary investments.However, profitable niches exist for mid-sized banks with revenues under $5 billion. Hence, size is not a strict requirement for profitability. Similar to the biggest players, the most profitable mid-sized global banks turn 10 to 15 cents of every dollar of revenue into economic profit according to our analysis. Figure 3: FY2017 economics by market infrastructure subsector $bnSource: Company Financial Statements; Accenture Research* Excludes broader universe of technology providers, rating agencies, and non-exchange group index providersRevenue Pre-tax Margin107Grand Total 41%28Sub Total (typically booked as cost) 33%23*Data Accenture ResearchRevenue ($bn)Asset Management0%5%10%15%20%25%30%35%40%0 2 4 6 8 10 12 14 16 18 20EconomicProfit/NetRevenue0%5%10%15%20%25%30%35%40%0 2 4 6 8 10 12 14 16 18 20EconomicProfit/NetRevenueRevenue ($bn)Wealth ManagementThis analysis describes the status quo in capital markets today. But what are the driving forces that will shape the industry going forward? And, more importantly, what effects will they have on different market segments and their respective business models?A catalyst for change: challenging the status quoShareholders, regulators and customers are exerting growing pressure on capital markets firms to deliver higher value at lower cost. Such pressure has been commonplace for sell-side and selected market infrastructure players in recent years. As catalysts for change emerge on all fronts, we see this development now expanding to include buy-side players as well. Every capital markets firm should expect to have its business and economic models challenged. 9 CAPITAL MARKETS VISION 2022On the buy-side, there are numerous potential vectors for change that will challenge existing business and economic models. These include what companies are managing for (such as moves towards “100-year life” pension solutions), how they are managing (with continued shifts to cheaper core beta and quantitative smart beta solutions challenging active managers), and how they are being compensated (with continued fee pressure and first movers introducing zero-fee index funds). That all translates into a single theme that will continue to dominate the industry: fee pressure. It is thus very likely that this fee contraction will offset or even overcompensateany future growth in assets under management (AUM) and will drive down economic profit. We believe that all buy-side players should prepare for a squeeze scenario in which volume will likely grow but margins will continue to shrink (see figure 5). The only questions are by how much and how quickly this will happen in the period leading up to 2022. This has four strategic implications for the industry as a whole: Continued growth opportunities for lower-cost and higher-value core services along with smart beta strategies. A much smaller cadre of managers being able to thrive on creating sustained “true alpha”. A stepped-up focus on efficiency gains and end-to-end industrialization, including truly capturing scale. An expectation that buy-side players will put pressure on their suppliers market infrastructure and some sell-side playersfor more efficiency, opening-up opportunities for market infrastructure and sell-side innovators to support the buy-side on their industrialization journey (much as automotive suppliers exerted substantial price pressure on their supply chains when they faced a similar market situation).10 CAPITAL MARKETS VISION 2022Figure 5: Buy-side revenue scenarios to 2022 $bnEstimated Margin (bps)Wealth ManagementAsset ManagementHedge Funds6125280Assuming global AUM growth around 5% CAGR552223045202103517180Source: Accenture Research489 489177212644241002142271071752049613617482WealthManagementAssetManagementHedgeFundsFY17 Actual 2022 Scenarios548475391Cost & EPCost andTaxesEPRevenueConservativeOptimistic SqueezeAn unsustainable cost structure, prone to disruptionTaking a broader view, our analysis highlights numerous angles to change this picture across the industry. These include adapting underlying operating models, employing different strategies and translating scale into profit by cutting organizational complexity. Indeed, organizational complexity represents a massive cost for the industry. Across all functions and industry sectors, the capital markets industry incurs costs of roughly $700 billion each year (including the cost of capital). This is due to industry structures that were built up over decades and born in a time of “lucrative inefficiency” in which there was little incentive to challenge or change the status quo. When growth was king, quick responses were required, and scalability was often only an afterthought. Regulatory requirements that followed industry developments have often made matters worse, further contributing to an inefficient cost structure in some areas.Note: Due to rounding, some totals may not correspond with the sum of the separate figuresSource: Accenture Research