Volatility on the path to innovation

If you were to cre­ate a word cloud to describe cap­i­tal mar­kets in 2020, most promi­nent, in large, emphat­ic cap­i­tal let­ters, would be VOLATILE.

At the start of the year, the most con­cern­ing aspect for those involved in cap­i­tal mar­kets was the UK’s exit from the Euro­pean Union. There remains an uncom­fort­able amount of doubt about how Brex­it will play out, with traders and busi­ness lead­ers alike look­ing long­ing­ly towards Brus­sels in the hope of a favourable out­come of nego­ti­a­tions before the tran­si­tion peri­od ends on Jan­u­ary 1. 

November’s Amer­i­can pres­i­den­tial elec­tion had long been cir­cled as a time when the cap­i­tal mar­kets might play bull or bear. But then, in March, came the world­wide spread of coro­n­avirus. The pan­dem­ic has touched every aspect of our lives and infect­ed all sec­tors and their mar­kets.

This extreme volatil­i­ty has accel­er­at­ed inno­va­tion to reduce risk, max­imise returns and improve resilience for gov­ern­ments, large finan­cial insti­tu­tions and traders. And dri­ving the nec­es­sary evo­lu­tion of the archi­tec­ture of cap­i­tal mar­kets is tech­nol­o­gy.

“Cap­i­tal mar­kets have had a tough year in 2020, main­ly as a result of the coro­n­avirus pan­dem­ic, with COVID-19 rates ris­ing and the prospect of a third shut­down across the world now appar­ent,” says Sankar Krish­nan, exec­u­tive vice pres­i­dent of cap­i­tal mar­kets and bank­ing at Capgem­i­ni. “Loom­ing fis­cal cliffs caused by shut­down, con­tin­ued virus uncer­tain­ty and the US elec­tion impact­ing glob­al pol­i­tics are all added to the mix.”

Against this back­drop, though, sev­er­al key trends have emerged and they might remain for some time. For one, there are new prod­ucts and ter­mi­nol­o­gy. “We nev­er before heard of terms such as ‘COVID stocks’, ‘work-from-home stocks’, ‘return-to-work stocks’ and few peo­ple had come across spe­cial pur­pose acqui­si­tion com­pa­nies or SPACs,” says Krish­nan.

Time to upgrade obsolete legacy systems

There has been sub­stan­tial growth in SPACs, whose main objec­tive is to raise cap­i­tal through an ini­tial pub­lic offer­ing to acquire com­pa­nies. In Sep­tem­ber, SPACIn­sid­er report­ed there had been $36.2 bil­lion in SPAC pro­ceeds so far in 2020, almost three times greater than the whole of last year at $13.6 bil­lion.

How­ev­er, pri­vate equi­ty firms closed around 30 per cent of deals in the first half of 2020 com­pared to the same peri­od last year, says Krish­nan. “This is expect­ed to con­tin­ue for the rest of the year,” he says. “That said, merg­ers and acqui­si­tions activ­i­ty con­tin­ued to be strong as val­u­a­tions dropped. 

“On the sell side, bro­ker-deal­ers and invest­ment banks have seen sig­nif­i­cant vol­ume decline, main­ly due to obso­lete lega­cy sys­tems that were dri­ving down mar­gins. Almost all large invest­ment banks are invest­ing in dig­i­tal, main­ly for improv­ing cus­tomer and employ­ee pro­duc­tiv­i­ty, cyber­se­cu­ri­ty and rethink­ing tal­ent.”

Pre­dict­ing more devel­op­ment in this area, he adds: “It is wide­ly antic­i­pat­ed tra­di­tion­al invest­ment bank­ing will get bro­ken down to spe­cial­ist invest­ment banks that focus on deal orig­i­na­tion and util­i­ties that will per­form mid­dle and back-office func­tions.”

Anoth­er trend iden­ti­fied by Krish­nan is the evo­lu­tion of data providers, who play a “crit­i­cal part of our cap­i­tal mar­ket activ­i­ty as we know it”. He says: “Tra­di­tion­al buy­ers rely on the likes of Slack and Bloomberg for trad­er com­mu­ni­ca­tions and buy­ers are direct­ly sourc­ing data from the mar­ket or bou­tique providers. A vari­ety of cap­i­tal mar­kets-focused fin­techs are also com­ing of age and estab­lish­ing niche mod­els in the field of Libor [Lon­don inter-bank offered rate] pric­ing, arti­fi­cial intel­li­gence-dri­ven bond pric­ing, fixed income ana­lyt­ics and so on.”

Technology driving innovation and reducing risk

Michael Voisin, glob­al head of cap­i­tal mar­kets prac­tice at law firm Lin­klaters, says: “Cap­i­tal mar­kets are in a good state, both glob­al­ly and region­al­ly. They are doing what they are designed to do: pro­vid­ing cost-effec­tive financ­ing to busi­ness­es in need of it.

“The endur­ing ben­e­fit of the cap­i­tal mar­kets is their abil­i­ty to pro­vide deep liq­uid­i­ty for large fundrais­ings at the most com­pet­i­tive rates.” As an exam­ple, he points to the Euro­pean Commission’s recent bond issues, which raised €17 bil­lion and car­ried neg­a­tive inter­est rates, so investors were will­ing to lose a small return on their invest­ment in return for cap­i­tal pro­tec­tion. “There was investor demand for €233 bil­lion, so they could have sold almost 14 times more bonds at that price than they were seek­ing to raise,” says Voisin.

What is clear is we can’t stay as we are

This year he has spot­ted a jump in financ­ing for envi­ron­men­tal, social and gov­er­nance (ESG) pur­pos­es, and is pleased gov­ern­ments are help­ing in this area. “Fundrais­ing for the pan­dem­ic has includ­ed gov­ern­ment-sup­port­ed schemes, such as the Bank of England’s COVID Cor­po­rate Financ­ing Facil­i­ty, as well as longer-term financ­ings,” he says. “And we have seen a raft of ESG issuance across the world, such as blue bonds in Asia to sup­port ocean-relat­ed envi­ron­men­tal pro­grammes.”

Ang­ie Walk­er, glob­al head of cap­i­tal mar­kets and bank­ing at soft­ware firm R3, believes blockchain tech­nol­o­gy and dig­i­tal assets “will play a fun­da­men­tal part in col­lat­er­al opti­mi­sa­tion, risk mit­i­ga­tion and dri­ving much greater effi­cien­cy through vast sim­pli­fi­ca­tion of oth­er­wise over-engi­neered and unnec­es­sar­i­ly com­plex process­es”. 

Sug­gest­ing that cap­i­tal mar­kets are “in a trans­for­ma­tion­al state”, she sounds a note of cau­tion. “It is evi­dent that much has to change and the grow­ing tide of reg­u­la­to­ry oblig­a­tions around risk, cap­i­tal ade­qua­cy and report­ing is going to con­tin­ue to fuel that,” she says.  

Blockchain and digital opportunities

When assess­ing the char­ac­ter­is­tics of glob­al cap­i­tal mar­kets that demand unique tech­ni­cal archi­tec­ture, Walk­er says: “Remote work­ing com­bined with a sig­nif­i­cant shift towards cap­i­tal for­ma­tion with­in the pri­vate sec­tor have dri­ven a need for new archi­tec­tures that allow for the facil­i­ta­tion and glob­al acces­si­bil­i­ty of asset types not acces­si­ble through tra­di­tion­al cen­tral mar­ket infra­struc­tures.”

And it is here where blockchain, the immutable ledger under­pin­ning bit­coin and hun­dreds of oth­er cryp­toas­sets, can play a piv­otal role. “The dig­i­tal­i­sa­tion of such assets and rep­re­sen­ta­tion of those assets on dis­trib­uted ledger-based tech­nol­o­gy is vital to allow­ing this to grow expo­nen­tial­ly, in a way that cen­tralised infra­struc­tures, such as region­al stock exchanges, would not have addressed,” she says.

Off­ing a final piece of advice to those oper­at­ing in cap­i­tal mar­kets, Walk­er adds: “What is clear is we can’t stay as we are. Yet for the braver, nim­bler and more pio­neer­ing indus­try providers, the oppor­tu­ni­ty to lever­age dig­i­tal inno­va­tion to dri­ve true green­field growth is immea­sur­ably large.”

In such uncer­tain and volatile times, these words envi­sion­ing a brighter, tech-pow­ered future serve as a wel­come balm.

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