I read a study by Broadridge and Institutional Investor this weekend that contemplates the future of capital markets. The two firms worked together to create a fascinating piece entitled Restructuring for Profitability. The study collected data from 150 equity analysts on their thoughts/opinions/predictions about investment banks. I also attended a panel sponsored by Broadridge that discussed the report’s findings with senior capital market professionals. The piece offers a very interesting perspective, through the lens of the views of an aggregated group of buyside and sellside equity analysts who spend their days assessing capital market firms. What I found especially interesting from the study was that none of the large banks globally will have RoE’s above their cost of equity capital in 2020:

• The US was nearly there with a gap of 0.09%
• Europe has an expected gap of 1.31%
• Asia has an expected gap of 2.77%

The report is full of data, and some key points focused on regulation and where investment bank earnings will come from. Other findings include:

• 61% of the analysts expect regulatory pressures on global securities firm to intensify between now and 2020. The breakdown on a regional level is even more telling with 75% believing regulation will increase in Asia, 67% expecting Europe regulation to increase and 39% expecting the US to increase. Perhaps getting Dodd-Frank and Volcker out of the way early will pay off!
• The analysts are largely optimistic about growth rates with a uniformity of view that growth will be better to 2020 vs the 2010-2014 periods. The analysts are most optimistic about M&A/advisory services (growing at a 4.86% CAGR) and least optimistic about FICC trading growing at 0.20% CAGR.

The attempt to close the profitability gaps discussed above, according to the analysts, will come from cost-control and restructuring, rather than revenue growth or balance sheet management. This path will continue to include rationalization and disposing of business units. Moreover, the report indicates a strong belief that banks have underinvested in technology and process improvement, with analysts responding that over the last 5 years banks have not invested aggressively enough in new technology to improve efficiency (61% of the time in US and 66% of the time in Europe). In searching for profitability and investing more aggressively in platform reengineering and technology, a fascinating point was made by a senior banking manager during the panel discussion. He stated that when banks analyze their investment in technology, they need to consider the cost of lack of clarity on necessary capital required, given the general opaqueness around actual regulatory levels, and to add a factor for potential regulatory fines, into project costing analysis to ensure that banks are properly evaluating the project economics of major technology investments. With a realistic view toward the future of their industry, business lines, and impending regulation, senior capital market decision makers need to utilize this type of calculus to ensure they are investing in efficiency in a difficult revenue environment.