As the events of the financial crisis grow more distant with each year that passes, the search for a sustainable operating model for capital markets operations is intensifying. Costs are escalating while the deleveraging of the business model has stunted the growth of the industry’s US$340 billion in annual revenues. As a result, the call for a transformational change in the back office have grown louder. Banks must reassess their definition of “core” operations and determine how to industrialize their current operating structure. Industrialized operations use specialized process, people, and technology practices to execute transactions more robustly with the flexibility to accommodate fluctuations in the scope and scale of a business. Global Business Services (GBS), the next step in the evolution of shared services, streamlines business functions and industrialize a firm’s operations resulting in improved scalability, lower costs, and optimized processes. This facilitates better decision making, flexibility, and nimbler pursuit of growth for all firms trying to mitigate the contracting margins industry wide.
The call for transformational change
Over the past several years, banks have been forced to curtail discretionary budgets meant to change the bank just to meet the market and regulatory initiatives required to run the bank. In most cases, the rate of implementation has led to a sprawling and fragmented set of “bolt-on” solutions that have increased the complexity but not the effectiveness of operations. The result has been a growing need for transformational change that has turned into a cry for revolution across the industry. One example of this is occurring within the client onboarding function undertaken by every bank in the industry. Current estimates show the industry spend on these activities at US$2.5 billion. However, as updated programs are implemented under the new regulatory regime that number is projected to reach US$6.2 billion by 2020. In one case, a leading bank has estimated the number of staff required to handle this function may have to increase threefold within five years. The need for transformational change in this function, as well as others, is evident; however, firms that choose to pursue a rapid transformation face accompanying risks. By definition, transformational change is disruptive, unpredictable, and expensive, with no guarantee of success. This increases a firm’s ordinary risk profile exponentially.
During a time when the industry is deleveraging in an attempt to mitigate risks, transformational change and the added risk do not belong in the back office. Yet it is clear that changes must be made to the current tangle of systems and processes that all market participants have been forced to endure. The challenge is to envision revolutionary goals and work toward attaining those goals through evolutionary means. By following a path of evolutionary innovation, firms can begin the journey toward an efficient and industrialized back office in a more secure, predictable, and manageable manner.
The growing opportunity
Last year, the capital markets industry spent more than $28 billion on operations that have not yet been industrialized. The vast majority of this amount (84%) was spent on what banks currently categorize as part of their “core operations,” covering a broad set of activities such as post-trade processing, client onboarding, credit risk management, asset liability management, and regulatory compliance.
Yet without the ability to invest strategically across the spectrum, many areas have been forced to deal with change through an ongoing series of tactical solutions. As additional market and regulatory initiatives come online, the total spend is expected to increase by nearly $5 billion. Under these circumstances, firms are left with no choice but to take a hard look at these operations and move them to a more sustainable and industrialized operating model. By doing so, firms access new growth opportunities through better client service and cross-sell opportunities, create resilience to hostile market or regulatory conditions, and facilitate enterprise-wide product innovation more efficiently. For example, experience shows that increasing the size of a large operation by 20% (or strengthening business infrastructure in a new country) typically takes a few years, but industrialized operations can often achieve this in half the time. In addition, when the scale of business process services is increased by a factor of ten, the GBS model can deliver a 50% savings in cost per transaction while also providing a leaner, more predictable cost structure.
The first step to realizing these benefits is to envision the optimal operating model of a function and achieve its end state through an iterative process. Some functions may emerge as candidates for a captive processing center or as a joint venture with business process managers such as those traditionally done entirely within the confines of the bank. Others may benefit from the increased efficiency and agility brought by a shared services or GBS model such as those already in the captive or managed model including: trade confirmation, clearing and settlements, reconciliation, reference data, and custodian services. Finally, in some cases banks may feel compelled to take the next step by carving out and commercializing entire functions leading them to partner in service utilities to fully eliminate redundant fixed costs. This would truly reflect revolutionary change in the way certain core operations are structured, yet can still be attained through a series of evolutionary steps. Regardless of where a firm starts in the evolutionary process, each stage enables greater efficiency in the back office while also stemming the tide of rising costs and freeing up capital.
Progressing toward an optimal operating model
The industrialization of the capital markets sector does not have to occur all at once. Market participants should examine their core operations and partner with business process experts in order to progress to the ideal operating model for each function. Certain internal functions may benefit from a move to a captive model, while others currently in that model may move toward GBS. Finally, those that have reached maturity in the GBS model may have the opportunity to evolve into a utility. Each function will progress at its own rate, and some will have a greater capacity for transformational change than others, but all will realize some added level of industrialization and cost savings. The goal of all firms should be to choose an operating model for each function that brings the maximum level of effectiveness and cost savings through the standardization and scalability of operations. The first step is to envision the ideal operating model for each core activity, and then set about achieving that vision through an evolutionary process. This mitigates much of the risk associated with transformational change by allowing firms to reassess and revise if necessary. It also provides a defense against those that seek to stifle change or steer the organization toward short-term or remedial solutions at the expense of longer team goals by ensuring a plan of continuous but controlled change.
Global business services in capital markets
Until this point, the capital markets industry has been very aggressive in pursuing an advanced and semi-industrialized model for the traditional areas for business process management. The industry has realized the benefits of advanced metrics, data-driven process management, specialized HR/ organizational design, and effective IT enablement in areas such as F&A, HR, and IT infrastructure, all areas that are highly commoditized and of less strategic importance. However, the industry has now reached a plateau in terms of the amount of benefit that can be wrung out of these functions. Individual banks that haven’t reached this point are now in a position where they must do so to stay relevant, while leaders are looking to the next-level, non-traditional functions. Areas such as reporting and compliance, collateral management, reconciliation and exception management, and even risk are all candidates to move to the industrialized GBS model.
Implementing GBS for emerging candidates
GBS implementation typically follows three phases, with focus and achievements shifting over time from foundational (often cost-driven) activities to more strategic ones. Full realization of benefits using the GBS model is achieved when it reaches maturity, which can take between five and 10 years. However, forward-looking organizations have successfully shortened the path to return on investment (ROI) with a well-defined target operating model and execution roadmap. Examples of scientific process improvement frameworks such as Genpact’s Smart Enterprise Processes (SEPSM ) are helping organizations define and improve this process. This has increased the ability to estimate the end-to-end business impact of target operating model choices, thus facilitating effective design earlier in the process. Still, some have discovered that building out GBS capabilities can be more difficult than anticipated, especially without a structured scientific approach.
Through work with clients around the world, Genpact has found a significant variance in the key performance indicators of companies adopting GBS. This variability across scope, location, and delivery models suggests that while broad-brush strategies and benchmarks have a place in this process, each business case depends heavily on the specific function undergoing transformation.
However, regardless of whether a bank is considering a change to its post-trade, collateral management, regulatory, or risk operations, a thorough analysis of the following four dimensions is critical for selecting the right target operating model.
Empirical experience and a significant level of granularity can help craft the right strategy for a target operating model. The key is to follow a structured approach:
- Review the as-is state and rationale. Understand the current state of performance, identify candidates for improvement, and review the process and sub-process practices.
- Identify top improvement opportunities. Use best-practice metrics and frameworks to benchmark key areas, identify top areas for improvement, assess the feasibility and risk of options, and conduct a preliminary analysis of benefits such as cost, efficiency, or effectiveness.
- Identify delivery alternatives. Assess options for consolidating processes into internal global shared operations, externally sourced operations, or a combination.
- Determine change implications. Outline both financial and risk-related implications for each location and structuring option (e.g., various types of risk).
- If needed to help executive decision making, build a business case for each alternative. Compile a high-level business case that encompasses process improvement, organizational structuring options, location choices, and change implications.
- Develop a detailed roll-out plan. Develop a roll-out plan to reach the targeted operating model by process and by location.
- Build the final business case. Identify emerging options for each process and develop financial and implementation plans.
By taking this approach, the capital markets industry can ensure a stable and continuous evolution of an operating model toward its most appropriate end state and realize significant savings on the $30 billion spent each year on functions that have yet to achieve their optimal operating model.
The capital markets industry will experience a transformational change in the back office. The challenge will be to manage that change in a way that minimizes costs and risk. Abrupt and sweeping transformational change does not work in an industry focusing on mitigating risk, but a staged approach offers an opportunity for firms to invest in new operating models while also minimizing risk. The added agility afforded to firms that apply optimal operating models, such as GBS, to new and non-traditional functions is a benefit that is no longer a luxury, but something that every firm must leverage going forward. Leading banks are already transforming their operating models to create a sustainable path to growth, profitability, and innovation. Those that continue to embrace changes to certain “core” operations will realize their share of the benefits sooner, opening up other areas for strategic investments while those that do not will be forced to endure one tactical solution after another and the added costs and complexity they bring.
For organizations looking to redefine their operating models, a significant amount of specialized knowledge is needed to navigate the continuum of design choices. Evolutionary strategies must and can leverage the experience curve of other organizations’ journeys over the past decade. Although the capital markets sector has been a leader in implementing new operating models in the past, there is still potential to benefit from additional levers such as increased scope, standardization and automation of the existing scope, outsourcing, offshoring—and eventually even the creation of one-to-many industry utilities for some functions.