In the final blog in this series, we look at three forces related to regulation and society that we expect to shape capital markets.
Under even the most benign of the scenarios, we expect the pandemic to have lasting repercussions, although the nature of the repercussions is dependent on the scenario. In particular, the scenarios variously encompass the possibility of a drive towards more socially-engaged ‘stakeholder capitalism’ or the prospect of governments adopting more isolationist policies. And in all scenarios, governments and regulators are likely to respond to lessons-learned for capital markets from the pandemic, including by introducing new regulations. In summary, society and government will be important forces in determining the future of capital markets.
As a reminder, our scenario planning framework considers four scenarios that could play out over the coming months (and years):
- The Passing Storm – relatively successful management means that pre-pandemic norms return in many areas, although not without lasting repercussions. These disproportionately affect lower and middle income individuals and communities.
- Good Company – the role of large corporations and of the wholesale financial services industry in supporting the public response accelerates developments towards more socially engaged ‘stakeholder capitalism’. The financial services industry adopts a heightened responsibility post crisis, both economically and socially.
- Lone Wolves – a prolonged pandemic period, with unpredictable bouts of volatility and an extended global recession spurs governments to adopt isolationist policies. This leads to insufficient global coordination.
- Sunrise in the East – a more effective response and better recovery trajectory accelerates a long term increase in the relative importance and influence of East Asian nations including China. Western recovery is based on lessons learned from the earlier recovery observed in the East.
Across all potential scenarios, there are underlying industry forces which we believe will drive impacts across capital markets institutions. For each force, we have highlighted likely implications and resulting key challenges that capital markets institutions will face under the relevant scenarios:
1. Deepening Capital Markets will play a more prominent role in funding and sustaining the real economy | |
Leading Observations: The pandemic has occurred at a critical time for European banks, with profitability already under pressure and Brexit raising the prospect of the fragmentation of European markets. In order to support the economy governments have guaranteed loan programmes to SMEs, but in the absence of a sustained economic recovery, many of these loans may ultimately default. Governments are considering longer-term solutions to avoid significant bankruptcies and the attendant unemployment. Historically, the concentration of liquidity and financial expertise within the EU in London impaired the ability of smaller corporates to access that expertise and capital markets, contribution to the less developed capital markets as compared to the UK and US. More than 80% of European corporate funding comes from banks and SMEs face unnecessarily high costs and complex obstacles in listing shares. | Key implications under the most significantly impacted scenarios: Sunrise in the East and Lone Wolves:
Key implications under the less significantly impacted scenarios: The Passing Storm and Good Company:
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We see the following key questions facing capital markets institutions:
- What new opportunities and possibilities does the coming economic reconstruction bring?
- What capabilities and resources will be needed to execute successfully on these? Is it necessary to partner or collaborate externally to access these?
2. New forms of financial supervision and new responsibilities for banks will emerge | |
Leading Observations: Globally, there has been an increased push from regulators, supervisors and policymakers for firms to consider climate change in their approach to risk management and scenario analysis, and in the disclosures they make to financial markets. While most climate risk related actions are currently voluntary initiatives, many are likely to become mandatory. Brexit will give the UK the ability to diverge from future EU financial services regulation and to revisit its implementation of existing directives and regulations, although there is unlikely to be a very significant shift in the near-term. While it is unclear what sort of market access arrangements will govern the UK and EU’s ongoing relationship, any significant departure from the EU’s regulatory rulebook may exacerbate any fragmentation of EU capital markets, leading to higher trading costs and less liquidity. | Key implications under the most significantly impacted scenarios: The passing storm and Good company:
Key implications under the less significantly impacted scenarios: Lone Wolves and Sunrise in the East:
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We see the following key questions facing capital markets institutions:
- How can new metrics and factors be introduced into risk and capital management structures? What enhancements to data and process infrastructure are required to do this effectively and efficiently?
- How to calibrate response to new regulatory priorities, given the differing emphasis given to these in different key regions?
3. There will be an increased expectation for government and banks to work together and for banks to play a societal role beyond shareholder return | |
Leading Observations:
| Key implications under the most significantly impacted scenarios: ALL scenarios
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We see the following key questions facing capital markets institutions:
- Do new financial instruments and markets require new lines of business and new models?
- How to ensure that capital markets institutions remain able to attract and retain the leading talent, while continuing to serve existing and new clients?
Conclusion
While different scenarios will pose different challenges for institutions, particularly if those with a global footprint are faced with a divergent world (Lone Wolves), there are clearly some common themes. The world has changed in ways that give institutions both opportunities and imperatives – new financial markets, new metrics and models for assessing performance and long-term risks, and a changed social and political context.
Understanding this changed environment is the first step to navigating and executing successfully.
If you would like to discuss any of the implications articulated above, please reach out to one of the authors who can connect you with the appropriate expert.