As mad scientists on the payroll of the big bond houses conduct experiments in the futuristic field of distributed ledger technology (DLT), it’s fair to wonder exactly how the banks themselves will benefit.
After all, the main tangible effect of all this innovation so far has been to increase the amount of money investment banks spend on technology.
Not that they’re complaining about it. On the contrary, the big banks seem to be competing to see who can spend the most.
HSBC was the latest to join the arms race, announcing on February 22 its intention to put at least 21% of its operating expenditure towards technology by 2025. It already spends $6 billion a year, or 19% of its total costs.
JP Morgan – despite the views of its CEO Jamie Dimon, who said cryptocurrencies have “no intrinsic value” – has been one of the most enthusiastic investment banks for blockchain technology. It created a blockchain unit in 2016 and launched its own digital coin, JPM Coin, in 2019. More recently, it embraced the so-called metaverse by opening its doors to the online world Decentraland, whose payment system is based on Ethereum.
And everyone in European capital markets knows about Societe Generale’s in-house blockchain lab, Forge, which has helped the French firm position itself at the center of developments such as the European Investment Bank‘s first digital bond. in April 2021.
But all of this comes at a cost. After all, technology is one of the few industries where compensation rivals that of investment bankers. Not everyone is happy with the expenses.
“Until we can walk into blockchain with both feet from a regulatory perspective, things will only happen or improve at the margins, i.e. help us to make marginal gains compared to what we are already doing,” complained a union banker in London. “Blockchain is definitely a game-changer for primary capital markets, but only when we are allowed to use it. At the moment it’s £300,000 a year for our office – that’s the equivalent of about two associates – just to be there in case something happens.”
All of this begs the question, are these inflated investments in innovation departments worth it?
In some areas of banking, the answer is obviously “yes”. In retail, the benefits of having a top-notch online and mobile user experience are obvious. In M&A advisory, perhaps less, though analysts would probably appreciate any app that automates the process of compiling a 100-page pitch book.
What about applying blockchain to capital markets? The potential efficiencies, if DLT evangelists are to be believed, are huge, not to mention the prospect of self-adjusting coupons.
But it is precisely in the capital markets that the case for a “fast follower” rather than a “first mover” is particularly strong.
The interest of the capital markets is to enable organizations in need of capital to draw on the financial resources spread throughout the world in pension funds, in the balance sheets of insurance companies, in the treasuries of companies, in hedge funds and everywhere else.
For this process to work effectively, bonds need to be somewhat commoditized and – to use a word that many have only recently learned the meaning of – fungible. Ideally, an investor would look at a bond and find that it is the same as any other bond except for the risk of default.
Therefore, for new bells and whistles to be successfully pinned on bonds, these bells and whistles must be widely adopted and accepted. That’s part of the reason technological change is happening here at such a glacial pace.
That being the case, why would a bank risk experimenting with a new technology like the blockchain? Once the bank has cracked the code, it will have to share it with its competitors, otherwise its discovery will be useless.
Indeed, investment banks have found a way to share the risks associated with innovation that requires market-wide adoption: the consortium.
Since advancements in the application of blockchain technology are expected to benefit all market participants, it makes sense for banks to band together and pool their resources. One example is Fnality International, the company developing a blockchain-based payment system for wholesale markets, whose shareholders are a group of 15 banks from around the world.
Wouldn’t it be smarter, then, for a bank to step back, at least in this particular area of innovation, and wait for its competitors to do all the work?
This is a point that is not lost even for some fintech entrepreneurs.
“I think if it’s a positive move, it’s completely legitimate,” said one of many ex-bankers now trying to impose a technology platform on his former colleagues and rivals. “You weighed the pros and cons and decided that you were going to leave it to others to do the pioneering work, to make mistakes, to define the future or whatever. If they are ahead of you, how much have you actually lost? »
Another banker-turned-fintech entrepreneur went even further, suggesting that in some cases, banks might pursue historic technology breakthroughs primarily because the executives involved thought it would help their careers.
“People who are trailblazers are usually people trying to ‘cement a legacy’ or buy a ‘lottery ticket’ to become an expert in a lucrative field if the field takes off,” he said. “From a bank’s perspective, it would be much better to sit back and wait for the tokens to fall where they may.”
But there are strong counter-arguments. First, the benefits of marketing and public relations should not be entirely negated. Prime bank clients typically want to work with world-class investment banks, and being at the forefront of technological innovation is another marker of this, much like leadership in sustainable finance. JP Morgan, at least, seems to understand this.
Technological prowess also attracts other stakeholders, such as employees, not just those on the innovation team. GlobalCapital knows at least one senior capital markets banker who left his company in part because his ideas for innovative blockchain-based transactions were rejected.
Above all, there is the question of how a financial institution can make a calculated decision on whether or not to invest in a revolutionary technology unless it has an idea of what this technology could lead to.
What if automated bonds on the blockchain finally completely eliminate the need for a conventional bookkeeper? Wouldn’t it be better to be warned in advance that such a change is in the air?
Ultimately, there are strong arguments for being both a frontrunner and a fast follower. A deliberate choice to be one or the other is valid.
What would be inexcusable, however, would be to think it doesn’t matter, to defer completely to everyone else, and to assume that your own company can catch up later, come what may.
“It’s different to make the decision to be a fast follower,” said the first fintech entrepreneur. “It’s like saying I’m not going to hedge my FX exposure forward – it’s a conscious decision. There are clearly organizations that have said, ‘We’re going to wear the yellow jersey, be in the lead. of the peloton, define that future and run the risk of falling down dark alleys”. But a number of people are in the position of “we just can’t make up our minds. “”
One thing is certain: there will be no room in the future of capital markets for complacency.