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An endangered species: The survival of the broker/dealer
As upheaval buffets the financial services industry, it is already apparent that the resulting changes are nothing short of monumental. These changes are affecting virtually all players to varying degrees, and while some - including custodians, depositories and asset managers - will emerge as clear winners, broker/dealers will feel the impact most dramatically.
The reasons are complex. The advent of Straight-Through-Processing (STP), with its urgency for speed, its compression of time and its demand for immediate information and virtualization, is negating the need for traditional broker/dealer functions, such as order management and trade execution, as well as time-consuming processes such as controlling and tracing security movement. Furthermore, Electronic Communications Networks (ECNs) and electronic fixed income trading systems provide real-time or periodic cross matching sessions, "auction systems" that allow issuers to solicit bids directly for newly issued securities and "direct issuance systems" that allow companies to distribute debt directly to investors. These functions are actively diverting order flow away from exchanges and stealing commodity business from broker/dealers.
On the buy-side, institutional, corporate and financial services clients want direct access to markets - something that ECNs, as they consolidate, increase their liquidity and begin to succeed, can provide. By trading directly through ECNs, these self-directed, execution-oriented investors will severely reduce the role played by the traditional sales broker and significantly change the trader's role.
As a result, we'll soon see an order-driven market in which the participants - particularly asset managers, who seek close, cost-free connectivity with the people selling them securities - will provide liquidity, and broker/dealers selling commodity products like equities and fixed-income securities will have outlived their usefulness.
Reinventing the Future
For example, traditional investment banks will uncouple execution from the advisory part of the business. Instead of being paid for transactions, they will make money by developing and selling sophisticated financial solutions to meet client needs. Banks will work closely with their clients and with those executing for their clients to deliver the unbundled service in an efficient and effective way.
The implication for broker/dealers is that they must occupy the "aggregator" position in these new business models, identifying "value-add" providers and coordinating flawless delivery to their institutional customers.
To this end, broker /dealers must become financial strategists-providing research and strategic advice, identifying sophisticated trading strategies, solving client financial problems, offsetting their own risks in a cost-effective way, and focusing on relationship building. They must understand the new requirements of their customers and capture, analyze and share customer information in a way that creates knowledge. They must then integrate individual customer information into all their business proce- sses and filter product and service innovation ideas from their customer interactions.
After the dust settles, the remaining broker /dealers will resemble the merchant banks of the late 19th century: with an expertise in specific industry sectors, they will participate in putting deals together and, with global financial acumen, they will invest their own capital in those deals.
But to make money on such deals, investment banks will have to change their business models. Instead of taking one idea book to prospects one by one, they will distribute deal ideas electronically. They might create an electronic community of CFOs, attract prospects to their web site and conduct "conversations" about topics directly related to a CFO's business problems. By monitoring the site, they can come to understand their prospects' specific needs, objectives or expectations and design products that address them directly. Even better, they will enable their prospects to assemble their own financial solutions using corporate finance "building blocks."
Broker/dealers will also see new opportunities in market intelligence and in process and service excellence. They can, for example, transform real-time data into trade ideas and executions by providing sophisticated multi-currency real-time risk management, analysis and advice; use information on holdings to collateralize with low-demand inventory and lend high-demand inventory at a premium; and identify and exploit opportunities for their own account. Process and service opportunities include concentrating on servicing existing and emerging needs associated with STP; for example, performing back-office operations, aggregating investors' activity across multiple brokerages and providing flawless entitlement processing.
New technologies will facilitate the work of these transformed broker/dealers. In the not-too-distant future, desktop capabilities will electronically search across all electronic and institutional exchanges to find the best price for transactions. Every trading desk at an investment bank will be equipped with this capability, and customers trading securities will soon expect nothing less.
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