With business booming and massive regulation on the horizon, financial services is fertile ground once again. Who would've thought?
By Joseph Kornik
For an industry that was rattled to its core a mere 18 months ago, financial services—and banking in particular—has apparently weathered the storm and come out just fine on the other side. Actually, even better than fine, at least for most of the biggest players. Many of the largest banks are back to their 2007 valuations long before even the most optimistic forecasters had imagined.
"I think we got to the gates of hell—and we got a pretty good whiff of hell—and we survived," says Jess Varughese, managing partner of Milestone, a New York-based financial services firm.
Survived, yes. The same? Not quite. For sure, two of the industry behemoths—Lehman Brothers and Bear Sterns—are no more. As a result, for many consulting firms, huge chunks of business disappeared practically overnight.
Yet, on the other hand, the industry remains largely unchanged. Since the U.S. Government intervened to help save the banking system in late 2008 and early 2009—and despite how one may feel about it, Varughese is pretty sure "we'd be trading beads and shark teeth by now" without it—the administration has spent much of its time and political capital on healthcare, not financial services reform.
"I think we've missed a real opportunity," says Richard Apostolik, president and CEO of the Global Association of Risk Professionals (GARP). "And I'm afraid we're running out of time to get anything meaningful done this year."
To be fair, some regulation has already passed, specifically compensation and consumer protections concerning credit cards, mortgages and overdraft protection. The House proposed its financial reform bill in November. In March, the Senate finally got around to introducing its draft bill, which would allow the Fed to examine any bank-holding company with more than $50 billion in assets and would implement a form of the so-called Volcker Rule that would place restrictions on large banks trading using their own capital.
And while Washington was dragging its feet on reform, the market was catching fire, particularly in the second half of 2009. The Dow is up some 70 percent from its March 2009 lows. Big banks are back to giving record bonuses and the entire financial services industry—for the most part—is still operating much the same way it did back in 2007.
All of this adds up to pay dirt for financial services firms that were positioned properly to capitalize on a market that went through an unimaginable upheaval, then a period of stability and rapid growth with the help of Fed. Now, the industry is preparing for an uncertain, but undoubtedly enhanced, regulatory environment. It's been a perfect storm for consultancies.
Consider this: During the second half of 2009, Capgemini's Banking Consulting practice in North America was running at utilization rates north of 90 percent. Unbelievable, and "unsustainable," says Jim Washburn, Banking Consulting practice leader for North America. "We couldn't go on like that. We staffed up, shifted resources around to meet the demand and have gotten more selective about the types of engagements we pursue."
Capco, a New York-based financial services firm, couldn't bring people on board fast enough to meet consulting demand. The firm's average number of days between hiring and deployment was .8. Tom McKelvey, Capco's chief operating officer, says the firm will grow about 300 percent in North America and will double the overall business by the end of the year. Capco will have 600 North American consultants by the end of 2010. It had 200 in October.
"We've accomplished this quarter something we thought would take us four years to do," he says. Not bad for a firm that just launched its expansion plan less than six months ago.
| Bringing the Napster Model to Financial Services Sandeep Vishnu, a partner in Capco's Finance, Risk and Compliance group, has a unique idea that he things could work in financial services. With portfolios flying around in second and even third markets, Vishnu maintains that the industry simply lost the ability to price risk because bankers really didn't know what they were buying. His solution? Vishnu envisions a world where each financial transaction would carry a digitized data tag that would include the complete risk profile for that particular portfolio. "This was sort of the Holy Grail for Napster and other digital peer-to-peer distribution networks," he says. "There's no reason why this concept couldn't be transferred to financial services—each security is its own digital asset." For another real-world example, he points to freight shipping containers that carry an electronic tag giving workers immediate access to all pertinent information regarding the container at any point in the process. "We need that in financial services," he says. Although it might make good business sense, Vishnu says won't hold his breath waiting for financial firms to develop the system. "There will be up-front costs associated with it, and if they don't have to do it, they won't," he says. "This is where the regulators will have to play a part. Someone will have to tell the industry that they'll be held accountable for what they originate." |
Just a few blocks away at Milestone, a 30-person firm, demand outpaced supply. The firm doubled in 2009 and is once again on pace to double this year, says Varughese. "We finished '09 and exhaled and thought we'd get a bit of a breather. But on the morning of January 4, the phones were right back to ringing off the hook," he says. "This industry is in turmoil and there's a tremendous amount of change going on," Varughese says. "If you can help manage change, you'll be in high demand."
The same financial services story is being told at Deloitte and The Boston Consulting Group, among others. What's going on?
An Industry Bounces Back
John Garabedian, a senior partner who leads BCG's Financial Institutions practice in the Americas, says the financial services industry is entering a new normal. "The industry is going to restructure, and that bodes well for taking action and rethinking the business. It also bodes well for financial services consulting demand," he says. "There's a great deal of strategic work going on right now because so many of the economic models are being challenged."
Most of the belt-tightening was done last year without consultants, he said. But now, "clients are asking: 'how do we make ourselves more effective?' That's the work that we've been doing. Clients took a hard look at their businesses, restructured, took the necessary defensive actions and now are thinking about offense."
That includes, Garabedian says, a much higher demand on customer insight work. "Consumers have gone through a financial trauma. Clients are thinking: 'how can we rethink customer service, how can we rebuild that trust?' As a result, we're seeing higher demand for new product development to win back the hearts and minds of consumers," he says.
At Capco, there's a similar refrain around pro-active thinking, specifically "aggressive efforts around cost control, cost transparency, risk process and reporting, analytics and target operating models," says Christopher Hamilton, a partner at Capco. "Clients are re-assessing the business they have.
They are also migrating to more offensive behaviors, such as revenue replacement, customer attraction and merger integration. That definitely wasn't the case a year ago." Those mergers, however, will be more targeted acquisitions rather than large scale mergers that have defined the last two decades in banking, he says.
Milestone's Varughese agrees that the client tone has shifted "away from knee-jerk, hold your breadth management styles" to more controlled and forward-looking decisions. "Cost reduction is still an area of focus, but it's no longer a force of will, but more about transforming the business model," he says. "We've seen rationality and strategic thinking come back. Now, we're starting to help clients plan 18 to 24 months out instead of just leading them through a fire drill."
Varughese also sees significant merger and integration work ahead because of the serious dichotomy between the largest banks and the regional banks. "That problem is waiting to flesh itself out, and I think there is a significant shoe left to drop there," he says.
"As these smaller, more regional banks get closer to crisis levels, the FDIC will look for potential partners for these banks. This could remake the banking environment just below the Top 10 and will fuel a lot of the consulting work we'll do."
Meanwhile, over at Capgemini, Washburn says he's starting to see the investment in technology and consulting coming back after being shelved in 2008 and the early part of 2009. And by all indications, it's only going to get better. "We're seeing a lot of Phase 1 analysis of major transformation programs," Washburn says. "Companies are spending $10 million now to see how they'll spend $100 million down the road. That $100 million will be spent in 2011 and 2012. If the economy stays good, then I think we're looking at double-digit growth this year, as well as in 2011 and 2012."
Regulation Rules the Day
Technology is also on the minds of clients of Deloitte & Touche, specifically about helping them deal with the inevitable—an enhanced regulatory environment.
"Inadequate and fragmented technology infrastructures were one of the big problems and lessons learned from the crisis," says Tom Rollauer, director, Governance and Risk Strategies practice for Deloitte & Touche. "[Regulations will] require a higher degree of technology and management information to be in place, and we're being proactive with clients to help them prepare for that.
"Accessibility to that type of information is in much higher demand right now since regulators will most likely require that to manage systemic risk to understand capital and liquidity positions. You always want to be out ahead of the regulations, not reacting to them."
Even though the regulation landscape hasn't been clearly defined, "I think it's pretty clear that everybody has woken up to the fact that the regulatory train is bearing down on them, and the broad outlines are clear enough," Varughese says. "I think there's going to be a lot more focus on derivatives, risk management and transparency. The examiners are coming in with a completely different mindset; they've bolstered their ranks and they are in no mood to let anything slip between the cracks."
And keep in mind, Capgemini's Washburn says, "there are some clients that had to become bank-holding companies in order to get federal money and are now suddenly dealing with regulation they were not well positioned for," he says. "Clients are spending tens of millions of dollars to ready their financial and operational systems to handle the regulatory reporting that's already required. That drove a lot of our business in 2009."
What the regulation ends up looking like may still be open for debate, but everyone agrees on one thing: something significant is coming. "When things are good, the industry always has a tendency to take its eye off the ball," Deloitte's Rollauer says. "But this crisis was different from the others that we've gone through. It was serious, it was global and the regulators are taking the position, at least today, that they aren't going to let this happen again," he says. "I'm hopeful we'll end up with meaningful regulation this year, but I'm less optimistic as time marches on. At a minimum, I'd like to see them deal with systemic risk, the resolution authority for failing institutions, derivatives and too big to fail."
On that last point, Sandeep Vishnu, a partner in Capco's Finance, Risk and Compliance group, says "if a bank is too big to fail than it's too big to exist. I don't think we should never have a situation of too big to fail, and I think that's going to need to be addressed with legislation." Everyone seems to think it will.
And while plenty of people are concerned that lawmakers could go too far and stifle and stagnate what's still a pretty delicate system—the Volcker Rule is a case in point—the industry also seems to recognize that policing itself may not be the best course of action right now. In light of what's happened, most see the renewed rigor toward risk management as a very good thing.
"I'm a big fan of risk-based capital," says GARP's Apostolik. "I think that imposes its own regulations. The more risks you take, the more capital you'll be required to have on hand. That will be a governance measure. Focusing on the riskiness of the activity and assigning capital charges to that activity is the way to go, I think, rather than trying to make one-size-fits-all regulation."
For his part, he puts the odds at meaningful regulation getting done this year at less than 50/50, but adds that "something will get done next year." There has to be regulatory reform and it has to be done globally, he says. "All this talk about banks too big to fail, how to handle the demise of a bank, transaction taxes, derivatives… these all have global implications."
When all the smoke clears, Apostolik says there needs to be some type of coordinated global regulatory effort. "If not, we're going to end up with a regulatory arbitrage type of issue, and you're going to find all types of problems with banks being able to compete fairly."
A noble enough idea and, in theory, most would agree. The Basel Committee on Banking Supervision and the G-20 member countries are working on doing just that. While there is general agreement and coordination on several big themes—stronger capital standards, oversight of systemic firms, oversight of derivatives and international compensation standards—the devil, as they say, is always in the details.
"I just don't see global regulation happening," says Capco's McKelvey. "It's just too difficult because each county has it's own self interest to protect."
| Will Volcker Rule Take Us Back to the Future? There's been a lot of talk in Washington lately about President Obama's so-called Volcker Rule, which would—among other things—ban proprietary trading by U.S. banks. The rule, which was unveiled in January, is named after its chief proponent, former Federal Reserve Chairman Paul Volcker, who is now chairman of the White House's Economic Recovery Advisory Board. Despite the Obama Administration's tough talk about the need to return to a functional separation between commercial banking and investment banking that once existed under the Glass-Steagall Act, there's still plenty of skepticism to go around. The proposed ban on proprietary trading was met with tough opposition from critics who say it would put the largest U.S. banks at a competitive disadvantage. "I think the Volcker rule is an overreaction, and I think it would be a disaster for the U.S. banking system," says Richard Apostolik, president and CEO of the Global Association of Risk Professionals (GARP). "You simply can't have U.S. banks being subject to what the Volcker rule proposes without the same rule in place globally or else U.S. banks become uncompetitive. "None of the things that rule addresses caused the crisis. Why are we making changes that had nothing to do with what we are dealing with?" Sandeep Vishnu, a partner in Capco's Finance, Risk and Compliance group, says that "it's not a question of separating retail and investment banking; rather, it's more a question of this—is there enough transparency in the system that people are able to make judicious risk-weighted decision before they move things forward in the market?" he says. "The secondary market, even if had been separated between retail and investment would still have existed and would have been able to buy portfolios without having all of the risk positions and they would've continued to move them on into secondary markets." Vishnu says the problem wasn't too much risk, but how it was priced. "We lost the ability to price risk. That's not going to be fixed by re-instating Glass- Steagall," Vishnu says. "Glass-Steagall was repealed because there was a feeling that wasn't a level playing field internationally." "I would be shocked to see a huge structural change in the types of business that banks can operate in," says Jim Washburn, Banking Consulting practice leader for North America. "I think there will be more and more scrutiny and legislation about the types of products and the mix of products that banks can have to manage the systemic risks. I don't think we'll see [the administration] dictate a separation, but they might try to encourage a separation. I think that's more likely." Tom Rollauer, director, Governance and Risk Strategies practice for Deloitte & Touche, also thinks we'll end with some type of compromise. "I wouldn't like to see us revert back to a less competitive model but I think we need to be very sensitive to what just happened, and I think we need to give our regulators enough power to address those risks in the normal course of prudential regulation, not through legislation," Rollauer says. "A lot of banking institutions have spent the last ten years trying to create common infrastructures between the two aspects of the business in terms of shared services and shared systems," he says. "A lot of technology and consulting dollars have been spent combining the two." |
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