Capital markets have been evolving more rapidly than ever over the last year and a half, and we don’t expect the pace to slow anytime soon. Democratization of markets, anticipated regulatory changes, and continued debate around digital assets are just some of the dynamic shifts forcing capital markets organizations to adapt if they want to remain competitive.
RSM has identified five key trends driving this change in the capital markets space.
1. Growth of digital assets: Digital assets and cryptocurrencies are becoming significantly more popular as it becomes easier for consumers to invest in these products on the increasing number of platforms allowing for such trading activities.
The growing investor interest in the digital asset space has not gone unnoticed by the Securities and Exchange Commission. SEC Chair Gary Gensler has warned that the industry will not advance without greater regulatory oversight and that consumer protection should be a top priority.
Although there will likely be some criticism if the SEC moves forward with regulations surrounding the crypto space, many will applaud the move, as such regulations would likely lead to broader acceptance of cryptocurrencies by institutions and retail investors alike.
2. Changes to the regulatory landscape: With the Biden administration in place and Gensler now helming the SEC, we expect a shift toward more regulation for capital markets firms in the near future. Several factors will drive this change, including the volatility the market has experienced during the pandemic, the increasing popularity of digital assets and cryptocurrencies, and increased security and privacy risks for businesses and consumers.
According to Reuters, Gensler has already expressed concern over the lack of regulation for cryptocurrency trading platforms as well as the controversial practice of payment for order flow, “whereby wholesale market makers pay broker-dealers to send them client orders which they execute on their own trading platform or a third-party platform.” It would be no surprise to see new proposals or changes to existing regulation in the near future as the SEC digs into these focus areas.
3. Rise of retail investors: Newer entrants into capital markets, such as Robinhood, are using advanced digital platforms to attract a new class of retail investors into the market, enabling more everyday consumers to invest in stocks. This has led to the further democratization of investing beyond institutional investors.
This democratization, coupled with the power of social media, has created significant market-making movements that have caught even the most seasoned investors by surprise. With online retail trading becoming mainstream, many of the legacy firms will need to adapt to remain competitive in the market. Events like this will require trading firms, hedge funds, and even clearing firms to rethink not only their revenue strategies but also their risk tolerances in order to avoid loss exposure if similar situations arise in the future.
4. Transition away from Libor: With the end of the London Interbank Offered Rate, commonly known as Libor, market participants must navigate new alternative reference rates. The Alternative Reference Rates Committee, formed by the Federal Reserve Board, selected the secured overnight financing rate (SOFR) as its preferred alternative to Libor.
However, SOFR is not the only new reference rate out there. Other alternatives, unsecured reference rates, such as Ameribor® and the Bloomberg Short Term Bank Yield index, may be a better option for some organizations. Because these rates are designed differently, they will behave differently. Furthermore, the implications for contract design and execution, operations, and performance reporting will be different depending on the chosen rate. There are also financial reporting considerations that will come with the adoption of a new rate that companies should be aware of.
As part of this transition, it is important that organizations first understand which contracts will be affected. Existing contracts with Libor terms will expire after 2023; however, any new contracts created after 2021 will be affected. Further, understanding the differences between the new alternative reference rates options and knowing what your business needs are will be critical in identifying which rate is best for your organization. Planning for the transition away from Libor will be important regardless of which alternative you choose.
5. Shorter settlement cycle: The Investment Company Institute, the Securities Industry, and Financial Markets Association, and the Depository Trust & Clearing Corporation are collaborating on an initiative to accelerate the trade settlement cycle from two days after a trade is executed (T+2) to one business day after a trade is executed (T+1).
“Reducing the settlement cycle will create greater efficiencies in the market and further protect investors,” as this ICI article explains. “Accelerating the settlement cycle will help reduce systemic risk, operational risk, liquidity needs” and counterparty risk, ICI added. “By reducing these risks, it would also reduce margin requirements and collateral requirements for broker-dealers. It will also allow investors quicker access to their funds following trade execution and settlement.”
With final research and analysis underway, we can anticipate a definitive timeline for the move to T+1 in the near future. A shortened settlement cycle could profoundly enhance the health and resiliency of our capital markets.
Conclusion
The capital markets are often seen as the engine that powers the financial services ecosystem. To keep the engine running at optimal capacity, it will be important for capital markets firms to remain watchful for changing regulations, proactively anticipate emerging competition, and position themselves to deliver on evolving investor preferences. While failing to do so doesn’t mean they will be left behind, it may mean that they will become less relevant.
