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June 2015

THE DIGITAL TRANSFORMATION OF CAPITAL MARKETS

THE DIGITAL TRANSFORMATION OF CAPITAL MARKETS2 COLLATERAL MANAGEMENT: WHEN DOES IT MAKE SENSE TO OUTSOURCE? 2

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PART 1: Capital Markets Feel Digital Transformation 4

PART 2: Digital Transformation: Agility Needed 6

PART 3: Digital Transformation = Cultural Transformation 8

PART 4: Digital Transformation: A Look Ahead 10

TABLE OF CONTENTS

Sapient Global Markets recently participated in a four-part article series entitled, “The Digital Transformation of Capital Markets,” with leading online financial services magazine, MarketsMedia. The series, included here, examined some of the key themes within digital transformation, including the pace of change, the need for agility, cultural shifts required to ensure success and the future of digital.

THE DIGITAL TRANSFORMATION OF CAPITAL MARKETS

THE DIGITAL TRANSFORMATION OF CAPITAL MARKETS4

“On top of that, and this is particularly true of the capital markets sector, new regulations are changing the whole operating and capital cost model,” said Matthew Hopgood, London-based vice president at Sapient Global Markets and co-head of the firm’s visualization practice. “Organizations are having to aggressively re-think what their service model and value proposition is, or exit the space. You can see certain banks getting out of fixed income or commodities.”

Companies like Uber, Airbnb and Spotify have

disrupted the businesses of transportation,

hospitality and music. Agents of change are now

eyeing capital markets as the next frontier for a

similar digital transformation.

The financial sector historically hasn’t been

the most fertile ground for disruptors and

innovators, but that has changed in the past few

years as new regulations in North America and

Europe have encouraged competition in areas

such as corporate, investment and

retail banking.

CAPITAL MARKETS FEEL DIGITAL TRANSFORMATION

Part 1

Matt Hopgood, Sapient

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Hopgood noted that the concept of digital transformation can be perceived as solely driven by technology, when in reality it’s much more than that. “Digital transformation is not just a technology imperative, but a cultural and agility change,” he said. “You have to change the attitude and the culture so that the organization has agile thinking and adaptability at the core of what they believe.”

Retail banking in the U.K. is an example of a business that is digitally transforming, as new players such as Atom Bank, Charter Savings Bank, Fidor Bank, and Starling position themselves to take on a formidable roster of name-brand incumbents that includes Barclays, HSBC, Lloyds and RBS. Hopgood has observed more start-up activity in the past year than there had been in the previous decade.

As they’re free of legacy systems, the challengers can offer the latest technological systems and features, but tellingly, they have gone beyond that in their early competitive salvos. Atom Bank has said it will be “fair and transparent,” and act “in the best interest of its customers,” while Starling promises “a digital banking service that’s truly personal to each customer,” rather than “just mobile versions of paper statements.”Said Hopgood, “it should be not just about the competitive and the market gaps that you’re seeking to adjust, but ultimately how you’re positioning your organization for increased and sustainable corporate agility.”

The same type of transformation that’s happening in retail banking can be expected to occur in the capital markets space, according to Ari Lightman, a professor of digital media and marketing at Carnegie Mellon University in Pittsburgh.

Lightman cited Covestor and Marketocracy, online investment managers that lean toward social networks, as examples of budding digital transformation in capital markets. “The folks that have the interface with the customer are getting the really good market research,” Lightman told Markets Media. “They can present and monetize information in ways that some of the legacy players are very interested in.”

The digital-transformation bar is also being raised by institutional customers of capital-markets businesses. When investment executives at Principal Global Investors meet with clients, the expectation is for commentary on fund performance as of the most recent market event, rather than just quarterly which had been the norm.

“We focus on digital transformation efforts in alignment with business priorities,” said Brian Ness, vice president and chief investment officer-IT at Principal Global Investors, which manages $330 billion. “We have a growing and diversifying set of products and clients worldwide. This provides opportunities for digital transformation in how we interact with clients as well as how our teams work together across the globe. As a result we have transformational activity occurring in both customer interaction and staff agility.”

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“Our brand is no longer front and center,” said Stephen Jenvey, principal architect for sales, marketing and digital at Capital Group. “In order for us to get our message out there we need to look at methodologies typically used to target consumers in the B2C space to influence purchase decisions, without necessarily looking to convert in a traditional B2C way.”

“This is a new approach for us,” Jenvey continued. “Historically we produced a lot of communication materials. We would create literature for both web and print, for our advisors to enable them to share the American Funds Voice, Insights and Viewpoints which would be distributed via wholesalers and our web presence. That’s really changing, as we’re looking for new ways of getting our message out there to investors, advisors and the marketplace at large.”

For a capital-markets firm to digitally transform

itself, agility is needed. Lumbering, bureaucratic

organizations will be left behind.

Capital Group, which manages $1.15 trillion, has

changed the way it distributes and disseminates

information about its flagship American Funds,

which include equity and bond mutual funds.

Rather than distribute funds through advisors

and service accounts through share classes as

per standard practice, the Los Angeles-based

firm is shifting to a fee-based model where the

advisor provides advice as well as follow-up

customer service.

DIGITAL TRANSFORMATION: AGILITY NEEDED

Part 2

Stephen Jenvey, Capital Group

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To be sure, agility — defined as the ability to be quick and graceful — won’t win any customers in and of itself; rather, it’s what an organization is able to provide by virtue of being agile in an evolving marketplace. In the context of digital transformation, agility enables a company to provide advocacy, focus and transparency.

Within capital markets, initiatives around advocacy and brand loyalty have increased since the global financial crisis of 2008-2009, when cratering markets gave the financial sector a black eye.

As a result of weak customer advocacy — manifested by firms acting more like manufacturers and product producers rather than service providers — and an ensuing erosion of brand loyalty over the past decade, “a lot of banking brands and asset-management brands are feeling particularly vulnerable in regards to new market entrants,” said Matt Hopgood, vice president at Sapient Global Markets and co-head of the firm’s visualization practice

“You have a whole new sense of urgency,” Hopgood explained. “We’re seeing a lot of banks in the client-advocacy space — increasing standalone client portals and mobile platforms, joining up channel platforms, etc. These are all very good things to spend and invest your money on, but the opportunity is broader than that. It should be not just about the competitive and the market gaps that you’re seeking to adjust, but ultimately how you’re positioning your organization for increased and sustainable corporate agility.”

There are three aspects of digital transformation for financial organizations, according to Stephane Dubois, founder and chief executive of market data provider Xignite.

One is to break out business lines into separate pieces that can be reinvented to better compete with startups; two is to create a unique, transformational front-end user experience via mobile and web-based solutions and optimized user interfaces; and three is to create a scalable, low-cost technology stack on the back end that leverages open source software, the cloud, and application program interfaces.

“The next generation of financial organizations will be built on the cloud and on top of APIs — from scratch,” said Dubois. “Firms will be able to create new hedge funds or financial service providers by leveraging existing services offered digitally via APIs…all of that will run in the cloud for a fraction of the cost of traditional finance. The millennial generation will gobble up those services.”

Capital Group used the Adobe digital marketing cloud, which provides a multi-channel experience, in conjunction with other vendors to build a platform that enables omni-channel content distribution. The asset manager has also ensured that they have appropriate change management to support organizational transformation and agility on top of the platform.

“Agility is a big deal,” Jenvey said. “How can you transition an organization which was a more traditional print-centric organization to omni-channel, while still respecting where you need time to market and still acting within the constraints within the capital-markets environment?”

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“It’s a real change from picking up the phone to an aggregation of different applications on the desktop and electronic markets,” said John Reilly, managing director of capital markets trading at Wells Fargo Advisors, the retail brokerage division of Wells Fargo Corp. “The trader now has those tools available to them at their fingertips, in front of their faces, without having to go to the phone. It’s a much more efficient process. The aggregation of the information is an incredible change.”

San Francisco-based Wells Fargo has a company-wide initiative to encourage employees to come up with new ideas and question the old ways. “The cultural shift isn’t going to happen by itself. There’s a big effort to push it along and to try and change things,” said Reilly. “Some of these municipal bond traders have been here 15-20 years. We have to force them out of their comfort zone and ask them to question their processes.”

Digital transformation represents a cultural

shift, particularly for the sell side. The changes

that have taken place in equities, such as

electronic order books, alternative trading

systems, and algorithms, and which are now

starting to carry over into fixed income,

require shifts in mindset as much as advances

in technology.

DIGITAL TRANSFORMATION = CULTURAL TRANSFORMATION

Part 3

John Reilly, Wells Fargo Advisors

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“We also ask them to question our policies,” Reilly continued. ” What can we do be doing better? How can we leverage all this information that’s now in front of them to make their jobs not only easier but more productive?”

Brokers are being called on to adapt to the continuous sophistication of market participants, protect their information, manage their footprint and empower more users, said John Donahue, senior vice president and head of equities at Fidelity Capital Markets.

For example, Fidelity Capital Markets Service Bureau allows its clients to optimize routing and trading algorithms to enhance existing workflows and improve trading performance. “With Service Bureau, clients have been particularly enthusiastic about our analytics capabilities and expertise as a best-execution partner,” said Donahue. “We leverage our proprietary comparison tools to explore, rank and select the best situation-strategy combination for a specified trading objective.” “It has not only initiated a deeper dialogue between our clients with their brokers leading to performance improvements by improving or identifying the right liquidity and execution offering, but it has also better aligned the order-allocation process to generate performance improvements for investors,” said Derrick Chan, senior vice president at Fidelity Centralized Electronic Trading.

Companies need to create an environment where employees are encouraged to explore opportunities for transforming customer experience, operations, and business models.

“Every company needs to figure out how to develop their own digital maturity,” said George Westerman, research scientist at the MIT Sloan Initiative on the Digital Economy. “We see this as being a very top-down effort led by a very strong vision for how you’re going to be different and then driving that transformation through the organization.”Many companies make the mistake of putting technology people in charge of the digital transformation. “That’s the wrong way to go, not because the technology people are bad, but because the real value comes from changing the way you operate,” Westerman said. “What you want to do is have a very strong top-down transformation that you’re leading. That’s business and IT working together. It’s not something you just delegate to technology.”

Westerman, whose research and teaching focus on digital technology leadership and innovation, uses the term “digital masters” to define corporate leaders in digital transformation. “We definite digital mastery in terms of two dimensions,” he said. “One is digital capability, and the other is leadership capability, which is how to envision and drive change.”

Companies that are higher on digital capability tend to generate higher revenue, while those that are higher on leadership capability tend to be more profitable, averaging 26% higher profitability than their peers, according to Westerman. “The technology is one thing, but leading the transformation, envisioning, engaging, governing is even more important,” he said.

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“There’s a great line from The Origin of Species, where Darwin says it’s not the strongest that survive or the most intelligent, but the one that’s most adaptable to change,” said Matthew Hopgood, London-based vice president at Sapient Global Markets and co-head of the firm’s visualization practice. “That’s at the heart of the digital-transformation conversation.”

Within capital markets, that adaptability to change will manifest itself in a multitude of specific ways.

“The most successful firms will have a well-planned data strategy and product architecture to adapt to the evolving marketplace,” said John Donahue, senior vice president and head of equities at Fidelity Capital Markets. “More buy-side firms will be investing or partnering with technology providers in order to merge their proprietary data with external data, to assist in identifying opportunities and trading improvements.”

For a perspective on the future of the digital

transformation of capital markets, rewind to a

seminal work of scientific literature published

156 years ago.

DIGITAL TRANSFORMATION: A LOOK AHEAD

Part 4

Josh Sutton, Sapient

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The goal will be to effectively integrate that data with broker or other third-party platforms into an end-to-end optimal execution strategy, with a sustainable process that can adapt to innovation in the industry. “The trader’s role will continue to expand to integrate more information to improve the broader execution strategy, creating a far more cohesive trader-technology relationship,” said Donahue.

There are four primary lenses through which digital transformation can be viewed, according to Josh Sutton, vice president at Sapient: customers, employees, processes and business.

As global lead for digital transformation in financial services at Sapient, Sutton works with clients to identify opportunities to transform their business in the areas of customer engagement, empowerment of employees, optimization and automation of business processes, and the creation of new business lines. The customer lens is about, “How does your customer engage with your firm and how do you create a better experience for them?” he said. “The second is the employee: How do you empower your employees to do their jobs better, to perform more efficiently, and to create a better result for the company and for its clients. The third is: How do you optimize and automate your processes? How do you look at business functions that aren’t strategic and drive automation? The fourth, which is going to have the most impact in the three- to five-year window, is around new business lines, which include accretive and disruptive lines.”

Accretive lines, Sutton explained, are about how firms can capitalize on changes in the market and create new revenue streams, for example, a clearing service that wasn’t a revenue stream yesterday but could become one tomorrow once regulations come in to force and demand for those services increases. Disruptive business lines are about how firms can leverage innovations as a result of digital technologies, such as peer-to-peer lending, which can impact the entire business in a fundamental way and shift the way it works.

“Investment in technology will continue to create efficiencies in the market and, in order to differentiate, brokers will focus more time not only on processing trades, but value-added services and products that help their clients improve performance for their end investors,” said Derrick Chan, senior vice president at Fidelity Centralized Electronic Trading.

Brokers will need to be innovative and identify where they can best provide value in the process. “Competition, technology, and the pursuit of performance enhancements will lead to market efficiency improvements throughout the capital markets spectrum,” Chan said.

Capital-markets firms have “led the world” in driving business via high-velocity technological advancements, but there’s more to digital transformation than that, according to Jason Bloomberg, president of training and advisory concern Intellyx.

“Continuing to place bets on velocity at the exclusion of agility will lead established players to fall prey to the ‘Innovator’s Dilemma’, thus opening up opportunities for newer, more agile players who seek to disrupt the status quo,” Bloomberg said.

Digital transformation, concluded Sapient’s Hopgood, “requires an evolution of the entire company because it’s elevating change outside the departmental silos, to a corporate-wide and cultural level.”

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