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Financial Services Space-Time Continuum

Financial markets firms have consistently earned more than the average company over the last decade, by a large margin, through innovation and value add. What's in store for the next decade? Suzanne Dence, a managing consultant with IBM, and Peter Poulin, global head of administration and accounting at Brown Brothers Harriman, explore this topic.

Poulin: Suzanne, you've been thinking about the future of investment management quite a bit lately.

Dence: Yes, as part of IBM's Institute for Business Value, I focus on what the future might be like in the financial markets industry. Financial markets firms have long benefited from the competitive edge provided by proprietary information access and market insight, but these advantages will come under significant pressure over the next decade given greater levels of transparency and speed.

Poulin: Speed and transparency-both are redefining every aspect of our business and personal lives.

Dence: As our recent Financial Markets 2015 study suggests, given speed and transparency, the marketplace will have to delve into new areas to find value. Analysis, not knowledge, will be key.

Poulin: In theory I agree that if everybody knows everything and knowledge is instantaneous, then many things would be commoditized. In practice, however, as an industry we are a long way off from reaching the limits you mention.

And I'd contend we will never get there because the boundaries as we define them today will be measured differently in the future. For instance, our industry claims very high straight-through-processing rates. Ten, 20, 30 years from now, it will still be very high, but the bar will be much higher; we will look back at 2007 and realize we were actually closer to 0% STP.

Dence: Companies have limited resources to push these boundaries.

Poulin: Right, successful firms will push these boundaries more successfully than others. I would say analysis and knowledge will be key.

Dence: Understanding and managing your risk will also become increasingly important. Value will be created either by assuming and managing risk or mitigating it for clients.

Poulin: What's interesting is that there will be more opportunities than ever to create value or alpha throughout the entire supply chain.

Dence: Another important finding in our research is that the separation of alpha and beta will become complete. In essence, investors, both retail and institutional, will be less willing to pay alpha fees for beta returns, and the way that funds are priced and managed will have to change. The emergence of ETFs is a good example of paying less for beta returns.

Poulin: Yes, we already are seeing our clients focus on ways to generate more alpha. As we all know, operationally it is more challenging to deal with new securities typically associated with alpha management like derivatives.

Dence: Have you heard the new one? Weather futures.

Poulin: Betting on the weather. I've heard, but don't believe our clients have any of these yet. Give it time.

Dence: Another important development will be the increasing use and importance of alliances. By partnering, firms can address pressing internal challenges and improve their ability to respond to change. Successful firms will partner to service their clients as specialists, with some choosing to divest parts of their firms as part of a capability swap.

Poulin: Another concept that we believe will be even more important is innovating in an open architecture.

Dence: I certainly agree with that. Respondents in the study named many innovations that they expect will provide a competitive edge over the next 10 years. Risk measurement systems were cited as the number one technological innovation to help achieve strategic goals. Improving capabilities in client analytics, data distribution and client/adviser connectivity were among the most frequently mentioned. All are key to supporting client relationships.

Other improvements, such as multi-asset class platforms, services-oriented architecture and disaster recovery systems were also frequently mentioned.

Poulin: Most people's energy is on what you are innovating; I think how you innovate will become increasingly important. A recent IBM study found that firms are starting to realize that some of their best ideas and innovation come from outside their company.

Let's wrap up. In summary, what is a fundamental change we will see in our industry 10 years from now?

Dence: Driven by transparency and speed, the industry will make money in two ways: assuming risk or mitigating risk on behalf of others. Excess agency profits will evaporate, the separation of alpha and beta will become complete, and the creation of successful alliances will become critical. And you?

Poulin: The opportunities to succeed or fail will exponentially increase throughout the supply chain. The winners will be those firms and individuals who are nimble and add intellect to information, using it to create measurable value for their clients.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.