The global economy is undergoing a profound shift driven by technology, which is harnessing advances in medical science, biochemistry and machine learning to reshape the boundaries of human endeavour.
The artificial intelligence revolution could prove to be the most fundamental development since the original rise of homo sapiens, according to Nick Bostrom, a professor at Oxford University.
The pace and complexity of change makes the future hard to predict, but some of the changes have already arrived and are reshaping industries and consumer behaviour. The financial services industry stands at the cutting edge of technological change.
The advent of blockchain and cryptocurrencies such as bitcoin have created a financial market worth $1trn, while fintech is revolutionising the payments industry and disintermediating banks, which are moving away from traditional bricks-and-mortar branches to becoming increasingly digital platforms. Financial services firms are committed to massive IT investments in a race to upgrade ageing infrastructure and keep pace with more innovative, nimble start-ups.
Data lies at the heart of the technological revolution—how firms collect, understand, protect and process it will define future winners.
“Nimble companies from unrelated industry with deep behavioural insights gained through big data are increasingly competing in financial services,” says Mazars’ Michael Tripp.
Regulatory change is forcing boards to invest in state-of-the-art technology to ensure compliance, and while this constitutes a considerable investment, it will bring benefits in enabling boards to gain greater group-wide oversight.
For example, many insurance companies made great strides in improving the automation of its actuarial systems, but the introduction of IFRS 17 will require them to take this to the next level. This will lead to an improvement in governance standards because it will help compliance, reduce costs and manual errors and make it easier for management teams and boards to access and share risk insight.
Consumer protection and cybercrime
Alongside a big data “arms race” is the importance of consumer protection and its corollary, cybercrime. By the very nature of their business, financial services firms possess and process vast quantities of highly confidential and sensitive information, whether for pension funds, corporations, wealthy individuals or high-street customers.
Any breach or compromise of this information, whether intentionally by cyber-criminals, by rogue traders within an organisation, or simply by human error, can trigger huge financial losses and destroy reputations.
This presents additional challenges for boards to understand the profound changes reshaping the industry. The most pressing of these is cyber-risk and how it is handled by financial services firms. In 2014 JP Morgan fell victim to the biggest data breach in banking history, with 74 million bank accounts hacked. The bank devoted an entire subsection to its cyber-strategy and apportioned $250m to digital security. That amount could grow to half a billion dollars by 2020 based on new projections.
In 2017, banks and other financial institutions spent three times the sum that non-financial organisations devote to cybersecurity, according to a report by Kaspersky Lab. In his 2017 letter to shareholders, Jamie Dimon, JP Morgan’s CEO, called for better cyber-laws in banking to bring them in line with other industries such as aviation and shipping.
“We must also be far more aggressive in protecting ourselves from cybersecurity risks, both within the banking system and across the financial system…” he wrote.
Banks have introduced dedicated units aimed at combating financial crime and tackling cyber-risk. These have sprung up in response to regulatory censure but have become the norm at big banks, which employ regulatory and crime specialists to lead them.
As an indication of the scale of these operations, HSBC’s Financial Crime Threat Mitigation unit employs 3,000 people globally. The sheer scale of this means it is essential for boards to apply “big picture” principles to cybersecurity, requiring a broad view of risk management and implementing a culture that is collaborative, security-conscious and aware of the financial and reputational consequences of data breaches.
Boards must prevent “silos” developing between businesses, where specialist knowledge is retained by a small number of technologically savvy individuals and they must understand the complexity of the products that they manufacture.
They must also be sufficiently balanced with non-executives who understand the technology that their departments are using, especially in investment banking, where complex algorithms are deployed to trade securities. In 2010, the so-called “Flash Crash” wiped $1trn from the value of the US stock market in 36 minutes when a group of algorithmic trading programs triggered a mass sell-off.
Structure and expertise
Effective cybersecurity begins at the top of the organisation. Firms need a structure that highlights business issues relating to cybersecurity, while providing the expertise to deal with threats.
Strong leadership is essential and those firms that have put systems in place to ensure immediate reporting of security incidents to the CEO will appear more robust. Boards should set the tone from the top by ensuring the firm has a company handbook which outlines security requirements to all employees, including the sanctions that could arise from a failure to comply.
Some banks have already adopted new technologies such as biometric identification at automated teller machines, to prevent cyber-attacks. When it comes to data security, organisations must ensure that regulations such as GDPR are adhered to, with minimum disruption to customers. The chief information security officer should report directly to a senior executive and should have a direct line to the CEO, or chair, in the event of a serious security breach.
“As technology plays an ever-more embedded role in financial services, cyber-risks will intensify, and boards and management teams must find ways of monitoring and combating it,” says Tripp.
But boards cannot just view technology through a prism of compliance. If they limit themselves in this way, they will lose the race to innovate.
“Boards should think about the talent they have in the boardroom, and whether they should appoint futurologists to help with big-picture thinking,” adds Tripp.
The challenge for the boards of financial services firms is to stay ahead of technological change at a time when small fintech companies are proving more agile at innovation. With such fast-paced innovation, it is becoming increasingly difficult to future-proof by picking the winning technology solution.
According to Winning Under Pressure, the annual survey of the global financial services industry by Morgan Stanley and Oliver Wyman, the asset management sector faces disruption on an unprecedented scale that could result in its “Uberisation”.
The report says: “In an extreme case, we could see the emergence of an Amazon-like marketplace—distribution largely disintermediated (i.e. directly provided to end-investors) and unbundled from advice. This is the exact opposite of how most markets are structured today, where advice remains bundled and intermediated, for example via bank distributors, independent financial advisers or investment consultants.
“Such an outcome would lead to significantly more price transparency and a magnetic pull to a Vanguard-like pricing for active management. We estimate this could eliminate up to 50% of industry revenues.”
Technology is an opportunity and a threat to asset managers, who see great potential in automation as a way to substantially reduce costs.
“The biggest potential cost lever is automation and better use of data and analytics,” says the report, which was compiled following extensive interviews with the CEOs of global asset management companies. “Firms typically spend 10-20% of their cost base on data management and are now thinking hard about how to increase the impact of their spend.”
But while automation and greater outsourcing can help firms reduce headcount, the reports estimates that up to 40% of the workforce will require fundamental retraining and places responsibility for managing this transition at the door of senior management and the board.
The report continues: “The depth and speed of change required far exceeds the traditional change management process handled by HR departments. We believe that the workforce of the future is a CEO topic, requiring strong top-down guidance and a clear understanding of how the organisational set-up and glue will have to change. However, we view this as a 5–7-year journey requiring many boards to also adjust incentives for the C-suite.”
When it comes to the day-to-day operations of senior management teams and boards, there are clear benefits to be gained from technological innovation. Real-time data is available on a far more granular level than previously, improving management intelligence, and that can feed into improved reporting.
Tripp concludes: “Financial services firms are in the risk business, and they must constantly strike a balance between prudence and entrepreneurialism.”
This article is an excerpt from the Special Report – Future-Proofing Financial Services . You can read the full report here