April 27, 2009

Financial markets firms are predicting a whole new ballgame when it comes to doing business. According to findings of a study by the IBM Institute for Business Value, 70 percent of financial services executives surveyed are concerned that the government will "overshoot" and over-prioritize financial stability at the expense of innovation as the industry enters a new era of hyper-regulation.

IBM says many respondents recognize the need for more stringent regulation. The two main changes anticipated are greater transparency and higher capital requirements. However, one of the biggest difficulties in crafting any new regime is likely to be the conflict between politics and policy. The governments of the developed world have already spent more than $1 trillion to shore up the global financial system. With such a big stake in the game, politics could get in the way of creating rational policies for the market.

The survey of 2,754 industry participants included 1,076 individual investors and 1,678 executives and government officials. It incorporates views from a range of organizations, including buy side, sell side, processors and government/regulatory bodies. The study's goal was to determine how financial markets firms should prepare for the future. Respondents overwhelmingly agreed that as the industry restructures itself, firms would have to get used to lower returns—90 percent of participants.

At the same time, respondents said they will seek to further streamline redundancies and expect to aim for 20 percent in efficiency improvements. IBM says many firms already implemented the most obvious cost-cutting measures since the recession earlier in the decade. Therefore, they will need to focus on realizing economies of scale, tightly integrating their IT with their business strategies and eliminating a greater proportion of their non-core activities.

IBM's suggests seven elements for creating a robust financial architecture that also fosters healthy innovation:

1. A shared frame of reference among the market participants to build a common understanding of what is important. 2. Recognition that global collaboration is essential for the "whole" to become stronger. 3. A rational regulatory regime that balances the principles of the "efficient market hypothesis" with those of the "financial instability hypothesis." 4. Incentives that balance "returns to society" with "returns to shareholders." 5. Leaders who have the will, the commitment to the interests of their clients and fellow citizens, and a sense of shared stewardship to move beyond today's "herd mentality" and chart a different course. 6. Transparency, systemic intelligence and proactive management at every level to improve risk management, decision making and the ability to respond in an agile fashion. 7. Flexible mechanisms that facilitate innovation, as well as the orderly and transparent processing of distressed assets, the unwinding of government ownership, crisis resolution, consumer protection and insurance.

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