A Digital Wall Street Revolution: How FinTech is Transforming Morgan Stanley Post-Crisis
The investment banking model is all but broken. Only technology will save the day.
In today’s post-crisis era, investment banks like Morgan Stanley have struggled to meet return on equity targets. In 2015, these institutions barely managed an average ROE of 6.7%, compared with 25%+ pre-crisis returns and 10% cost of capital [1], due to an intensified regulatory landscape that has limited risk-taking and return of shareholder capital. While we can argue whether the system is truly safer today [2], market realities together with intense pressure from shareholders to hit 10% have forced MS to act. Along with peers, it has slashed headcount [3] [4] [5], divested capital-intensive businesses [6], embarked on ambitious cost-cutting initiatives [7], and fought for Federal Reserve approval to return more capital to shareholders [8] [9].
While things are looking up after last week’s election results (MS stock has risen ~20%), deregulation is not something MS’s leadership team is, or should be, embedding into its long-term plan to meet and exceed its cost of capital. Rather, technology holds the key to sustainable 10%+ ROEs in numerous ways, and MS is aggressively pursuing this strategy.
Wealth Management
As MS’s business has shifted towards Wealth Management (WM), the Firm is delivering digital resources to its 16,000 financial advisors and 3.5 million clients to further improve these personal relationships with technology and bolster an already strong ROE in WM.
Leading the charge is Naureen Hassan, hired away from Charles Schwab earlier this year to serve as Chief Digital Officer [10], a role in which she is coordinating a three-pronged digital strategy. First, the Firm is integrating robo-advice with human advice in a hybrid approach, thus freeing up advisors’ time to build deep and trusted client relationships, a key competitive advantage (along with the ability to scale) in a landscape littered with robo-advisor start-ups like Betterment and WealthFront. Secondly, it is actively building out data and analytics capabilities that will eventually increase advisor and client confidence in product recommendations and investment ideas that were once exercises in informed guessing about how to capture alpha. Finally, MS is developing innovative channels, like mobile apps, for clients to interact with the Firm and access information [11].
Institutional Securities (Investment Banking and Trading)
The true ROE anvil has involved the traditional institutional securities businesses, particularly fixed income and commodities, as a result of difficult market conditions and heightened capital intensity driven by regulation. The opportunities for technology in Institutional Securities have more to do with removal of costs and headcount than with enhancing top-line revenue growth and core competencies as seen in Wealth Management.
One such technology is blockchain, a distributed ledger infrastructure that originated with bitcoin. In traditional securities trading, a central clearinghouse typically collects a fee per transaction and takes 3 – 4 days to settle a trade, forcing banks to hold capital on their balance sheet for that much longer [12]. Alternatively, blockchain can settle trades within seconds (allowing capital to be deployed almost immediately to other revenue-generating opportunities), eliminate the middleman, and significantly reduce costly margin of error. According to a paper published by Santander, Oliver Wyman and other experts, blockchain could save banks a collective $15 – 20 billion by 2022 [13].
Other technology-focused efforts have involved a consortium-based approach as banks seek to reduce costs through collaboration. MS, together with rivals JP Morgan and Goldman Sachs, is building an entity called SPReD (Securities Product Reference Data), a tool intended to cleanse, consolidate, and store reference data at a significantly lower cost than what each bank would spend on their own. A larger group, including the three aforementioned, is building Symphony Communications, a secure messaging system intended to disrupt the monopoly of the ubiquitous and expensive (~$20k per unit per year) Bloomberg terminal [14].
Finally, machine learning and artificial intelligence are making headway into the space with the promise of reducing not just back office headcount but also the need for professionals across investment banking, research, sales, and trading. This is best exemplified by Kensho, otherwise known as the Siri of Wall Street, a dynamic analytics system that “aims to reduce human decision-making…by instantaneously analyzing slews of data that move markets…” [15].
What’s Next?
For an investment bank, MS has surprised to the upside, rapidly embracing the opportunities presented by technology to cut costs / headcount and boost revenues across its business model. The Firm should continue to make headway via strategic investments in fintech startups and consortium-style ventures with its peers. The competition is fierce, but Morgan Stanley is proving to be more nimble and collaborative than expected and on track to hit 10%.
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Sources:
[1] Financial Times. “Investment banks’ return on equity declines.” https://www.ft.com/content/0c65e85a-d719-11e5-8887-98e7feb46f27
[2] Brookings Institution. “Have big banks gotten safer?” Lawrence Summers and Natasha Sarin. https://www.brookings.edu/wp-content/uploads/2016/09/2_sarinsummers.pdf
[3] Wall Street Journal. “Morgan Stanley Lowers Ambitions.” http://www.wsj.com/articles/SB10001424127887324682204578513583116318610
[4] Financial Times. “Morgan Stanley axes 1,200 jobs.” https://www.ft.com/content/26e503f8-9dcd-11e5-b45d-4812f209f861
[5] Bloomberg. “Morgan Stanley Shrinks its Workforce Most in Three Years.” http://www.bloomberg.com/news/articles/2016-04-18/morgan-stanley-shrinks-its-workforce-most-in-three-years-chart
[6] Wall Street Journal. “Morgan Stanley to Sell Oil Arm to Castleton.” http://www.wsj.com/articles/morgan-stanley-to-sell-oil-arm-to-castleton-1431379581
[7] Wall Street Journal. “Morgan Stanley Details $1 Billion Cost-Cutting Plan.” http://www.wsj.com/articles/morgan-stanley-details-1-billion-cost-cutting-plan-1465922849
[8]Wall Street Journal. “Fed Approves Morgan Stanley’s Capital Plan with Conditions.” http://www.wsj.com/articles/fed-approvesmorgan-stanleys-capital-plan-with-conditions-1467232234
[9]Wall Street Journal. “Radical Changes Are On The Way For Investment Banks.” http://www.wsj.com/articles/radical-changes-are-on-the-way-for-investment-banks-1464904490
[10] ThinkAdvisor. “Naureen Hassan — Digital Diva.” http://www.thinkadvisor.com/2016/05/09/naureen-hassan-digital-diva-the-2016-ia-25
[11] Business Insider. “Morgan Stanley’s Digital Strategy Relies Heavily on Robo-Advising.” http://www.businessinsider.com/morgan-stanleys-digital-strategy-relies-heavily-on-robo-advising-2016-7
[12] Wall Street Journal. “What Is Blockchain?” http://blogs.wsj.com/cio/2016/02/02/cio-explainer-what-is-blockchain/
[13] “The FinTech 2.0 Paper: Rebooting Financial Services.” Joint research paper by Santander, Oliver Wyman, InnoVentures, Anthemis Group. https://www.finextra.com/finextra-downloads/newsdocs/the%20fintech%202%200%20paper.pdf
[14] Wall Street Journal. “JP Morgan, Goldman Sachs, Morgan Stanley to Form Data Company.” http://www.wsj.com/articles/j-p-morgan-goldman-sachs-morgan-stanley-to-form-data-company-1440005471
[15] Bloomberg. “How Goldman Sachs Became a Tech Investing Powerhouse.” http://www.bloomberg.com/news/features/2015-07-28/how-goldman-sachs-became-a-tech-investing-powerhouse
Great article! I do, however, think that deregulation needs to be taken into account, as many FinTech startups are pushing the envelope of traditional regulation and demonstrate the advantages of new and innovative approaches.
Interesting post.
As a former banker, the tagline, “the investment banking model is all but broken” certainly caught my attention. However, after reading your post, it seems your criticism focuses more on trading efforts rather than traditional advisory banking (which appears to be flourishing given the record years for deal-making, albeit perhaps the bigger banks are losing share to smaller boutiques).
https://blogs.thomsonreuters.com/answerson/record-year-deal-making/
In terms of your proposal of investing in digital for trading to reduce costs, are you focusing on a tree rather than the forest? If trading really is the “ROE anvil,” would MS be better simply exiting the business altogether? Or, have these last few years simply been challenging and therefore trading remains a structurally attractive business with need of minor improvement?
I really enjoyed reading this article. From Robo advisors to crypto currencies to online lending, emerging technology is truly disrupting the way banks create the value. I fully support the pathos of the article that the only way forward is to embrace and aggressively invest in emerging tech.
I didn’t realize MS was pursuing digitization so strongly. Two questions I though of: (1) What edge does MS have in this space? and (2) How does MS’ investment in cyber security factor into its overall plan? Thanks for sharing!