ankers have the unfortunate habit of thinking of themselves as the best and thebrightest — products of unemotionalmeritocracy — creative, entrepreneurial, cal-culated risk-takers. After all, wasn’t ShermanMcCoy (Tom Wolfe’s apocryphal bond sales-man) a certified master of the universe?Although his world came crashing downaround him for reasons not directly related tohis job performance, his real world peers arenonetheless fortunate that their jobs requiresomething far short of perfection in execution.In a recent speech, Jack Welch, the formerchairman of General Electric, made exactly thispoint: “...[if] you put six sigma in an invest-ment bank, they would all gag!” In case youthink he was just engaging in some gratuitousbanker bashing, consider this: six sigma quality means having fewer than 3.4 defects or errorsper million operations in a service process.That is 99.99966% perfection.Contrast this benchmark with the assuranceonce made to me — by a senior syndicate man-ager of one of the largest and most respectedglobal bond underwriters — that it was perfect-ly normal and necessary to expect and reservefor 5%-10% errors in the allocation of a jumbomulti-tranche bond deal! Assuming an averageof 200 individual orders (including splits) on atypical new issue, to reach six sigma quality lev-els you would need to have fewer than fourerrors over 5000 issues!Some banks are lucky if they have lessthan four errors per deal. Even if you changethe assumptions, it is obvious that ourindustry is embarrassingly tolerant of poorprocess execution.So why do customers and clients acceptthis level of service? Firstly, the direct costsare largely borne by the banks themselves,and secondly, it is very difficult for a cus-tomer to objectively and quantitatively mea-sure the quality of service. (Compare theproblem of an investor or issuer in identify-ing variation from best/perfect execution ona new capital markets issue to that of a com-puter manufacturer, for instance, who is sup-plied with a shipment of 100,000 micro-processors of which x are defective.)Assuming that the banks cannot and do notindirectly pass on these costs, why have they not made more significant progress inaddressing this problem?
A plea for perfectionism
My guess? In one word, hubris
fixingthis is all about the details. It requirespainstaking attention to process, to thebanal minutia of the obvious and anunswerving dedication to perfection
qualities more often found in engineersthan masters of the universe. Fixing theseshortcomings is just not seen as exciting orimportant to teams of bankers feverishly searching for the next million dollar tradeor idea. However, intuition tells us thateven if the costs are difficult to measure andare absorbed by the banks, they are no lessreal for this, and ultimately result in one orall of the following: higher capital costs forissuers, lower investment returns for inves-tors, and lower operating profits for banks.And therein lies the next major opportu-nity for capital markets bankers over thenext decade: to use technology not only asan enabler of innovation (as has been thecase over the past 15 years) but as a driverof industrial efficiencies.
Mapping out a paradigm shift
So what exactly does an industrial revolutionin investment banking (or more accurately defined, capital markets) mean? Why is thisrelevant now? What are the advantages forissuers, investors and banks? What are thecosts? Who will be the winners (and losers)?Is technology and/or the internet an enablerof the revolution? And if so why?The industrial revolution in investmentbanking is all about creating a new paradigmfor the execution of capital markets business.It is about reinventing the organisationalmindset, replacing the traditional front, mid-dle and back office with a highly flexible andefficient product factory attached to a profes-sional cadre of relationship managers andsolution providers who work with customersand clients to tailor products and solutions tobe produced and executed by the factory. It isabout viewing the services we provide as twodistinct value propositions, one resting onthe creativity and knowledge base of the bankand its bankers, and the other resting on theefficiency and accuracy of production andexecution.Two factors are driving the inevitability of the paradigm shift: market size and cost-effective technological solutions. Theincredible growth and globalisation enjoyedby capital markets over the last 15 years hasgiven us a market where economies of scalestart to become extremely compelling:rather than dealing with tens of issues, hun-dreds of tickets, and tens or hundreds of millions of trading and underwriting, thetypical medium to large sized investmentbank now deals with numbers that are a fac-tor of ten or more higher than these. Theupfront and fixed costs of building the(highly scaleable) factory are now justifiedby the volumes of throughput.Hand in hand with this growth in vol-umes, the market has seen increasing stan-dardisation including, but not restricted tothe introduction of the euro, debt issuanceprogrammes, benchmarking and so on andso forth. As a result, for even the mostbespoke products and client solutions,upwards of 80% (often more than 95%) of the process can be stripped away and com-pletely engineered to very high tolerances.At the same time as the scale and homo-geneity of the market opportunity haveincreased, the (technological) inputs need-ed to build the factory have become moreand more useful, flexible and inexpensive,reducing not only the costs of building thefactory in the first place, but vastly improv-ing time to initial delivery and limitingfuture maintenance and capex require-ments. The coming together of software,novel programming techniques, processingpower and communications infrastructurewitnessed by the birth of the internet (orany other private network for that matter)is and will continue to be the technologicalcatalyst for an industrial revolution in capi-tal markets.One of the reasons why banks have been
An industrial revolution: newcapital markets paradigm
Sean Park,global head of debt syndicate,Dresdner Kleinwort Wasserstein
Celebration of Excellence:
Our industry isembarrassingly tolerantof poor processexecution