The Global Financial Crisis
The 2008 financial crisis was the worst economic disaster since the Great Depression, leaving firms and economies in shambles.
The leading cause was the housing market bubble. People were borrowing more than they could afford to purchase bigger houses, which drove house prices through the roof.
While that was happening, banks were paving the way to their inevitable fall. More loans were being applied, causing banks to be overwhelmed and make moves based on impulse and speculation. As a result, many financial innovations were introduced, but it was moving way too fast and way ahead of regulations. Even the banks themselves were unable to keep up with the risks.
And that is when the bubble popped.
Financial institutions and banks alike did not have enough capital to combat the losses. And the global financial system wasn’t ready to absorb the shock. The aftermath rippled to all financial institutions across the globe.
New Regulations in the Regions
To prevent such an event from recurring, regulators and governments worldwide have tightened their measures on financial regulations with an emphasis on transparency and accountability.
Here are some regulations that have been implemented according to the region:
Europe – MiFID II
The MiFID II was implemented by the European Union (EU) in 2018 to regulate financial practices and improve protections for investors. The primary purpose of the framework is to standardize financial practices across the EU and regain the trust of investors, all through increased transparency.
The US – Department of Labour Fiduciary Rule
The US Securities and Exchange Commission is re-evaluating the Department of Labour Fiduciary Rule with the main aim of developing a uniform fiduciary standard. The newly updated Fiduciary Rule will ensure that high commissions do not influence advice provided to investors- following the initiative started by the UK Retail Distribution Review in 2012.
The Asia Pacific
Individual countries have implemented stringent regulations within the Asia Pacific region built on four pillars: board effectiveness, risk and compliance, financial integrity, and disclosure and transparency.
Compared to the US and Europe, such regulations opened up new opportunities for investors and firms in the Asia-Pacific region.
How do the Regulations Affect Financial Institutions?
These new regulations are putting pressure on financial institutions, especially in terms of cost and profit margins.
Disclosure of Costs and Fees
As part of increasing transparency, the regulations implemented require financial institutions to disclose all costs and fees. The MiFID II bans asset managers from paying retrocession– usually seen as non-transparent fees. Similarly, the US Fiduciary Rule requires firms to increase disclosures and voluntarily make statements more self-explanatory.
With such rules implemented, it has massive implications on customer acquisition capabilities. Under the new regulations, financial institutions will need to charge an explicit advisory fee and/or increase the brokerage fee to make up for the lost revenue from retrocessions. Thus, there is a higher chance of losing clients who are unwilling to pay such fees. However, this also means that it is easier for clients to pick and choose.
To counteract this problem, financial institutions need to adopt new cost-efficient advice models, such as Robo-advisor, so affluent clients can still obtain the same guidance even if the fees structure changes.
The disclosure of costs and fees bears another problem — higher prices for firms. There has been a rising cost-to-income ratio across the industry as financial institutions incur more costs than before. But where do all these costs come from?
Well, after the implementation of regulations, operating and compliance costs have skyrocketed. Mainly due to the competitive pressure from peers.
Additionally, investors are demanding more. More customization, complex products, and different reports add to the cost in servicing assets. Based on a study of firms in North America, Europe, and Asia-Pacific, the average cost of managing each dollar of AUM has increased by 4% since 2014. The cost of salaries also rose by 5%, and non-compensation costs (regulatory expenses, technology, and office space) now account for ⅓ of a firm’s budget compared to just 26% in 2014.
Ultimately, this will impact the revenue margin, and it did. It has been decreasing since 2014 and is continuing on a downward trend.
The stringent regulations have played their part in slowing the growth of the financial industry. Now coupled with the Covid-19 pandemic, the change does not seem so rosy anymore.
Unfortunately, in 2020, Covid-19 sent the world into a downward spiral, the financial industry. PwC forecasted AUM to grow from US$84.9 trillion in 2016 to US$145 trillion by 2025– a growth rate of approximately 6%. Hence, forcing a downward revision of the earlier predictions to be within the 1% – 3% range.
What Can Firms Do?
It is hard enough to thrive in a competitive environment, and now with even more uncertainty, the tough just got tougher. However, this is no time to lose hope. According to McKinsey, firms can overcome the pandemic and the ever-changing environment through three horizons.
Horizon 1 – Short Term
Business continuity is the priority.
- Taking clear and well-communicated steps to protect the health and well-being of all stakeholders
- Educate investors on holding on through these volatile times
- Be transparent with clients through frequent communications, as this will strengthen the relationship between firms and clients.
- And more importantly, ensure that the firm’s infrastructure can offer omnichannel communications- consistent and on-brand communications across multiple customer touchpoints (variety of offline and online channels)
Horizon 2 – Medium Term
The market is slowly stabilizing so:
- Focus on upgrading digital and analytics infrastructure across the value chain
- Upskill employees to ensure they are prepared for the increasing reliance on digital engagement platforms
- Develop new approaches to meet client’s needs, such as through digital advisory platforms
Horizon 3 – Long Term
Both incumbents and newcomers must reinvent the wealth management scene through:
- Striking a balance between physical and online channels
- Shifting from a product-centric approach to client-centric advisory methods
No matter the horizon or the cause of the volatility, firms need to remain agile and transparent. Financial institutions that navigate through the turbulence will emerge above others- transformed and well-positioned for the new challenges ahead.
It has only become more evident the importance of digital platforms as part of a firm’s offerings. Let us help you make that move towards digitalization.
At Bambu, we specialize in developing Robo-advisory solutions for the financial services industry, from smaller RIAs and wealth advisors to some of the largest banks in the world. We help our clients work through the above vital considerations to implement solutions that genuinely benefit their wealth management business.
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