How is 2023 shaping up for market infrastructure groups? Our agenda outlines the priorities that will define their coming year.
1. Tailwinds have faded
Market sentiment on what drives value has shifted, with the pendulum swinging away from a singular focus on growth and the widening of the strategic footprint, and back towards driving higher profits and cashflows. A wave of high-profile, drastic cost-cutting measures have been undertaken by the leading technology outfits and banks – and market infrastructure groups will not be exempt from economising. That’s why it’s important that market infrastructure groups emphasise and deliver on sustainable performance improvements, mindful of their longer-term strategic growth agenda. This is not about over-reacting and shedding costs in a one-off frenzy, but about establishing a culture of continuous performance improvement – and sending a strong signal to the market. In those critical areas of the market that are highly regulated, however, market infrastructure groups will need to tread carefully, giving considered thought on where to cut, where to invest to increase resilience, and where to grow in the short as well as the long term.
2. What’s not listed does indeed exist
As capital formation migrates beyond the public-listing arena, market infrastructure groups need to reconsider their role in capital formation – or else they risk becoming irrelevant. Whilst the largest groups, often joined by their home market regulators, have started to rejuvenate corporate listing rules, we don’t think this is sufficient to answer the structural trend towards private capital. For the boldest market infrastructure groups, the strategy is not to play defence, but instead to go on the offensive, with the goal of creating a central infrastructure for the bilateral private-markets world, similar to what the industry achieved with over-the-counter trading following the global financial crisis.
3. Adapting to the platform economy
Given a wave of market structure regulation on the horizon, we are likely to see further pressure on cash equity trading and associated market data revenues at market infrastructure groups, given competition from alternative venues, consolidation across markets, new retail platforms, and brokerage models. Market infrastructure groups must continuously evolve and improve their core offering, such as with better data and analytics services for key clients, while re-thinking their footprint geographically and across the value chain and adapting their capabilities and commercial models to the reality of the platform economy.
4. Next turn of the crank in fixed income
Dealers’ fixed-income liquidity provision capabilities are evolving, with top banks and non-bank liquidity providers operating algo trading desks in the low millions ticket size, and more planning to launch these in 2023. Asset managers are developing better capabilities in fixed income trading, often using new offerings from Fixed Income Execution Management System vendors to stage orders and engage with the market. Direct dealer connectivity has gotten the attention of some in the industry, but for many it remains a distant prospect. This up-tiering of capability on both sides of the trade increases the potential volume addressable for electronic venues – and throws down the gauntlet to the market infrastructure community to develop (or buy) offerings catering to this more sophisticated client base.
5. The empire strikes back
Following the market crash in crypto, the implosion of digital asset native fintechs, and the loss of trust in surviving fintechs, regulated market infrastructure groups have an opportunity to regain market share by rolling out digital asset propositions under well-functioning risk frameworks – and capture burgeoning institutional prospects. Developing an institutional-grade infrastructure for digital assets (including crypto), plugs into central bank digital currency efforts – as well as continuing to evolve use cases around distributed ledger technology and smart contracts to chart a sustainable pathway for digital asset technology.
6. Aligning risk management to evolving markets
Big market swings in 2022 exposed the vulnerability of trading and clearing models. Given increased volatility and continued economic and political risks, exchange venues and clearinghouses need to ensure current risk management practices are up to navigating these dynamics. We are seeing market infrastructure groups assessing the opportunity to support market participants with solutions that can traverse this new environment. Enterprise risk management buildout at market infrastructure groups will continue across targeted themes, responding to three factors: (i) additional phase-in of regulatory requirements (such as DORA, MiFID III), (ii) specific areas of risk focus (IT/cyber, third-party risk management, model risk), and (iii) expanded scope of risks associated with more diversified business models (such as expanding coverage of non-financial risk management across data and analytics business lines).
7. Exit ESG indices 1.0; enter climate transition indices [Contributed by Huw van Steenis]
Underneath the current ESG backlash, a huge shift is taking place: from holistic ratings to the underlying components, and an intense focus on better climate analytics and indices. The race for decarbonisation indices remains wide open. Holistic ratings, which seek to balance a multitude of risks, have been found wanting. At the core of the issue lies the inherent difficulty of weighing multiple different factors against each other. There’s no objective way of balancing a company’s climate plan against its diversity practices and then against its system of governance. Moreover, the indices have been overweight in technology stocks and underweight in oil and gas, meaning they have underperformed in the past two years, and performed worse than exclusion indices. Poor performance and inherent incoherence over the factors being targeted, mean that ESG ETFs are likely to fail as a core allocation replacement. Indeed, ESG ETFs took in just $3billion in 2022 (0.5% of all ETF inflows) in the US, according to Bloomberg reporting. During first three weeks of 2023, there have already been $1 billion in outflows. Europe performed better - in part due to regulatory nudges. Weighing non-financial data is still critical, however, with the underlying inputs in strong demand. But energy security, energy transition, and climate transition commitments will require better climate analytics. MSCI saw an 80% increase in climate metrics to $80 million in 2022. I expect there to be huge interest in crafting indices and analytics to measure real world decarbonisation – what could be called “khaki finance”, the greening of the grey industries. So, while the ESG backlash may slow their development, the future is climate transition indices.
8. Finding a sweet spot in a crowded data and analytics space
Many market infrastructure groups have ventured into data and analytics, yet many are still to find their right place in this complex ecosystem that aligns with their franchise strengths and delivers continuous revenue growth. The key question for medium and small-sized groups especially is where to position themselves on the data, distribution, analytics, or data management layer and how to best deal with dynamics – (structural decline in terminal volumes, rise of alternative and unstructured data, client challenges with data management, white label analytics solutions).
9. Now begins the real work
Market infrastructure groups will need to prove they are more than financial buyers. There needs to be more explicit recognition of the hidden costs of operating large and diversified groups (such as the strain on management bandwidth, slowdown in decision-making, dilution of technical expertise from group leadership teams). These costs are hindering the performance at many large institutions – we expect a more critical eye is needed in the next wave of portfolio reviews. With the expected slowdown and valuation adjustments in private market activity, opportunities remain for mid-sized and smaller groups who are earlier on in their diversification journey.
10. Sky-high expectations
Leading exchange groups have announced partnerships for their transition to the cloud. Whilst expectations on potential benefits are high, results have yet to appear. If banking can serve as an example, then changing the infrastructure is the easy part – it’s rearchitecting technology and the business across low-latency trading and data that will prove the major lift for market infrastructure groups, cloud service providers and end clients. This transition will redraw the lines for market infrastructure groups versus service providers – bringing major benefits to ones who can support the ecosystem in the move to cloud, but also requiring significant investment for them and end clients.