By Ken Schoff, Principle Partner-Sustainability; Rashmi Rao, Senior Industry Consultant-Financial Markets; and Raja Basu, Business Architect-Financial Markets, IBM
The ever-changing financial-market landscape, the intricacies of novel products, the lack of historical data, the geographical challenges and the cybercrime menace all pose significant challenges for major investment banks, along with smaller banks. Although the risks associated with financial markets are well established, embracing innovative methods, models and technologies could empower the banking industry to meet the surging demands of this evolving landscape. Furthermore, optimized operations and user-friendly technologies could effectively address the escalating requirements of regulatory authorities, ensuring meticulous compliance. A firm’s transparency and efficiency are paramount for investors and profitability. This article delves into how the latest technologies can efficiently manage capital-market operations.
Characterized by artificial intelligence (AI), big data and automation, Industry 4.0 marks a revolutionary shift in the industrial sector. In the context of capital-market operations, its impacts are transformative, leading to automated trading, data-driven decision-making, more effective risk management with real-time analytics and personalized investment strategies to enhance customer satisfaction. Nevertheless, it demands robust cybersecurity measures and regulatory adjustments to address the challenges posed by these innovations.
Industry 4.0 refers to the Fourth Industrial Revolution, primarily in manufacturing and supply-chain technologies and applications. Many Industry 4.0 concepts and technologies can also be applied to financial applications. As financial products and markets become increasingly complex, the need to simplify operations and adopt Industry 4.0 technologies becomes imperative. While managing a small bank might be straightforward, scaling up the business and integrating cutting-edge technologies could lead to significant implementation costs. Therefore, any new change must undergo thorough analysis and decision-making, focusing on Industry 4.0 solutions that offer integrated platforms to manage multiple asset classes efficiently, enhance data-driven decision-making and empower staff with proper training to maximize the potential of these advanced technologies and troubleshoot unexpected events. Embracing Industry 4.0 principles can enable financial institutions to stay competitive in an evolving landscape and cater to the rising demands of investors and market participants.
Some of the technologies supporting Industry 4.0 principles are listed below. They may all be employed to ensure improved automation and straight-through processing for financial applications.
Secure and reliable data exchange
In today’s world, it’s all about data. The volumes of data used in applications of every kind continue to grow at an accelerating rate. Data must be delivered promptly, unaltered and secured from unauthorized access. Data is delivered in files and via message queues for supply-chain and financial applications. Files are well suited for large transfers that can be processed asynchronously. In banking applications, a single file containing millions of payment transactions may be exchanged for payment processing. Files can be exchanged via various transfer protocols. Value-added networks (VANs) are commonly used to connect thousands of supply-chain suppliers. For financial applications, the SWIFT (Society for Worldwide Interbank Financial Telecommunication) network is the primary equivalent to the EDI (electronic data interchange) VANs used for supply chains.
Messaging works well for synchronous exchanges. Recently, APIs (application programming interfaces) have been introduced for synchronous transfers, especially for supply-chain applications. Messages and APIs are appropriate for smaller data quantities.
Industry 3.0 required data to be structured for the specific application. Industry 4.0 drops this requirement and utilizes large quantities of unstructured data. Structured data may be stored in a data warehouse for high-performance, high-volume processing. A data lake may be used to store structured and unstructured data for applications that combine analyses of all the available data and do not require the performance levels typical of transaction-processing systems. More recently, we added the concept of the data lakehouse, which adds functionality to prevent a data lake from becoming a data swamp.
Artificial intelligence introduces the ability to process large quantities of data from a data lake or lakehouse. It allows interactions with systems in natural human languages, including speech recognition. AI can identify patterns and create linkages between various data sources, providing new insights into financial markets and processes that may be used for risk management and, potentially, automated trades. AI is often used to recognize potential disruptions in supply chains and can be employed to accomplish the equivalent in financial applications. For example, AI might predict potential failed trades, enabling trade participants to intervene and prevent failures.
Industry 4.0 utilizes IoT (internet of things) technology to connect and monitor the sensors and machines used in manufacturing processes. Software applications can also be instrumented in a conceptually similar manner. Technologies such as Kubernetes can monitor discrete software processes while automatically replacing failed processes and scaling processing to address changes in demand. AI can track critical data and respond to events outside the norm, enabling automated and human interventions to address problems. For example, if the price of a certain type of security starts either rising or falling very rapidly, many market participants will want to be notified.
Let’s delve into the intricacies of the trade-lifecycle functions for investment-banking operations, which banks frequently opt to outsource.
The trade lifecycle encompasses the series of events and processes involved when a trade is executed. It begins with the trade decision and execution and then continues until the final settlement, with close monitoring of various key factors. Efficient trade management is crucial for investment banks, as they handle numerous transactions daily, and any discrepancies in trade economics could result in significant financial losses. Therefore, establishing a robust network and effective communications between the front, middle and back offices is vital to ensuring smooth operations and catering to larger client requirements, thus promoting business-expansion opportunities.
Trade initiation, execution and capture
Within the realm of Industry 4.0, investment banks assume the responsibility of executing trades on behalf of their clients. Armed with advanced technologies and automation, traders undertake essential tasks, such as verifying cash and currency balances, evaluating position sizes and prices, and strategizing hedging techniques. Additionally, they assess the probabilities of profit and consider margin requirements, leveraging data-driven insights for well-informed decision-making.
The data must be captured once a trade is executed, incorporating cutting-edge technologies. This includes recording and documenting trade economics and enabling seamless investigations, analyses and reconciliations. It is imperative that the data, platform and/or application utilized by traders be efficiently replicated downstream to other pertinent teams, including the middle and back offices and risk and legal teams. Therefore, trade capture is central to subsequent steps, encompassing validation, confirmation, settlement and reconciliation.
Trade validation and enrichment
Trade enrichment enhances captured trade data by integrating supplementary information, ensuring smooth transactional processes throughout a trade’s lifecycle. Driven by advancements in Industry 4.0, investment banks leverage cutting-edge systems and technologies to streamline trade-enrichment processes. This proactive approach not only helps minimize errors but also provides valuable information, such as cash-flow projections, predictive analyses and other reliable information that will help banks make informed decisions.
Following trade-data capture, it is a regulatory requirement that the data be confirmed by all parties in the trade, primarily buyers and sellers. Investment banks can automate confirmation procedures as part of their risk management and compliance efforts by leveraging technology. This will save effort, time and cost, which can be used to investigate disputes or make adjustments.
With the integration of Industry 4.0 applications, the settlement process ensures the seamless fulfilments of all contractual obligations and equitable distributions of entitlements to all parties involved in a trade. Once the trade details and economics are finalized, the settlement process commences, benefitting from advanced technologies for efficient execution. The durations of settlement cycles vary depending on the types of instruments and exchanges involved, with Industry 4.0 facilitating faster and more streamlined settlement procedures.
Within settlements, multiple steps may exist, including matching and affirmation, instructions to custodians and clearing houses, security delivery, cash payments, payments versus deliveries reconciliation netting and final confirmations. In all the above processes, several data exchanges occur between different parties, during which automation can enhance efficiency. Bank professionals could devote their time and skills to value-adding services rather than spending them on multiple data reconciliations.
Reconciliations encompass a broad range of activities for investment banks, involving various reconciliation processes. Most reconciliations could become nonexistent with the efficient use of technology.
A few possible reconciliation use cases:
Price and position reconciliations: matching the trade prices and quantities between buyers and sellers. Some differences could be due to corporate actions, which can be investigated further.
Market-value reconciliation: Sometimes, several banks use different sources of reference data to arrive at the calculated market value of an instrument, which can lead to big differences on the books. This must be reconciled to avoid any issues with future payments or settlements. If needed, the calculations must be discussed and agreed upon.
Internal-system reconciliation: Within the organization, there could be several internal systems through which data is fed for further statistical or market analysis. Intercompany systems and legal entities are reconciled regularly to ensure all books are clean and data is not missing from any source. This also serves as a point of reference for auditors. The important point here is to have a simplified technology infrastructure.
Numerous other reconciliations may arise from various factors, including the trade’s country of origin, regulatory mandates, audit-specific requirements and internal versus external data reconciliations to ensure accuracy and completeness. This underscores the importance of investment banks maintaining robust technology infrastructures to prevent errors and avoid unnecessary rework.
In conclusion, the complexities of novel products, historical-data limitations, geographical challenges and cyberthreats present substantial challenges for major investment banks. However, embracing innovative methods, models and technologies can empower the banking industry to meet the evolving landscape’s surging demands. Integrating Industry 4.0 technologies, characterized by AI, big data and automation, holds transformative potential for capital-market operations, enabling automated trading, data-driven decision-making and personalized investment strategies to enhance customer satisfaction. Despite these opportunities, robust cybersecurity measures and regulatory adjustments are imperative to overcome the challenges posed by these innovations. Overall, Industry 4.0 principles offer a promising path for financial institutions to stay competitive, cater to investors’ rising demands and navigate the complexities of an ever-evolving landscape.