The Dodd-Frank Act (DFA) represents the most significant change to financial regulation in the United States in living memory. While full DFA implementation has a way to go, and there remain important uncertainties to be clarified about how it will happen in practice, the industry has made strong progress towards compliance. It has established new market infrastructure and operational processes and has solved numerous complex legal and technical challenges.
While considerable progress has been made in defining and interpreting rules and becoming compliant, a number of major questions about the future shape of the industry remain. It isn’t completely clear what the industry’s future product structure will look like. There is ambiguity, for example, about the extent to which over-the-counter markets will adopt a futures-style model. There are also conflicting views about how the makeup of the industry will evolve, whether there will be further consolidation between organizations or a greater number of smaller, nimble specialists.
Perhaps the biggest unanswered question is: what will be the most successful strategy to compete and win in the new world?
While the answer to this question will only become apparent over the next few years, one thing is already becoming clear: if firms want to move beyond compliance and into optimization, bold thinking will be required in a number of areas. In particular, they should concentrate on being focused, agile and efficient.
Unreflective ‘me-too’ business models are unlikely to survive and thrive in a DFA-defined financial landscape, and it will be critical for most players to double-down on the businesses where they have genuine competitive advantage. They should also be ruthless about exiting those that are currently unsuccessful. ‘Everything everywhere’ will only be a viable strategy for very few, if any: disciplined market participation decisions will be of paramount importance.
Where there is not sufficient information to set a long term strategy, firms must be prepared to make pragmatic assumptions in order to keep their momentum. To mitigate the risk of this they should evaluate decisions from a perspective of preserving optionality, so as to be able to respond rapidly to market developments as they arise.
The combination of evolving market structures and increasing capital requirements and overheads mean that profitability in many markets will be lower for the foreseeable future. Operating successfully will therefore require effective cost management and integration between different business lines. In addition, as firms focus on a smaller number of markets, inherited cost structures will need to be addressed.
In this environment, one parallel that springs to mind is the old story about an unhelpful man giving directions – ‘I wouldn’t start from here’. Perhaps, to extend this parallel, it would be an instructive exercise for market participants to think about what a ‘zero-based design’ for their business would look like, and compare this to where they are now and where they are planning to go. In any case, to move beyond compliance and into optimization following DFA, bold thinking will be required.
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