This is the sixth in a 12-part series of “The Korea Times ― the Boston Consulting Group (BCG) Joint Project” designed to identify new realities in the post-crisis world and provide winning strategies for leading Korean firms in 11 key industries. In cooperation with BCG, The Korea Times will look into a wide variety of issues both in the global economy
and major industries. ― ED.

By Cho Jin-seo
Staff Reporter

Remember how bad the stock market was only a year ago?

On March 6, 2009, the Dow Jones index was at 6626.94. Now, it is back in the 10,000-11,000 range after rebounding 65 percent. The same story goes for the British FTSE 100 index, which has risen by 60 percent over the past 12 months.

In emerging markets, the rebound is even stronger. The MSCI Emerging Markets Index has almost doubled over the past year. Now it is only a quarter below its record-high of 2007.

Being back to normal, however, also means that there is little room for spectacular growth anymore as was seen last year. Instead, what the global capital market players are facing is the era of the ``New Normal'' with tougher regulations, severe competition and thinner margins.

In fact, the good days are gone, says the Boston Consulting Group (BCG). Its recent report on the investment banking and capital markets shows that last year's high performance at global investment banks was only possible because of ``exceptional market conditions,'' especially the large spread of fixed-income bond products.

The performance of big global investment banks began to decline in the last three months of 2009. ``The comeback will falter in 2010, as markets continue to normalize,'' the BCG report says. It forecasts that the global net revenue of investment banks will shrink by 11 percent this year, in a neutral market scenario.

The BCG Investment Banking Performance Index fell from 139 to 104, signaling that the strong recovery is not sustainable under normal market conditions. Bankers, say bye-bye to bonuses.

The investment, trading and financial advisory industry is bracing for a changing reality. The most popular term describing the shift in the industry is New Normal, since Mohamed El-Erian, CEO of U.S. based investment fund PIMCO, used it to refer to the new order in the financial industry after the crisis early last year.

BCG summarized this concept into three bullet points: slower market growth and thinner margin; increased regulation and government pressure; and a move from complex financial engineering to old-fashioned investment strategies based on fundamentals.

‘New Normal’

Firstly, financial firms have to face slow growth as their clients have become risk-averse and more fee-sensitive. The fourth-quarter data is especially ominous for brokerage firms ― equity trading revenues fell 29 percent despite an increase in trading volumes, which means clients are paying less commission than before. Fixed-income bond trading is also less profitable than last year as there was a sharp 49-percent decline over the same period.

The good news is that underwriting and the M&A sector are showing strong signs of growth while the trading sector is not. Underwriting and advisory revenue surged by 27 percent in the fourth quarter of 2009.

Last week, the Financial Times reported that U.K. insurer Prudential is paying $1 billion to underwrite its $20 billion rights issue, which means a commission rate of 5 percent. This is higher than the industry norm of 2 percent before 2008, meaning that client firms are ready to pay more for the service. (In Korea, however, this is not the case. The commission is much lower than 2 percent as explained below)

The second aspect of New Normal is the ``regulatory tsunami.'' In many nations, financial regulators are devising ways to prevent another crisis by imposing new regulations on banks and securities firms.

BCG predicted in its recent report that 32 large global banks will have to increase their combined core capital by as much as $650 billion in order to meet new capital ratios proposed by an international body of banking regulations.

This means that they will have less money to invest in equities and other assets. Similar schemes are being developed in many nations. One of the worst scenarios is the adoption of the Tobin Tax, which taxes cross-border financial transactions. This is a nightmare for global investors.

The third trend of New Normal is that the financial industry will have to go back to basics to some degree. A good example is the private equity (PE) industry. Until 2007, PE firms used cheap loans from banks to buy companies.

Then they profited by selling the companies at higher prices when the stock market was up. But after the financial crisis, such a leveraging strategy won't work, and firms will have to create value by improving operations.

``The time to bet on a financial lever is over,'' said a BCG report titled ``Time to Engage _ or Fade Away.'' The financial crisis has made investors more prudent when selecting agents who will look after their money, so the gap between winners and the losers in the industry will only widen, it concluded.

Losing trust in traditional profit models is also making investors turn their eyes to new types of assets. ``As investors look for new approaches to asset allocation, they are seeing that economic developments can create opportunities that fall outside traditional investment categories,'' said Bruce Britain of PIMCO, the U.S. hedge fund.

cjs@koreatimes.co.kr